Edited version of your written advice

Authorisation Number: 1051255892495

Date of advice: 24 July 2017

Ruling

Subject: Timing of Income

Question 1

Was the Purchase Price Balance referred to in the Put and Call Option Deed assessable income of the Taxpayer pursuant to section 6-5 Income Tax Assessment Act 1997 in the income year ended June 20ZZ?

Answer

Yes

This ruling applies for the following periods:

1July 20XX to 30 June 20AA

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

● ABC Pty Ltd (ABC)is the head company for a tax consolidation group

● LMN Pty Ltd is a subsidiary company of ABC.

● RST Pty Ltd is a subsidiary company of ABC

● ABC held properties (the Properties) as trading stock

● ABC sold the Properties to 123 Pty Ltd (123)

● 123 executed put and call options over the Properties. 123 paid a security deposit

● 123 executed the call options and a contract for sale of the properties was formed

● Annexure B of the Contract states that within X days ABC was to give notice to relevant Lessees of the Properties to terminate their leases. ABC was also required to provide 123 with certified copies of the termination notices and evidence that the notices were served on the Lessees

● To enable a redevelopment clause to be inserted into the leases, or amend existing redevelopment clauses, ABC made incentive payments/agreements with some Lessees

● ABC issued the termination notices within the X days

● The Contract states that 'at Completion … Purchaser may withhold some funds from the balance of the purchase price (Purchase Price Balance) until the last of the lessees to receive termination notices has vacated the property’

● The Contract appoints ABC as 123’s property manager for the purpose of solely managing and supervising the Lessees within the Properties in complying with the termination notices

● The Contract states that if the Lessees have not vacated their premises within XY months following Completion 123 may take whatever action it reasonably considers necessary in order to require any remaining Lessees to vacate their premises and may deduct from the Purchase Price Balance its costs reasonably incurred in removing the remaining lessees.

● Standard Commercial Condition 4 was amended.

● Definitions are provided in the Contract

● Completion – means completion of the sale and purchase of the property under this contract

● Completion date – means the date on which Completion occurs

● The Contract was completed, ABC was paid the outstanding purchase price less a Purchase Price Balance

● At the Contract completion date the Properties had YY Lessees

● Appendix B to the ruling application is a Historical Title Search. A sub-lease for QPO Pty Ltd (subsidiary of ABC) was lodged

● The Tax Agent advised the last of the Lessees vacated the Properties in 20AA

● ABC received the full Purchase Price Balance

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 70-80

Reasons for decision

Issue 1

When does an entity account for income?

Question 1

Was the Purchase Price Balance referred to in the Put and Call Option Deed assessable income of the Taxpayer pursuant to section 6-5 Income Tax Assessment Act 1997 in the income year ended June 20ZZ?

Summary

ABC Pty Ltd is the head of a consolidated group (Group). The Group holds properties as trading stock. The Group sold 2 properties.

The Group issued termination notices to the lessees and made payments to several of them to facilitate termination. The contract was completed and the Purchaser withheld funds as the Purchase Price Balance until the last of the lessees vacated the property. If vacant possession had not been secured the Purchaser could make payments themselves to ensure lessees had vacated the property and would duly reduce the Purchase Price Balance for any costs they incurred.

In 20AA the last of the lessees vacated the properties. The Group then received the Purchase Price Balance.

We considered your accounting method, the conditions of sale, the existence of a recoverable debt, your position as 123’s agent and that the final payment made to you did not have a contingent nature. As such we have determined the Purchase Price Balance payment was assessable income in the income year ended 30 June 20ZZ.

Detailed reasoning

You entered a contract to sell properties. You held these properties as trading stock.

The sale price of the Properties was fixed in the contract.

Accounting method

Taxable income must be worked out not only in relation to a fixed accounting period but also in accordance with the method of accounting that correctly reflects the entity’s true income. There are two methods of working out income for tax purposes:

● The cash or receipts basis; and

● The accruals or earnings basis

Under the accruals method, income is accounted for when the right to receive it comes into being. It is not actual receipt of money but the right to receive that is critical.

Section 6-5(4) Income Tax Assessment Act 1997 (ITAA 1997) states that when working out when income is derived '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’. The Commissioner's view on income derivation is contained in Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings.

