Price Is Only Part Of The Cost

For most people entering into negotiations to purchase a business, there is only one end in sight – the final sale price. While this is clearly important, price is just one variable in the negotiations. Often, the simple wording of the sale contract will have huge tax repercussions for the purchaser, once they take over the business.

In the recent Federal Court case of Primary Health Care Ltd v FCT [2010] FCA 419, the purchaser of a medical practice was denied depreciation deductions for copyright in the practice’s patient records. The purchaser argued that copyright existed in the medical records, and that they had paid consideration for that copyright when they bought the business.

If the purchaser had been successful in their argument, they may have been entitled to depreciation deductions for any cost attributed to those medical records. Unfortunately for the purchaser, their argument was unsuccessful.

The Court generally followed the long-held principle not to disturb amounts allocated for specific assets in a sale of business contract when parties to the transaction are negotiating on an arm’s length basis.

In this case, for most of the medical records being transferred, there was no specific consideration in the contract of sale.

This is not to say that if the vendor and purchaser had agreed to specific amounts for the transfer of the copyright, the purchaser would have been entitled to depreciation deductions for that amount.

Since the case was handed down, the ATO has said that this case “highlights the limitations on the copyright likely to subsist in medical or dental records”.

However, it does show the need for a thorough due diligence before a sale of business contract is finalised. If both vendor and purchaser had agreed to, say, $100,000 being allocated to the copyright in the medical records, this amount may have been available for depreciation by the purchaser as it represented the cost of a depreciating asset to the purchaser.

But for the depreciation deduction to be available, intellectual property would need to subsist in the medical records. Based on the Primary Health Care case, this is possible. As Justice Stone noted in relation to referral records, “I am satisfied that copyright would subsist in the letters which are in evidence before me and which were written by the sample doctors.”

Once it is established that intellectual property does subsist, a value must be attached to it (that is, the asset must have a “cost”) in order for depreciation deductions to be available to the purchaser.

As a general rule, purchasers will want to maximise the amount in the contract that is allocated to items that may be deductible at some stage in the future (for example, trading stock or depreciable property).

Vendors, on the other hand, will want to maximise the amount in the sale contract that attaches to items that provide for specific concessions in the Tax Act (for instance, capital gains).

As a result, vendors and purchasers have diametrically opposed interests. This is why it is vital to get good tax advice before signing the contract for the sale or purchase of a business.