Edited version of your written advice

Authorisation Number: 1051243846678

Date of advice: 27 July 2017

Ruling

Subject: Capital gains tax – royalty – ordinary income

Question

Will the amount received from XYZ Group be assessed as ordinary income under section 6-10 of the Income Tax Assessment Act 1997?

Answer

Yes.

Question

Will the amount received from XYZ Group be assessed as a capital payment under Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2016.

The scheme commences on

1 July 2015.

Relevant facts and circumstances

After 19 September 1985 you agreed to enter into a contract (the initial contract) under which you would write a contribution in the form of chapters for a publication.

Approximately X years later you were informed in writing from that due to the delay in releasing the publication you will not see any royalty payments within the next Y years.

A few weeks later you agreed to vary the terms of the initial contract and entered into a new contract under which you would receive a final lump sum payment in full and final satisfaction of your interest in all of the chapters and the work.

You have received the payment in accordance with the new contract.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 15-20.

Income Tax Assessment Act 1997 Section 118-20

Reasons for decision

Summary

Payments agreed to be received as royalties under the initial contract are assessed as income. While the lump sum payment was received as a substitute for the royalty payments, it will also be assessed as ordinary income.

Detailed Reasoning

Royalty payments are income

Section 6-5 of the ITAA 1997 states 'ordinary income’ is assessable income. Examples of ordinary income include salaries, wages, rent, interest, dividends and the proceeds of carrying on a business.

Section 6-10 of the ITAA 1997 states assessable income also includes some amounts that are not ordinary income. For example, royalties received by authors are income under section 15-20 of the ITAA 1997 and are included in assessable income under section 6-10 of the ITAA 1997.

Lump sum payments take the characteristic of the initial payment

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR540; (1952) 5 ATR 443; ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered in Coward v. Federal Commissioner of Taxation 99 ATC 2166; (1999) 41 ATR 1138. In that case Mathews J held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing redemption of those future weekly payments was also income.

This is consistent with the approach taken by the Commissioner of Taxation Determination TD 93/3 (TD 93/3) which deals with the partial commutation of periodic payments to a lump sum. As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect was simply to pay in advance the future weekly payments.

This can also be seen in a number of other cases including but not limited to:

Senior v. Federal Commissioner of Taxation 2015 ATC 10-392 para 63 where:

Like the monthly benefits paid under the Support Scheme, the Finalisation Payment was a substitute for income. A change in the method of the payment (that is, a lump sum payment rather than a monthly payment) does not alter the character of the Finalisation Payment as being a substitute for income.

This is repeated in Sommer v Federal Commissioner of Taxation (2002) 51 ATR para 16:

The fact that the payment of the monthly benefits in the present case is made in one lump sum does not change the revenue character of the receipt if it was essentially designed to compensate the applicant in respect of his income replacement claims or was a payment in substitution for those claims ...

In Brackenreg v. Federal Commissioner of Taxation [2003] AATA 824; 2003 ATC 2196; (2003) 53 ATR 1116 (Brackenreg) para 13:

The weekly compensation payments made to Ms. Brackenreg had their basis in a formula which took account of her ``normal weekly earnings'' which was preferable to what she was earning when she was employed by the Commonwealth. Her compensation was in substitution for earnings and was paid for loss of earnings and was assessable under section 25(1)(a) of the Tax Act. In her case (unlike Mr.Coward) the weekly payments did not change their character upon being redeemed by the payment of a lump sum.

In this case you have contributed to the contents of a chapter in a publication. For this service you were to be paid on a royalty basis. When the publication sold you were to receive a payment per sale.

Before the publication was sold you were contacted and informed that there was a delay in releasing the publication and that you would not receive any payment of royalties for at least Y years.

You were informed that they would modify the initial contract so you would be paid a lump sum amount for your time and any future payment you may have received.

Upon receiving the modified contract you agreed to the terms amended and were paid a lump sum for full satisfaction of your entire interest in the chapters and the work.

Based on the information and documents received there seems to be no reason why the same logic from the cases outlined above would not apply with equal force to this present case.

The payment was a substitute for the past and future income that was represented by royalty payments under the initial contract. Just because the initial contract had been modified to reflect the payment as a lump sum does not change the character of the payment.

The payment will retain the same character, namely income, as was borne by the royalty payments made under the initial contract.

Therefore the lump sum payment will be assessable as ordinary income under section 6-10 of the ITAA 1997.

Capital Gains

The disposal of a right to income will fall within the capital gains tax provisions in Part 3-1 and 3-3 of the ITAA 1997.

However, pursuant to section 118-20 of the ITAA 1997, the taxpayer will not declare any capital gain on the disposal to the extent to which the proceeds from the disposal of the right are assessable under another provision of the ITAA 1997 or ITAA 1936.

Having found that the payment was assessable income within section 6-10 of the ITAA 1997 it was unnecessary to deal with the submission that the payment was caught by the capital gains tax provisions.

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