Section 10-5 of ITAA 1997 sets out provisions for including assessable income amounts that are not ordinary income and income from sales of trading stock. Specifically, Section 70-80(1) of ITAA 1997 deals with disposal of trading stock. It states;

When you dispose of an item of your trading stock in the ordinary course of business, what you get for it is included in your assessable income (under section 6-5) as ordinary income.

TR 98/1 paragraphs 16 – 20 discuss the two commonly used methods of tax accounting for items of income - the receipts and earnings methods. It states that when accounting for income a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. Whether a particular method is appropriate to account for the income derived is a conclusion to be made from all the circumstances relevant to the taxpayer and the income. However, the earnings method is, in most cases, appropriate to determine business income derived from a trading or manufacturing business.

Conditions of sale

A condition of sale was imposed on you - that is you were required, within X days of entering the Contract, to give notice to relevant Lessees of the Properties to terminate their leases. You were also required to provide certified copies of the termination notices to 123 as well as provide evidence the notices were served on the Lessees. Paragraph 36 of Taxation Ruling TR 96/20 Income tax: assessability and deductibility of prompt payment discounts offered by traders of goods to their customers and certain other discounts (TR 96/20) states that the price at which the sale of your trading stock was mutually negotiated (and both communicated and quantified) is the amount of the debt arising out of the sale. The amount mutually negotiated, communicated and quantified in the Contract and as such is the sale price.

Taxation Ruling TR 97/15 Income tax: conditional contracts: derivation of income; allowable deductions; trading stock on hand discusses issues around conditional contracts (TR97/15) at paragraph 11 states that when determining whether an arrangement is properly characterised as a conditional contract, it is determined objectively according to the terms of trade and any other relevant circumstances of the parties.

The notices were served within the X day period and evidence was supplied to 123. All conditions of the Contract were then complete and there were no circumstances which would cause the Contract to become fatal and therefore fail. The Contract at completion date was, therefore, unconditional as at the completion date. Your Tax Agent advised us the Contract was completed in 20YY. As such, you had done everything, as the Vendor, you were required to do – your performance was complete.

Recoverable debt

TR 97/15 states income of a business trading in goods is derived when a presently existing debt is created under a contract for the sale of goods. Expressly,

'... trade debts which have accrued due in the relevant year but which have not been paid must be included for the purpose of ascertaining whether or not the business has earned a profit for the year, just as stock in trade at the beginning and end of the year must be taken into account for the same purpose.'

Further, the association between the existence of a debt and the sale of trading stock was supported in paragraph 27 of TR 97/15:

'... correct to lay stress upon the prominence given in Carden and Rowe to the importance of there being a debt in conjunction with a sale of trading stock before income is derived.'

Paragraph 29 of TR 97/15 states that the existence of a debt is not necessarily affected by an inability on the part of the seller to recover immediately the debt by action. It was necessary for you to account for both the reduction of your trading stock in your financial records and the income received. While the quantum of the recoverable debt could not be initially be determined when you sold the property, the contract contained no fatal clauses, you had accounted for the reduction in your trading stock and there was no impediment to you creating a recoverable debt even though that debt may not have immediately been payable. Therefore, the amount withheld by 123 was effectively earned when you completed all the actions necessary under the Contract - that is the 20YY completion date and within the 20ZZ financial year.

Principal and agent

The Contract appointed you as 123’s property manager. The purpose of appointment was solely to manage and supervise the Lessees within the Properties in complying with the termination notices.

Halsbury’s Laws of Australia online (2005) provides the meaning of 'agency'.

The traditional view of the term 'agency' connotes an authority or capacity in one person (the 'agent') to create legal relations between a person occupying the position of principal and third parties. However, it is not essential for an agent to have the capacity to actually create legal relations on behalf of the principal; an agent may be appointed to represent the principal in a less extensive manner, depending on the terms of the agent's authority, including merely to make representations on behalf of the principal. In each case, though, the critical element of the common law concept of agency is the representative capacity in which the agent acts vis-à-vis the principal. Whether an element of 'control' is also a part of the common law concept of agency is unclear, although its role may be to substantiate the representative element rather than as a stand-alone element

As advised by your Tax Agent the Contract was completed in 20YY. As stated in paragraph 36 of TR 96/20

…it is the price at which the sale has been mutually negotiated and it is both communicated and quantified. It is the amount of the debt arising out of the sale. Performance of the contract from the trader's perspective is complete - it is required to do no more to satisfy its right to receive the debt - the debt is presently due to it.

