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Edited version of your written advice
Authorisation Number: 1013103826469
Date of advice: 20 October 2016
Ruling
Subject: Assessable income or capital gains
Question 1
Are the amounts received for the future income of rental contracts ordinary income and assessable where the overall business is sold?
Answer
Yes.
Question 2
If the answer to question one is 'no', are the amounts received for the future income from rental contracts assessable as a capital gain where the overall business is sold?
This ruling applies for the following period
Year ending 20XX
The scheme commences on
1 July 20YY
Relevant facts and circumstances
In 20XX, you sold your business (the business).
The business buys assets and rents them out to customers. Customers pay rentals over monthly instalments. Asset ownership passes to customers at the end of the rental contract.
The business has a number of customer rental contracts partially completed and future monthly rentals are to be received.
You have received amounts for the future income from the purchaser with specified amounts that include goodwill and partially completed rental contracts.
You received an amount from the purchaser for 50% of the future income on the rental contracts.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 108-5
Income Tax Assessment Act 1997 Subsection 108-5(1)
Income Tax Assessment Act 1997 Section 118-20
Reasons for decision
Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states your assessable income includes income according to ordinary concepts, which is called ordinary income. Ordinary income includes revenue derived from the carrying on of a business.
In determining whether an amount is ordinary income, the courts have established the following principles:
● what 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 a statute dictates otherwise
● whether the payment received is income depends upon a close examination of all relevant circumstances
● whether the payment received is income is an objective test.
Relevant factors in determining whether an amount is ordinary income include:
● whether the payment is the product of any employment, services rendered, or any business
● the quality or character of the payment in the hands of the recipient
● the form of the receipt, that is, whether it is received as a lump sum or periodically
● the motive of the person making the payment, but noting that this latter factor is rarely decisive, as a mix of motives may exist.
Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income establishes the Commissioners view when determining whether profits from isolated transaction are income and therefore assessable.
Paragraph 17 of Taxation Ruling TR 92/3 states that
where an amount is received for the transfer of a right to an income stream severed from the property to which it relates, is income according to ordinary concepts. Future income is simply converted into present income. This is the case even if the income stream is produced by a contractual right rather than by the relevant property.
The payment received for the future income maintains the same character as income. The future income has simply been converted to present income.
Section 118-20 of the ITAA 1997 provides that where capital proceeds are also assessable income the capital gain is reduced where the amount is otherwise assessable such as under section 6-5 of ITAA 1997.
Application to your circumstances
As the rental contracts are made in the course of carrying on your business the payments received from these contracts are treated as income. The amount you received when you sold the business for the partially completed rental contracts is considered income.
Any capital gain from the sale of the business will be reduced to the extent of any amount already included as ordinary assessable income.
The amounts received for the future income is ordinary income derived from the carrying on of a business.
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