Commissioner publishes ruling on income from software development

On 12 March 2014, the Commissioner published Taxation Ruling TR 2014/1 in which the Commissioner expressed his view on the timing of derivation of income by commercial software developers from licence agreements and ‘hosted’ or ‘cloud’ arrangements for the use of proprietary software. Specifically, the Ruling considers the point of derivation of income and apportionment of contractual fees in relation to:

  • the granting of proprietary licenses
  • hosted arrangements, and/or
  • ‘other additional services’ which may or may not be bundled with the above.

This Ruling is relevant for the distributors of software whether by way of licence or hosted services. It raises fundamental issues for the recognition of income and follows on from questions raised by industry following the Federal Court decision in International Business Machines Corporation v Commissioner of Taxation (2011 FCA 335). In most cases, it will be necessary for developers / distributors to review their income recognition policies on a contract by contract basis and may bring forward income recognition in some cases.

In respect of the point of derivation of income, it is the Commissioner's view that where an amount properly attributable to a contractual obligation is subject to a ‘contingency of repayment’, the amount is derived for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (Cth) when the obligation is fully performed or the contingency of repayment otherwise lapses. A ‘contingency of repayment’ in the event of future non-performance refers to:

  • a contractual obligation to refund  a demonstrated commercial practice to make a refund, or
  • contractual exposure exists for damages in respect of the non-performance (potential exposure to damages pursuant to consumer protection law or damages in torts, does not constitute in a ‘contingency of repayment’ in this context).

When ‘contingency of repayment’ exists, contractual fees may be deferred in part or full for tax purposes, subject to the allocation of contractual fees between the granting of a license for the use of proprietary software and any ‘additional services’ bundled within the arrangement.

Where no ‘contingency of repayment’ exists, the amount is derived when a recoverable debt arises in respect of the contractual fee.

In respect of the allocation of the contractual fee, it is the Commissioner's view that when additional services are bundled with the proprietary license or hosted access, the contractual fee must be allocated across the discrete obligations for the purpose of determining the point of derivation. The allocation will depend on the circumstances of each case, and should be on a fair and reasonable basis and be evidence based.

The Ruling applies to years of income commencing both before and after its date of issue.

Productivity Commission report on Infrastructure

The Productivity Commission has released its draft report into the provision, funding and financing of Public Infrastructure. The draft report covers a wide range of issues, including:

  • the role of Federal and State Governments in at least partially funding public infrastructure, which should be sourced from broad-based taxes on income, consumption and land because such taxes have lower efficiency costs; and
  • the introduction of tax advantaged infrastructure bonds, which is not supported by the Commission.

Submissions can be made on the draft report until 4 April 2014, with the final report expected to be provided to the Federal Government in late May 2014.

Draft legislation for tax concession entities

The Department of Treasury has issued exposure draft legislation and regulations to implement the 2009-10 Federal Budget measure to restate and centralise the special conditions for tax concession entities. Closing date for submissions is Monday, 7 April 2014.

According to the media statement accompanying the release of the draft material, this measure proposes to amend the tax law to restate and centralise the special conditions for tax concession entities by:

  • re-stating the ‘in Australia’ special conditions for income tax exempt entities, ensuring that they generally must be operated principally in Australia and for the broad benefit of the Australian community (with some exceptions);
  • centralising and simplifying in one place the other special conditions entities must meet to be income tax exempt, such as complying with all the substantive requirements in their governing rules; and
  • codifying the ‘in Australia’ special conditions for deductible gift recipients ensuring that they must generally operate solely in Australia, and pursue their purposes solely in Australia (with some exceptions, such as overseas aid funds, some environmental organisations, some touring arts organisations and medical research institutes).

Exploration Development Incentive

On 13 March 2014 the Assistant Treasurer announced the release of a discussion paper on the policy design of the Exploration Development Incentive. The Exploration Development Incentive aims to provide incentives (by way of a tax offset for investors) for greenfields minerals exploration activity, with a focus on the small exploration sector.

The paper outlines and seeks feedback on possible implementation arrangements for the Exploration Development Incentive.

The paper canvasses:

  • options for targeting junior mineral explorers;
  • which investors will be able to receive exploration credits;
  • how ‘eligible expenditure’ and ‘greenfields’ could be defined;
  • options for capping the cost of the scheme; and
  • how the exploration credit system will work. Closing date for submissions is Friday, 4 April 2014.