Once you issued the termination notices, provided evidence of issuance to 123 and the Property titles transferred to 123, you had fulfilled all the conditions of the Contract therefore performance of your responsibilities was complete.

It is important to note that critical to the concept of agency is the representative capacity in which the agent acts in relation to the principal. Once the title of the Properties transferred to 123 the Contract appointed you to manage and supervise Lessees – to make representations on behalf of the principal. Any action taken once the title to the Properties had transferred to 123 could only be taken as an agent as you had no capacity to take action in your own right. Therefore, once the Contract was complete you were then acting as the principal’s (123) agent.

Contingency

Paragraphs 33 to 35 of TR 97/15 state that a contract of sale of goods is made when the seller agrees to transfer the ownership of the goods to the purchaser for a sale price. A contract of sale is an agreement to sell when the transfer of property in the goods takes place later or is subject to a condition later to be fulfilled. A sale occurs when property in the goods is transferred by the contract from the seller to the purchaser. The sale price of goods under a contract of sale is usually fixed by the contract or by the course of dealings between the parties.

Documents were lodged in 20ZZ transferring the Property titles from you to 123. You stopped holding the Properties as trading stock and 123 starting holding them when the sale occurred - during the 20ZZ financial year. The sale had then irrevocably occurred. It was then necessary for you to account for the reduction in your trading stock.

TR 97/15 paragraph 36 continues on to say;

Where property in goods has passed under a sale, the seller has a presently existing right to claim the sale price from the purchaser as a debt

As the title to the Properties passed under the sale at that time you had a presently existing right to claim the sale price - the Contract sale price.

We have considered your arguments around Taxation Ruling TR 96/5 Income Tax: take or pay contracts and the Arthur Murray case but do not consider them relevant to your circumstance as at no time were you required to provide a refund to 123.

We have also considered your arguments around Taxation Ruling IT 2450 Income tax: recognition of income from long term construction contracts and contingencies. The ruling relates to construction contracts and contains the following exclusion in relation to construction contracts:

A long term construction contract does not include a contract for the sale and supply over time of what may ordinarily be regarded as the sale of trading stock

We do not consider IT 2450 is relevant to your circumstance as the Contract for the sale of the Properties was for the sale of trading stock and a construction contract does not include sales of trading stock. Further, payments made to you were not made as part of progress arrangements rather they were based on conditions contained in the Contract, all of which were fulfilled before the Contract was completed. Importantly, there were no circumstances which would cause the Contract to become fatal.

Similarly, we have considered your arguments relating to Taxation Ruling TR 2014/1 Income tax: commercial software licencing and hosted agreements: derivation of income from agreements for the right to use proprietary software and the provision of related services and do not consider the ruling is relevant to your circumstance. Paragraph 8 of TR 2014/1 states that when the underlying obligation is fully performed the amount properly allocated to the obligation converts from 'unearned' income' to 'earned income'. We consider that all conditions had been met when you gave termination notices to the Lessees and then provided certified copies to 123 in addition to provision of evidence the notices were served. At this time there were no circumstances which would cause the Contract to become fatal.

ATO ID 2009/63 Income Tax: Assessable Income: securitisation arrangement - profit emerging basis of returning assessable income discusses bringing assessable income to account. We do not consider the determination to be relevant to your circumstance as you 'denuded’ yourself of any right to an interest in the Properties when the titles of the Properties were transferred to 123 on the 20YY settlement date. At this time you were required to properly account for the reduction in your trading stock and the realisation of income earned.

Considering the facts and our views on contingency payments we do not consider payment made to you was of a contingent nature as all actions were complete by the Contract completion date.

We have considered your accounting method, the conditions of sale, the existence of a recoverable debt, your position as R&F’s agent and that the final payment made to you did not have a contingent nature. As such we have determined the Purchase Price Balance payment was assessable income in the income year ended 30 June 20ZZ.

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