Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1051336491581

Date of advice: 8 February 2018

Ruling

Subject: Capital gains tax - intangible assets – ending - capital versus income

Question 1:

Is the Client Base a capital gains tax asset under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2:

Will capital gains tax event A1 occur on the disposal of your Client Base to Company A for the amount of $XXX,XXX under section 104-10 of the ITAA 1997?

Answer:

Yes. However, capital gains tax event C2 is the most relevant capital gains tax event in relation to the receipt of the $XX,XXX.

Question 3:

Will the payment of $XX,XXX received from Company A be assessable under either section 6-5 of the ITAA or section 15-2 of the ITAA 1997?

Answer:

Yes. It will be assessable under section 15-2 of the ITAA.

This ruling applies for the following period

Income year ending 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

You have worked as an professional in public practice for a number of years, having various employers including Firm A, which was a relative’s business. You decided that you wanted to work for a large firm rather than taking over Firm A and Firm A was sold to Firm B. You worked briefly with Firm B to assist with the transitioning of Firm A’s clients prior to you commencing employment with Firm C.

You took some of your existing clients with you when you commenced your employment with Firm C.

Your Firm C employment agreement included restraint of trade clauses however they did not apply to any person or entities who were already your client immediately prior to you commencing employment with Firm C.

You were approached by Company A while you were working at Firm C, who offered you a position with them. During the negotiations, you advised Company A that you had a small client base (the Client Base) that would come with you and they advised that while they were after you, your clients could come with you. It was agreed that you would not receive any payment for your Client Base and if in the future you acquired shares in Company B, who wholly owns Company A, consideration would be given at that time to reduce the purchase price of the Company B shares by an amount equal to the market value of your Client Base.

Company A sent an offer of employment to you.

You received a letter in relation to the transfer of your Client Base to Company A which included the following information and statements:

You commenced employment with Company A.

You have recently been offered the opportunity to purchase shares in Company B.

You discussed the pre-employment negotiation agreement with your current managing director at Company A who advised that as you would be buying your shares directly from an existing shareholder, it would not be possible for the share price to be reduced by the market value of your Client Base as agreed in your pre-employment negotiations. It was agreed that Company A would purchase your Client Base and you would use the sale proceeds to purchase the shares from the shareholder.

You entered into a deed with Company A which outlines the following:

You have always been an employee and have never owned a specific practice.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-2

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1936 Paragraph 26(e)

Fringe Benefits Tax Assessment Act Subsection 136(1)

Reasons for decision

Summary

The payment of $XX,XXX will be assessable under section 15-2 of the ITAA 1997.

Detailed reasoning

You entered into an arrangement with Company A under which the acquisition price of any shares that you were offered in Company B would be reduced by the market value of your Client Base. It is now proposed that you will receive the amount of $XX,XXX from Company A so that you can purchase shares in Company B directly from a shareholder.

We have considered the following when determining how the $XX,XXX will be assessed:

Section 6-5 of the ITAA 1997

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts, which is called ‘ordinary income’.

The legislation does not provide guidance on the meaning of 'income according to ordinary concepts' in section 6-5 of the ITAA 1997. However, guidance in determining whether a receipt will be ordinary income can be found in case law.

Ordinary income will generally have the characteristics of being periodic, recurring, and regular. Such characteristics of income have been emphasised by decisions in the FC of T v Dixon (1952) 86 CLR 540: 10 ATD 82 (Dixon case) and Just v. FC of T (1949) 8 ATD 419. As Dixon CJ and Williams J stated in their decision in the Dixon case:

However, a one-off payment may also be characterised as ordinary income where the payment has a sufficient connection with services rendered.

Section 6-5 of the ITAA 1997 is limited to receipts of a revenue nature. In practical terms, section 15-2 of the ITAA 1997 will generally only apply to receipts that are of a capital nature as section 6-5 of the ITAA 1997 would apply in preference to revenue receipts.

Section 15-2 of the ITAA 1997

Section 15-2 of the ITAA 1997 has the equivalent meaning of the former paragraph 26(e) of the Income Tax Assessment Act 1936 (ITAA 1936) and relates to assessable income including allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered.

Section 15-2 of the ITAA 1997 is relevant in the context of benefits etc. provided in respect of or in relation to:

With respect to the applicability of this provision, the critical issues to be considered are whether there was is direct or indirect connection between the payment received and the services provided to an employer.

Directly or indirectly related to employment

The phrase ‘in respect of’ in relation to the employment of an employee is defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act (FBTAA) to include ‘by reason of, by virtue of, for or in relation directly or indirectly to, that employment’.

The meaning of this phrase was considered by the Federal Court in J & G Knowles v. Federal Commissioner of Taxation [2002] 96 FCR 402; 2000 ATC 4151; 44 ATR 22 (Knowles case) and Starrim Pty Ltd v. Federal Commissioner of Taxation [2000] FCA 952; 2000 ATC 4460; 44 ATR 487 (Starrim case).

In Knowles case the Full Federal Court considered the judgements in Smith v. FCT (1987) 164 CLR 513; 19 ATR 274; 87 ATC 4883 and Federal Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 31 ATR 392; 95 ATC 4691 before concluding that it is not sufficient for the purposes of the FBTAA to conclude that there is a causal connection between the benefit and the employment.

