Edited version of your written advice

Authorisation Number: 1013088430398

Date of advice: 21 September 2016

Ruling

Subject: Assessable income - Timing and derivation

Question 1:

Is the amount received by you in the relevant financial year from Partnership A assessable income in the year of receipt?

Answer:

Yes.

Question 2:

Is the amount paid to you by Partnership A assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) rather than section 92 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Yes.

Question 3:

Is the assignment of an interest in work in progress to the value of $XX,XXX considered assessable income at the time of the assignment?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

The scheme has commenced

Relevant facts

You were a partner in Partnership A at a particular location.

Partnership A was approached by Partnership B with a proposal that the partners of Partnership A at that location join Partnership B.

You were concerned that your taxable income would fall as a consequence of joining Partnership B.

You advised Partnership A of your unwillingness to join Partnership B and would consider moving to another practice.

Partnership A encouraged you to join Partnership B and offered to underwrite your taxable income for the first X years after you joined Partnership B to ensure that your taxable income would be $XXX,XXX for each of those years. You agreed to this offer (the 'top up' agreement).

You left Partnership A and joined Partnership B.

Your income did not reach the agreed upon level in X of the years after you joined Partnership B.

You requested Partnership A fulfil their obligations under the 'top up' agreement to make up for the shortfalls in your income.

Partnership A disputed your claims and you commenced legal action.

During the relevant financial year, the following settlement terms were agreed to between yourself and Partnership A:

• Partnership A will transfer the sum of $XX,XXX to your nominated bank account, payment to occur within 14 days;

• Partnership A will assign work in progress to the book value of $XX,XXX to you.

• you will waive and release Partnership A from all related claims

• Partnership A will waive and release you from all related claims.

The work in progress which was transferred to you as part of the settlement existed at the time you finished working for Partnership A. As at 30 June 20XX none of this work in progress has been invoiced or recovered.

You advised that the procedure of Partnership A in accounting for work in progress was only to bring work in progress to account as income at the time that it had been invoiced and recovered, that is, paid by the client.

Relevant legislative provisions

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 6-5(3)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Income Tax Assessment Act 1997 Section 15-50

Income Tax Assessment Act 1997 Subsection 25-95(1)

Income Tax Assessment Act 1997 Subsection 25-95(2)

Income Tax Assessment Act 1997 Paragraph 25-95(3)(a)

Income Tax Assessment Act 1997 Paragraph 25-95(3)(b)

Income Tax Assessment Act 1936 Section 92

Reasons for decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states:

(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Note some of the provisions about assessable income listed in section 10-5 may affect the treatment of ordinary income

(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

(3) If you are a foreign resident, your assessable income includes:

(a) the ordinary income you derived directly or indirectly from all Australian sources during the income year; and

(b) other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source.

(4) In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.'

Generally speaking, a receipt will be income according to ordinary concepts if it is a receipt arising out of a taxpayer's employment, business activities or income producing activities. This will be so even if the receipt is not directly related to any service provided by the recipient to the payer (Federal Commissioner of Taxation v Dixon (1952) 86 CLR 540).

Taxation Determination TD 93/58 states that a lump sum compensation/settlement payment will be assessable under subsection 25(1) of the Income Tax Assessment Act 1936 (now replaced by section 6-5 of the ITAA 1997) if the payment is compensation for loss of income.

Subsection 92(1) of the ITAA 1936 provides that a partner's assessable income includes their individual interest in the net income of the partnership.

Under paragraph 23 of Taxation Determination TD 2015/19 Income tax: if a retiring partner is entitled to an amount representing their individual interest in the net income of the partnership for an income year, will section 92 of the Income Tax Assessment Act 1936 apply states:

The partner's individual interest in partnership net income is essentially a question of fact in each case, to be determined by reference to the partnership agreement; the partnership's accounting records and any other relevant documents.

Your circumstances

You entered into an agreement with Partnership A under which in exchange for you agreeing to transfer to Partnership B, Partnership A agreed to 'top up' your income if it fell below $XXX,XXX during each of the 20XX-XX and 20XX-XX financial years.

You made a claim against Partnership A in relation to this agreement and they settled the claim with a payment to you of $XX,XXX during the relevant financial year.

It is considered that this payment is compensation for lost income and therefore is assessable as ordinary income under section 6-5 of the ITAA 1997 when it was derived. You derived the income of $XX,XXX when you received it during the relevant financial year.

The $XX,XXX was not paid to you because you were a partner and therefore entitled to a share of the profits of Partnership A. Rather it was paid to you because of the separate 'top up' agreement you made with Partnership A.

Therefore, it is not considered that the $XX,XXX payment is assessable to you as a share of partnership income under subsection 92(1) of the ITAA 1936. Rather, the $XX,XXX payment is assessable to you under section 6-5 of the ITAA 1997 as ordinary income (being compensation for lost income) when you received it.

Work in progress payments

Section 15-50 of the ITAA 1997 provides that a person's assessable income will include a 'work in progress amount' received. Conversely a deduction will be available to the person who has paid a 'work in progress amount'- subsection 25-95(1) of the ITAA 1997.

A 'work in progress amount' is an amount as defined in subsection 25-95(3) of the ITAA 1997. This definition provides that an amount is a work in progress amount to the extent that:

(a) an entity agrees to pay the amount to another entity (the recipient) and

(b) the amount can be identified as being in respect of work (but not goods) that has been partially performed by the recipient for a third party but not yet completed to the stage where a recoverable debt has arisen in respect of the completion or partial completion of the work.

This provision makes it clear that any amount received by a partner or partners in consequence of disposing of their interest in the work in progress of their partnership would be assessable to them.

In your case, you were 'assigned' work in progress to the value of $XX,XXX. However, you were not actually paid this amount. As you were not paid a 'work in progress amount', the assignment of the work in progress to the value of $XX,XXX is not assessable income under section 15-50 of the ITAA 1997.

You will only be considered to have derived assessable income in relation to the work in progress either once a recoverable debt arises (if the accruals method is the appropriate method of determining your income) or you receive an amount for the work (if the receipts method is the appropriate method of determining your income). If the accruals method is the appropriate method, the most common situation with respect to professional fees is that a recoverable debt is created only when the professional person bills the client (Taxation Ruling TR 93/11).

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