Edited version of your private ruling

Authorisation Number: 1012313953567

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Treatment of customer contracts on consolidation

Question 1:

At the joining time, in respect of the relevant customers, did Clause 6 of the Standard Co X Agreement, Clause 4 of the Standard Co Y Agreement and Clause 3 of the Standard Co Z Agreement each constitute a right that is an asset covered by subsection 701-90(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Unable to rule.

Question 2:

For the purposes of Part 3-90 of the ITAA 1997, will the valuable rights identified in Question 1 be treated as separate assets in accordance with subsection 701-90(2) of the ITAA 1997?

Answer:

Unable to rule.

Question 3:

For the purposes of the tax cost setting rules in Part 3-90 of the ITAA 1997, is the market value of the rights referred to in Question 1 equal to the market value of the customer contracts?

Answer:

No.

Question 4:

Are the valuable rights to future income identified above assets that are covered by section 716-410 of the ITAA 1997 at the joining time?

Answer:

No.

Question 5:

Is the tax consolidated group entitled to claim deductions in respect of the unexpended tax cost setting amount of the customer contracts in accordance with the principles in section 716-405 of the ITAA 1997?

Answer:

No.

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.

On a specified date, the joining time, Co B, a subsidiary member of a tax consolidation group, completed the acquisition of a company and its subsidiaries (together, Co C). As a consequence of the acquisition, Co C became members of the tax consolidated group.

Co A was the head company of the tax consolidated group at the time of completing the Co A acquisition.

Co C provided specialised services under the business names Co X, Co Y and Co Z.

The proportion of revenue was 75%, 10%, and 15% for Co X, Co Y and CoZ respectively.

At the joining time, Co C had in place a significant number of customer accounts which were all subject to contracts (the customer contracts). These contracts governed the terms and conditions under which Company C would provide services to its customers, including the charges payable by the customers for the receipt of the services.

There were generally three types of standard contracts:

· Standard Co X Agreement

· Standard Co Y Agreement, and

· Standard Co Z Agreement.

At joining time, there were actually a number of different contracts in place with customers, some of which contained somewhat different terms and conditions to those set out in those standard agreements. The main differences are that some contracts required that the customer gives Co C notice of its intention to terminate the contract at varying periods (for instance, 60 or 90 days) prior to the end of the 12 month period, and some contracts provided customers with the right to terminate the contract in the event that Co C raised its charges above any increase in the Consumer Price Index.

Under each Standard Co X Agreement, Co X agrees to provide the services that have been required and negotiated by the customer (Clause 3 of the Standard Co X Agreement). In return, the customer will pay Co C the agreed charges within 30 days of being invoiced (Clause 6 of the Standard Co X Agreement).

The initial term of the agreement is 12 months. At the end of the initial 12 month period (and every subsequent 12 month period), the term of the Standard Co X Agreement will be automatically extended for another 12 months unless either party has given written notice at least 30 days prior to the 12 month period (Clause 5 of the Standard Co X Agreement).

Co X has the right to terminate the Standard Co X Agreement at any stage if the customer fails to comply with its obligations under the agreement, and the failure is not remedied within two business days of the customer receiving notice from Co C to remedy the breach (Clause 5 of the 'Co X' Agreement).The customer does not have any corresponding right to terminate the Standard Co X Agreement, other than by giving notice prior to 30 days before the end of one of the 12 month periods.

Under each Standard Co Y Agreement, Co Y agrees to provide the services that have been requested and negotiated by the customer (Clause 2 of the Standard Co Y Agreement). In return, the customer will pay Co Y the agreed charges within 14 days of being invoiced (Clause 4 of the Standard Co Y Agreement).

The initial term of the agreement is 12 months. At the end of the initial 12 month period (and every subsequent 12 month period), the term of the Standard Co Y Agreement will be automatically extended for another 12 months unless either party has given written notice at least 60 days prior to the end of the 12 month period (Clause 3 of the Standard Co Y Agreement).

Either party has the right to terminate the Standard Co Y Agreement at any stage if the other party materially breaches the agreement and the failure is not remedied within 14 business days of the party receiving notice from the non-breaching party to remedy the breach (Clause 6 of the Standard Co Y Agreement). The customer does not have any other right to terminate the Standard Co Y Agreement, other than by giving notice prior to 60 days before the end of one of the 12 month periods.

Under each Standard Co Z Agreement, Co Z agrees to provide the services that have been requested and negotiated by the customer (Clause 1 of the Standard Co Z Agreement). In return, the customer will pay Co Z the agreed charges within 30 days of being invoiced (Clause 9 (Annexure 1) of the Standard Co Z Agreement).

