Income derived from an app is assessable income – Part 2
Unless an app developer derives their income from an activity that is a hobby (refer below), income derived in respect of an app that has been developed by a taxpayer, or which the taxpayer has paid to have developed, will generally be ordinary or statutory income and must be included in the taxpayer’s assessable income. The difficulty in this regard is determining the nature of the income and how much to include in assessable income. This comes down to the agreements made between the relevant parties.
As noted, the tax implications vary depending on how the developer chooses to exploit the app, for instance it may be that the income received is a royalty under S.15-20 (under the ordinary meaning of that term), or ordinary income under S.6-5 (e.g., business profits) and/or the income may form part of the termination value for the balancing adjustment event that arises where the developer grants or assigns an interest in the copyright under Division 40. Refer below.
It seems that, where an app developer uses a third party platform to distribute (‘sell’) their app, there will be a contract between the developer and the end-user (called an ‘end-user license agreements’ or ‘EULA’) and an agreement between the developer and the third party platform (e.g., Apple). The EULA generally grants the user the right to use the app.
In these circumstances, and subject to the terms of the contract, the third party platform generally collects full payment from the end-user (e.g., income from downloads) and for advertising and in-app purchases. The payment is then forwarded to the developer minus a set, and agreed distribution fee. Despite a developer receiving the net amount, it may be that the developer is entitled to the gross income (and this is the amount included in assessable income under S.6-5), although the distribution fee would generally be a deductible amount.
Another way in which a developer may exploit an app they have developed is to grant or assign a licence in the copyright to another party for them to exploit/distribute for payment (e.g., this may be a lump-sum payment, on-going payment. Unfortunately, this scenario, although common, comes with complex taxation implications.
In these circumstances, the payment(s) for the use of the copyright (lump sum or periodic) may constitute royalties or ordinary income. However, in these circumstances, it is important to also be aware of a specific provision, S.40-115(3) that applies where a taxpayer grants or assigns an interest in an item of intellectual property (e.g., copyright). Under this provision, the item of intellectual property is treated as having been split in two; into an interest that has been granted or assigned and an interest that the taxpayer retains. The interest that has been granted or assigned is then treated as if it were no longer held which triggers a balancing adjustment (which, depending on the facts, could give rise to a ‘balancing’ deduction or assessable amount).
This provision is full of complexities. It requires that the cost of the intellectual property be apportioned on a reasonable basis to determine adjustable value (generally based on the market value of the split interests) and for ‘termination value’ to be determined. In this regard, there are special rules, which may prevent amounts already included in assessable income under S.6-5 from also being included in termination value.