30/09/2010

A recent High Court decision has considered whether a professional business can claim depreciation on the copyright in their client records.  The decision, and the ATO’s Decision Impact Statement, may well have application to buyers of financial planning practices.

Primary Health Care Limited (PHC) is a publicly listed company which operates medical centres.  Its business strategy included purchasing existing medical and dental practices and then signing up a practitioner (often the seller of the practice) to work in the medical centre as a contractor.

All of the practice purchase agreements provided for the purchase to include the goodwill of the practice.

For the purposes of this article we will ignore PHC’s specific legal structuring and focus on the real issues. PHC sought to claim depreciation on the intellectual property rights it purchased, namely copyright in the patient records that it acquired when it bought a practice.  Clearly if the deduction for depreciation were allowed PHC’s net income would have been reduced.

The relevant legislative provisions are the Income Tax (Transitional Provisions) Act 1997; former Division 10B of ITAA 1936: former Division 373 of ITAA 1997 and Division 40 of the ITAA 1997. These provisions allow a deduction for depreciation, or a capital allowance, for an interest in copyright that was used or available for use, in the course of carrying on a business for the purposes of producing assessable income.

PHC’s claim rested on two arguments.  Firstly PHC claimed that the goodwill of the practice included the assets of copyright in the patient records. The High Court had previously considered this issue in Commissioner of Taxation of the Commonwealth of Australia v Murry (1998) and had held that goodwill is an indivisible item of property that is legally distinct from its sources - including other assets of the business. The Commissioner's position following that decision is reflected in TR 1999/16.

Secondly PHC argued that the purchase price for the practice, although apportioned between goodwill and some minor physical asset, included an amount for the copyright in the patient records. Again, existing case law did not fully support this argument (see Murry v King (1984) and TD 2005/1).

The Court considered PHC’s arguments by reference to each of the sample practice purchase agreements, and looked at four points.

Firstly, did copyright subsist in the patient records? It held that there was no copyright existing in the majority of the patient records in evidence. However it pointed out that this did not imply that copyright can never subsist in medical or dental records.  The copyright issue could be the subject of an article all by itself.  Suffice to say that it is possible for copyright to exist in a financial planner’s client records, most particularly documents created by the planner and involving the planner’s expert input.

Secondly, did the buyer acquire ownership of any copyright or a licence to use any such copyright? Only one purchase contract expressly provided for the transfer of copyright, and in the case of that contract only, the Court was prepared to find that this requirement was met. In the financial planning context, the purchase contract should expressly provide for the transfer of copyright.

Thirdly did the buyer pay to acquire copyright from the seller? On the facts of this case, the contracts did not provide for any part of the purchase price to be paid for the transfer of copyright. The Court considered that where the parties had agreed to allocate the sale proceeds between goodwill and certain other assets, the Court should not interfere to re-allocate part of the price to the copyright transferred. To meet this requirement the purchase contract has to apportion some of the price to the purchase of copyright.

Fourthly, how, if at all, was any such copyright used or available for use by the buyer for the purpose of producing assessable income?  Although it was not necessary to decide this point, the Court thought that, under Division 373, use of the copyright or the physical records was sufficient and under Division 40, the requirement that the copyright be available for use is satisfied by the availability of the physical records. Use of the records by the buyer in providing services to the client should constitute appropriate use.

According to the ATO’s Decision Impact Statement, the High Court’s decision supports the Commissioner's view on the meaning of goodwill as set out in TR 1999/16 and on the application of the capital allowance provisions to the sale of a medical practice set out in Taxation Determination TD 2005/1.  The ATO intends to review the Determination to bring it more into line with the High Court’s reasoning in PHC’s case.

There would seem no reason that the buyer of a financial planning practice could not meet the High Court’s required criteria and thereafter be eligible to claim depreciation on the copyright in the client records.  Buyers of financial planning practices should investigate this possibility with their tax and legal advisers.

For more information on this topic please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.