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Ruling

Subject: Derivation of income

Question

Is the conditional call option fee considered to be derived as assessable income in the financial year in which the project approval for stage 2 is obtained?

Answer

Yes.

Relevant facts

The rulee and a company entered into a Deed of Option for lease granting the company an option to require the rulee to lease to them certain premises to be constructed by the rulee.

Government approval for the concept plan and stage 1 of the project were granted. Stage 2 of the project has not yet received approval.

The rulee received a call option fee from the company.

A clause of the Deed of option states that the company cannot call upon the rulee to refund the call option fee following the approval date.

The approval date is defined in the Deed as being the date upon which the Minister approves the stage 2 project application.

A clause of the Deed of option states that the company may terminate the Deed at any time prior to the approval date upon giving the rulee notice in writing of such termination.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997), a taxpayer is required to include in assessable income the ordinary income it derives during the income year.

It is an accepted principle of income tax law that the method under which a taxpayer accounts for its business or income producing activities for the purposes of income tax must 'give a substantially correct reflex of the taxpayer's true income' (see Dixon J in The Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Ltd (1938) 63 CLR 108 at 154; (1938) 5 ATD 98 at 131 (Carden's case)).

Taxation Ruling TR 97/15 deals with issues relating to the tax treatment of conditional contracts and states that based on the decisions in J Rowe & Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421, Cardens case and Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130 (Gasparin's Case) it is clear that the income is derived when the when all contingencies are satisfied.

In Gasparin's Case, the Full Federal Court determined the following:

- the trading stock was real property and the allotments remained registered in the name of the vendors until settlement

- until settlement the vendors had not lost dispositive power and had not ceased to have proprietary interest in the land

- the allotments remained trading stock on hand until each transaction proceeded to the point where a debt accrued due from the purchaser, and

- it was only when all contingencies and uncertainties are satisfied that a debt, being a sum certain, accrued due to the taxpayer and it was at that point that income was derived for the purpose of levying taxation (that is, at settlement).

Based on the findings in Gasparin's Case, an amount is not receivable if it is subject to any contingency. This point was considered in AAT Case 8284 (1992) 24 ATR 1085; Case Z37 93 ATC 342 where a joint-venturer contracted to buy property from the joint-venturers on the condition that the local council issued the necessary building permit. The taxpayer was one of the joint-venturers and the issue was whether the final sum paid in July 1988 was derived in the year in which the contract was executed or in the year in which the contract became unconditional. It was held that the contract for the sale was either conditional or contingent upon the issue of the building permit, and that the taxpayer did not derive income under the contract until it became unconditional.

The situation where income was taken to be derived at a point after a receivable debt arose, because the taxpayer had not completed all steps required in order to become entitled to the debt, was also examined by the Full High Court in the case of Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation 114 CLR 314; 14 ATD 98;(1965) 39 ALJR 262;(1965) 9 AITR 673 (Arthur Murray's Case).

The Court in that case found that the taxpayer was not assessable on the income received in advance of services being provided. The advance receipts were held not to form part of the taxpayer's assessable income at the time of the receipt, but became assessable as and when the dance lessons were given.

In Arthur Murray's Case, the Court held that income could not be taken to have come home to the taxpayer if the services had not been provided and if the possibility existed that any part of the advance receipts would need to be repaid.

Your case

The principles examined in Gasparin's Case and Arthur Murray's Case are applicable in determining the timing of derivation of the conditional call option fee.

Until approval is granted for stage 2 of the project, the rulee is obligated to refund the amount of the conditional call option fee to the company, under certain circumstances.

According to a clause of the Deed of option, the company may terminate the Deed of option at any time prior to the approval date requiring the rulee to refund the fee.

Once the approval is granted at stage 2 of the project, the company then can no longer terminate the Deed of option and at this time the rulee becomes absolutely entitled to the conditional call option fee.

In accordance with the principles in Gasparin's Case and Arthur Murray's Case, the income from a conditional call option fee would be derived by the rulee for the purposes of section 6-5 of ITAA 1997, when the Deed of option is free of contingencies and uncertainties, being at the time when Stage 2 of the project is given approval.

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