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Ruling

Subject: Timing of income tax deduction for employee bonuses

Question

Can the taxpayer claim a tax deduction in the current income tax year for bonus expenses accrued in relation to the current income tax year but not paid until the next income tax year?

Answer: No.

This ruling applies for the following period

Year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

The taxpayer has to date accrued bonus expenses in its accountings books in the current year but not claimed a tax deduction until the following year when the bonus amounts were paid. It was considered the bonus was only deductible when paid.

The taxpayer bonus accrued comprises several elements which are each able to be reasonably estimated in total and to some varying degrees at an individual level.

The payments of bonus are prescribed in a collective employment agreement and therefore create a liability for the payments to be made.

The elements of the bonus are:

1. Individual bonus for administrative staff. These staff receive a percentage of their actual salary depending on their individually assessed performance. At year end each individuals rating are not known however the overall provision can be reliably estimated by reference to the salary bill and an expected average rate of bonus.

2. Specialist staff receive a fee earning bonus based on a calculation of their fee earning compared to budget. These calculations are reasonably accurate at year end although small adjustments may be subsequently made for changes to budget and collectability of the fees.

3. A profit related element is also paid to all staff. This calculation is known at year end once the final audit is completed.

4. Some staff receive a set bonus for nominated roles with the business. On average the bonus can be estimated.

5. Some staff report directly and receive contractual bonus amounts depending on performance and as documented in their employment arrangements. On average the bonus can be estimated.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Section 51(1) of the Income Tax Assessment Act 1936

Reasons for decision

Deductibility of Losses or Outgoings:

The general deduction provision, section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) relevantly provides:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) …

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Taxation Ruling IT 2534 sets out the Commissioners view as to when an amount is incurred for the purposes of section 8-1 of the ITAA 1997, in relation to directors fees, employee bonuses etc. It states that to qualify for a deduction a company must, before the end of the year of income, become definitively committed to the payment of quantified amount of directors fees, bonuses or other such payments. The Ruling provides the example of a properly authorised resolution as evidence that a company is definitively committed. However, even in the case of a properly authorised resolution, the general meaning of incurred under section 8-1 must be considered to determine whether the loss or outgoing satisfies the requirements of that provision.

Taxation Ruling TR 97/7 sets out the Commissioners view on the meaning of incurred under section 8-1. The meaning of incurred in this ruling is derived from case law on the predecessor to section 8-1 of the ITAA 1997, section 51(1) of the Income Tax Assessment Act 1936.

The Ruling provides a summary of the principles that can be derived from case law on the meaning of incurred for the purposes of section 8-1 of the ITAA 1997.

The relevant principles are as follows:

A taxpayer must be completely subjected or definitively committed to the liability

Paragraph 16 of TR 97/7 provides:

16. A loss or outgoing may be incurred for the purposes of section 8-1 even though no money has actually been paid out. In W Nevill & Company Ltd v. FC of T (1937) 56 CLR 290 at 302 it was said:

'the word used is 'incurred' and not 'made' or 'paid'. The language lends colour to the suggestion that, if a liability to pay money as an outgoing comes into existence, [the section is satisfied] even though the liability has not been actually discharged at the relevant time … it is only the incurring of the outgoing that must be actual; the section does not say in terms that there must be an actual outgoing - a payment out.'

(See also New Zealand Flax Investments Ltd v. FC of T (1938) 61 CLR 179 at 207 (New Zealand Flax); FC of T v. James Flood Pty Ltd (1953) 88 CLR 492 at 506 (James Flood); Nilsen Development Laboratories Pty Ltd & Ors v. FC of T (1981) 144 CLR 616 at 624 (Nilsen Development Laboratories); FC of T v. Firstenberg 76 ATC 4141 at 4148; (1976) 6 ATR 297 at 305.)

FC of T v James Flood Pty Ltd (1953) 88 CLR 492 (James Flood) provides that in order for a loss or outgoing to be incurred under section 8-1 of the ITAA 1997, the taxpayer must have completely subjected or definitively committed itself to the liability and not be dependent on the occurrence of a future event.

According to the case of Nilsen Development Laboratories Pty Ltd & Ors v FC of T (1981) 33 ALR 161, a taxpayer is definitively committed to a loss or outgoing where they have a presently existing liability.

Subparagraph 6(d) of TR 97/7 provides that determining whether the taxpayer has a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed or arises.

For a loss or outgoing to be incurred for the purposes of section 8-1, it must therefore be a liability in the sense of an existing obligation to pay an amount, rather than a probable future payment.

The bonus payments, in the circumstances of this case, are dependent on at least one future events (after the end of the year ending 30 June 2011).

As such the taxpayer is not considered to be completely subjected or definitely committed to the liability at the end of the year ending 30 June 2011.

An outgoing may be incurred even though it is defeasible by others

Paragraph 19 of TR 97/7 refers to the case of Commonwealth Aluminium Corporation Ltd (77 ATC 4151) in stating that a taxpayer can be completely subjected to a liability even though it is defeasible by others. What is important is that the taxpayer is definitively committed to the outgoing, even though it may be defeasible.

The collective employment agreement shows that the taxpayer is definitely committed to the payment of bonuses. However eligibility and quantum of the bonus are unable to be determined until the happening of future events.

A liability whose quantum is not known may be incurred if it is capable of reasonable estimation.

According to the case of Commonwealth Aluminium Corp Ltd v FC of T (1977) 77 ATC 4151; 7 ATR 376, a liability is capable of reasonable estimation where it can be approximately calculated based on probabilities.

Paragraph 26 of Taxation Ruling TR 97/7 states that it may be necessary to consider the question of whether a loss or outgoing is properly referrable to the income year. However, Taxation Ruling TR 94/26, which contains the Commissioners view on determining whether an amount is properly referable, suggests at paragraph 22 that this consideration is usually only required in cases involving financing transactions and liabilities that accrue either daily or periodically, therefore it does not apply to the taxpayer as it involves an employee bonus payment.

The case of Merrill Lynch International (Australia) Ltd v Ors v FC of T (2001) 47 ATR 611 (Merrill Lynch International) furthers the Commissioners view in TR 97/7 that there must be a presently existing legal liability rather than a mere commercial certainty that an amount will be paid. This case involved a company who paid bonuses to employees after the end of the income year while it claimed a deduction for the bonuses in the income year. The taxpayer had discretion whether to pay the bonuses but commercial circumstances made it likely that they would be paid and management regarded it as a certainty and made accounting provision for them through the income year. The amount of the bonuses was determined after the end of the income year. It was determined that the taxpayer must have a legal liability to pay the bonuses in order for the bonuses to be incurred in the income year. That is, a taxpayer has only completely subjected or definitively committed itself when a legal liability exists. A legal liability was held not to exist in this case because the company could still exercise its discretion not to pay the bonuses.

It is considered that the amounts of the bonuses are capable of reasonable estimation as submitted by the taxpayer. However, as in the case of Merrill Lynch International, a legal liability is not considered to exist at the end of the year ending 30 June 2011. The determination of whether the taxpayer pays a bonus and the quantity of the bonus are dependent on events that occur in the subsequent financial year.

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