The initial term of the agreement is 24 months. At the end of the initial period (and every subsequent 12 month period), the term of the Standard Co Z Agreement will be automatically extended for another period unless either party has given written notice of 6 months prior to the end of the relevant period (Clause 2 of the Standard Co Z Agreement).

The services to be performed by Co C in respect of the customer contracts can be described as:

· type A services;

· type B services; and

· type C services.

Co M was engaged by Co A to undertake a valuation of the identifiable intangible assets of Co C (including goodwill) for purchase price allocation purposes under A-IFRS (AASB 3 and AASB 138). The customer contract and relationship asset held by Co C at the acquisition date was determined by Co M (in accordance with the excess earnings approach)¹ to have a fair value (for AASB 3 and AASB 138 purposes) of $XXX.

Relevant legislative provisions

· Income Tax Assessment Act 1997 Part 3-90 as amended by Tax Laws Amendment (2012 Measures No 2) Act 2012 (TLAA 2012 No 2) (Part 4 in Schedule 3)

· Income Tax Assessment Act 1997 section 701-63 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (TLAA 2012 No 2) (The Pre Rules Part 1 in Schedule 3)

Reasons for decision

The Application rules in Tax Laws Amendment (2012 Measures No. 2) Act 2012 (TLAA 2012 No.2) (Part 4 in Schedule 3) provide for which rules apply to the head company of a consolidated group in respect of an entity that becomes a member of that group at a particular time.

In accordance with subitem 50(2) of the TLAA 2012 No.2, the Pre rules apply to Co C as the joining time is before 12 May 2010. The Pre rules are those amendments made by Part 1 in Schedule 3 of TLAA 2012 No.2. It is noted that the following references to sections relate to the legislative amendments contained within Part 1 of Schedule 3.

Question 1:

Detailed reasoning

There can be no valuable rights identified in accordance with subsection 701-90(1) because section 701-90 was repealed under the Pre rules by TLAA 2012 No. 2.

Question 2:

Detailed reasoning

There can be no valuable rights treated as a separate asset in accordance with subsection 701-90(2) because section 701-90 was repealed under the Pre rules by TLAA 2012 No. 2.

Question 3:

Detailed reasoning

The market value of an asset held by a joining entity at the joining time is required if the asset is recognised as a separate reset cost base asset, in accordance with section 705-35 of Division 705 of the ITAA 1997 at this time.

The valuable rights referred to in Question 1 form part of the customer contracts held by Co C at the joining time. They constitute rights to future income under subsection 701-63(5) because they are valuable rights (including contingent rights) to receive an amount for the performance of work or services and they are neither a Division 230 financial arrangement nor part of a Division 230 financial arrangement.

Under the Pre rules, these valuable rights will be treated as forming part of the reset cost base goodwill asset for the purposes of the rules in Division 705 at the joining time. This is because all of the rights to future income identified in respect of the customer contracts held by Co C at the joining time are for work or services yet to be performed at this time (paragraph 2.4 and footnote 2 on page 6 of the ruling application) with none of the rights being for unbilled income or an unbilled income asset within the meaning of subsection 701-63(6).

As there is no unbilled income asset in respect of the valuable rights held by Co C at the joining time, all the rights are non-deductible rights to future income under subsection 701-63(4) and are treated as forming part of goodwill under paragraph 701-63(3)(c).

As the rights are not recognised as separate reset cost base assets, they have no market value (equal to the market value of the Co C customer contracts or otherwise) as separate assets for the purposes of the tax cost setting rules in Part 3-90.

Question 4:

Detailed reasoning

The result of subsections 701-63(2) and (3) is that a right to future income that is a non-deductible right to future income under subsection 701-63(4) forms part of a single goodwill asset of the business and is not a separate asset for the purposes of Part 3-90 (other than section 701-63).

As the valuable rights are non-deductible rights to future income and form part of the single goodwill asset of the business, there is no right to future income that section 716-410 applies to.

Question 5:

Detailed reasoning

The effect of the Pre rules is that only an unbilled income asset may have a tax cost setting amount that is set (for the head company's income tax core purposes) under subsection

701-55(5C) and deducted under section 716-405.

Section 716-405 does not apply to the valuable rights because, for the reasons stated above, these are non deductible rights to future income forming part of the goodwill. Subsection 701-55(5C) does not apply to the valuable rights and paragraph 716-405(1)(b) is not satisfied.

Therefore, the tax consolidated group is not entitled to claim any deductions under section 716-405 in respect of the Co C customer contracts.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).