Edited version of private ruling

Authorisation Number: 1011568123654

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Ruling

Subject: Assessability of trail commissions

Whether the trail commissions refunded by a licensed securities dealer and investment advisory firm and received by you is assessable income to you under the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

This ruling applies for the following periods:

1 July 2010 to 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The taxpayer is a client of a licensed security and investment advisory firm (the firm).

The firm is a servicing agent and is entitled to receive commissions from financial product providers. They act as a facilitator for the purchase of products by their clients. The financial product provider pays a trail commission to them.

The commission received by the firm is paid by the product provider from the management fees that they charge their clients. It is not an additional fee that is deducted from the products.

The commission payments from the product providers are received by the firm on a monthly basis which is based upon the value of the investments. These payments are assessable income of the firm and they do not have the option of turning the commission off or having it rebated or refunded direct to investors.

Their clients are not entitled as per the ASIC guidelines to receive the commission from the product providers as they are not licensed securities dealers or investment advisers holding an Australian Financial Services License.

In consideration of being loyal customers of their firm, they wish to introduce a scheme whereby they refund these commissions to their clients with the option of:

· refunding the commission via cheque format, or

· direct debit to the client's bank account, or alternatively

· paying the commissions to their client's home loan.

They will charge their clients an administration fee.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 21A

Income Tax Assessment Act 1997 subsection 6-1(1)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 subsection 6-10

Income Tax Assessment Act 1997 subsection 10-5

Income Tax Assessment Act 1997 subsection 15-2.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The trail commissions refunded by a licensed securities dealer and investment advisory firm and received by you is assessable income to you under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-1(1) of the ITAA 1997 states that assessable income includes ordinary income and statutory income.

Subsection 6-5(1) of the ITAA 1997 defines ordinary income as income according to ordinary concepts. There is no legislative definition for "income according to ordinary concepts". However, there is a large body of case law that has evolved which identify the factors that indicate if an amount is "income according to ordinary concepts".

Subsection 6-5(2) of the ITAA 1997 states that the assessable income of an Australian resident will include the ordinary income derived directly or indirectly from all sources, whether in or out of Australia.

Section 6-10 of the ITAA 1997 states that amounts that are not ordinary income but are included in your assessable income by some provisions of assessable income, are called statutory income.

Section 10-5 of the ITAA 1997 lists a summary of the particular kinds of assessable income.

Income according to ordinary concepts

No one factor is decisive to determine if an income receipt is income according to ordinary concepts. The circumstances of each situation must be examined.

Common examples of ordinary income include salary and wages, proceeds from carrying on a business, rent, interest and dividends. Income derived from the sale of land will ordinarily be capital in nature as it relates to the sale of a capital asset. Examples of items which are not generally income include lottery prizes, proceeds from a mere hobby, loans, and gifts.

There have been many cases which have dealt with the topic of ordinary income, and over the years a number of indicators have been identified which are relevant in determining whether an amount is income according to ordinary concepts. These indicators include:

· whether the amount has the characteristics of periodicity, recurrence or regularity

· whether it is convertible into money or money's worth

· whether it is associated with business activities or services rendered, as distinct from the sale of mere property, and

· whether it is solicited, as distinct from a windfall gain.

However, none of these factors are exhaustive or conclusive, and their relative importance varies significantly according to the circumstances and to the presence of any countervailing factors.

"Income according to ordinary concepts" in subsection 6-5(1) can be traced to the judgment of Jordan J of the NSW Supreme Court in Scott v C of T (NSW) (1935) 3 ATD 142, in relation to the Income Tax (Management) Act 1928. His Honour stated (at pp 144-145):

The word 'Income' is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of receipts.

In FC of T v Cooke & Sherden 80 ATC 4140 (1980) 10 ATR 696, Brennan, Deane and Toohey JJ, in a joint decision of the Full Federal Court in relation to ITAA 1936, stated (at pp 4147-4148):

Whether a receipt is to be treated as income or not is determined according to 'the ordinary concepts and usages of mankind' ... except where statute sweeps in particular receipts or amounts which would not ordinarily be taken to fall within the concept.

...

... The notion that the items of income are money or are to be reckoned as money accords with the ordinary concepts of income as 'what comes into (the) pocket' to adapt Lord Macnaghten's phrase in Tennant v Smith (1892) AC 150 at p. 164. That is not to say that income must be received as money; it is sufficient if what is received is in the form of money's worth... Nor is it necessary that an item of income be paid over to the taxpayer: it is sufficient, according to ordinary concepts and usages, that it be dealt with on his behalf or as he directs...