At paragraph 26 the Court said:

At paragraphs 28 and 29, the Court said:

In Starrim Lindgren J. further considered the phrase ‘in respect of’ in relation to a private company which provided benefits to a husband and wife who were its only shareholders and directors. In considering whether the benefits were provided in respect of their employment as directors, Lindgren J said at paragraph 52:

The closer the benefit or gain is to the workplace or employment, the more likely it is to be ordinary income (or be subject to fringe benefits tax). In Federal Commissioner of Taxation v. Smith (1986) 86 ATC 4463 (Smith case), a taxpayer received a payment for completing a management certificate course. Once the court accepted that the payment would not have been made if the relationship of employer and employee had not existed, it was impossible to deny that employment was not a contributory cause of the payment. The payment was therefore causally connected to the taxpayer's employment by the bank and was assessable under paragraph 26(e) of the ITAA 1936.

Services rendered

The expression "services rendered" refers to situations not encompassed by the term "employment". "Services rendered" was considered in FC of T v Holmes 95 ATC 4476 (Holmes case) where was held to be assessable on his share of a salvage reward payment. Although the obligation to make the payment to the taxpayer was contingent upon the success of the salvage operation, there was a real connection between the payment received and the services rendered by him in the course of the salvage operation. The payment was a reward for the services rendered by the taxpayer and fell squarely within the language of former s 26(e) of the ITAA 1936.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

A CGT asset is:

CGT event A1 happens if you dispose a CGT asset and your ownership interest in the asset is transferred to another entity.

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

The general rule of applying CGT events if more than one CGT event happens, with the exception of CGT events D2 and H2, is that the one that applies is the one that is most specific to the taxpayer’s situation.

The anti-lap provisions contained in section 118-20 of the ITAA 1997 operate to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains to ensure that the amount is not taxed twice. That is, where a CGT event occurs which causes an amount to be assessable income and also results in a capital gain for CGT purposes, the full amount is included in assessable income and the capital gain amount is reduced by that amount.

Application to your situation

Your Firm C employment agreement created a CGT asset, being your Client Base, which enabled you to take any person or entity that was already your existing client immediately before commencing with Firm C with you when you left their employment.

You were approached by Company A while you were working for Firm C. At that point you had a number of clients in your Client Base which you had obtained during your employment prior to commencing at Firm C.

During the pre-employment negotiations with Company A it was agreed that your existing clients could come with you to Company A. It was also agreed that you would not receive any payment for your Client Base and if in the future you acquired shares in Company B and consideration would be given at that time to reduce the purchase price of the Company B shares by an amount equal to the market value of your Client Base.

You state that you wanted the following outcomes from your pre-employment negotiations with Company A:

You have been offered shares in Company B which are owned by a shareholder. As a result, you will receive an amount of $XX,XXX so that you can purchase the shares from the shareholder instead of having the acquisition price reduced by the market value of the Client Base.

Consequently, the question being posed in this situation is whether the benefit obtained, being the receipt of $XX,XXX, is a reward for service/employment or the exploitation of a valuable right independent of that service/employment is based on whether the right has an existence independent of the employment relationship.

Prior to you commencing your employment with Company A you had a CGT asset, being your Client Base. It is viewed that when you entered into your agreement with Company A that an intangible asset was created for CGT purposes, being your right as against Company A to receive the market value of your Client Base if you were offered equity in Company B in the future.

A CGT event A1 will occur on the disposal of the Client Base. However, CGT event C2 will also occur as a result of your right ending due to Company A making the payment of $XX,XXX. It is viewed that in this situation that the most relevant CGT event is C2.

We have taken the following into consideration when determining whether the $XX,XXX will be assessable under either section 6-5 of the ITAA 1997 or section 15-2 of the ITAA 1997.

The terms of the pre-employment negotiations indicate that it was anticipated that you would be offered shares while employed by Company A. As the benefit, being either the market value reduction on the purchase price of the shares or the $XX,XXX, received by you was dependent on you being employed at Company A and being offered shares after you commenced your employment, it can be viewed that your activities to facilitate and assist with the complying of the necessary conditions played a part in the provision of payment to you. Additionally, Company A would not be paying you the $XX,XXX for your right if the pre-employment negotiation agreement did not exist.

The fact that you are now receiving the amount of $XX,XXX for the ending of the right instead of having the acquisition price of the shares reduced by the market value of your Client Base will not alter the fact that the amount is being received is relation to your employment, either directly or indirectly.

There is a discernible and rational link between you receiving the payment from Company A and your employment, being a product or incident of your employment, which is therefore not only a contributory cause but a proximate cause for the payment of the $XX,XXX to you.

While the payment will be capital payment, it is also a benefit and a payment made and performed by Company A, your employer. It is not viewed that the $XX,XXX will be assessable under section 6-5 of the ITAA 1997 as it will not have the characteristics of ordinary income and it will not be revenue in nature. Therefore, the $XX,XXX will be included in your assessable income in the income year in which it is received under section 15-2 of the ITAA 1997.

The basic CGT provisions will still apply even if the calculation results in there being no capital gain or loss, or the capital gain or capital loss is being disregarded in accordance with section 118-20 of the ITAA 1997. Therefore, any capital gain or capital loss will still need to be calculated for the CGT event C2. Section 118-20 of the ITAA 1997 will reduce any capital gain made on the ending of the right to the extent that payment will be assessed under section 15-2 of the ITAA 1997.

Conclusion

Your Client Base is a CGT asset for CGT purposes. You also have an intangible asset, being the right, when you entered into your agreement with Company A under which they would reduce the acquisition price of any shares offered to you by the market value of your Client Base.

CGT event A1 will occur on the disposal of your Client Base. However, CGT event C2 which will occur when your right ends and is considered to be the more relevant CGT event in this situation.

The payment of $XX,XXX will be assessable under section 15-2 of the ITAA 1997.


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).