Similarly, in Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693, the Full High Court (in a joint judgment) said (at p 4370):

The periodicity, regularity and recurrence of a receipt has been considered to be a hallmark of its character as income in accordance with the ordinary concepts and usages of mankind.

As stated in the Explanatory Memorandum to ITAA 1997 (p 40), it has been left to the courts to develop principles for determining what is "ordinary income". However, there is no complete set of rules for determining that question, the indicia of ordinary income are found in numerous decisions.

Proceeds of an isolated transaction even received as a lump sum, may be income. A reimbursement of capital will not be income unless the advance was in the nature of a revenue outgoing incurred in the course of a business. A gift is not usually regarded as income. However, a tip is income, as it is a product of the services rendered.

Capital gains are not ordinary income in the hands of the recipient. They may still be assessable statutory income under the ITAA 1997. It is possible to convert a capital asset to income. If the payments are periodical, the question becomes, are the payments instalments of the capital amount or really in the nature of income.

The character of the receipt in the hands of the recipient must be determined. It is in this context that the character of the payment is determined (Liftronic Pty Ltd v. Federal Commissioner of Taxation (1996) 66 FCR 175; 96 ATC 4425; (1996) 32 ATR 557).

Section 15-2 of the ITAA 1997 (formerly section 26(e) of the ITAA 1936) includes in the assessable income of a taxpayer the value of allowances, gifts, gratuities, compensations, benefits, bonuses and premiums given to an employee in respect of their employment or services.

Section 21A of the ITAA 1936 includes the arm's length value of non-cash business benefits in the assessable income of a taxpayer. Non-cash business benefits are defined as property or services provided in respect of a business relationship. Non-cash business benefits that cannot be converted to cash will be treated as if they were convertible to cash.

Commission income paid under an agreement is regarded as ordinary income and is assessable under section 6-5 of the ITAA 1997.

Taxation Ruling TR 93/36 discusses the assessability of commissions paid by investment funds to intermediaries. TR 93/36 states commission which is received by an intermediary from an investment fund (other than an initial service fee or entry fee) and then passed on to the investor under an obligation or liability is assessable in the hands of the investor.

Consumer loyalty program

A consumer loyalty program is a marketing tool operated by suppliers of goods or services to encourage customers to be loyal to the supplier.

The standard features of a consumer loyalty program are:

· the customer deals with the supplier in a personal capacity. A normal arm's length, commercial relationship exists between the customer and the supplier

· membership is restricted to natural persons

· membership of the program is usually by application, which may require application fee and/or annual fee

· points are received with the purchase of goods or services

· members and non-members pay the same amount for the goods or services purchased, and

· points are redeemable for goods and services.

Rewards received under consumer loyalty programs will be assessable where they are received as part of an income earning activity and:

· there is a business relationship between the recipient and the reward provider and the benefit is convertible to money's worth, or

· you are carrying on a business and section 21A of the ITAA 1936 includes the value of the benefit in your assessable income.

The reward will also be assessable under section 21A of the ITAA 1936 where the activities associated with obtaining the reward amount to a business or commercial activity.

Application to the taxpayer's circumstances

The taxpayer is engaging the firm to provide them with services. Under a loyalty scheme to be introduced by them, the taxpayer will be refunded the trail commissions received by them from the financial providers less any administration fee charged by them for the existing investments held by the taxpayer with the independent financial providers.

The commission received by the firm is paid by the financial product providers from the management fees that they charge the taxpayer.

The firm subsequently refunds part of the commission to you under a loyalty scheme. The loyalty reward you receive is in the form of money. Therefore, in accordance with TR 93/36 the trail commissions the taxpayer receive is assessable under section 6-5(2) of the ITAA 1997.

The trail commission received by the taxpayer from the firm clearly displays the characteristics of ordinary income which is assessable to the taxpayer under section 6-5(2) of the ITAA 1997 as they will be paid in cash, paid regularly and are associated with business activities (of the firm and the financial providers).

Further, once the loyalty scheme is in place, the firm will be under an obligation to pass on all or part of the commissions they receive from the independent financial providers. Hence, as explained earlier, as per TR 93/36, the obligation to pass on the commissions to the investor makes the commission assessable to the investor.

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