Edited version of your written advice

Authorisation Number: 1051341626825

Date of advice: 2 March 2018

Ruling

Subject: TOFA – premium paid to acquire a portfolio

Question

Is the premium paid to acquire a portfolio of financial arrangements spread on a straight line basis over the expected 15 year life of the portfolio pursuant to Division 230?

Answer

Yes the premium is spread on a straight line basis for 15 years while the portfolio is held by the taxpayer.

This ruling applies for the following periods:

Year ended 31 December 2017

Year ending 31 December 2018

Year ending 31 December 2019

Relevant facts and circumstances

In the relevant year the taxpayer acquired a portfolio of credit card receivables.

The acquisition was pursuant to a number of agreements.

You have provided relevant clauses of your agreements which detail the obligations of the parties and the consideration involved. This includes a total purchase price and the face value of the receivables.

Intangible assets were valued and recognised in the accounts representing:

● the benefits expected to be generated from the current customer relationship.

● the benefits expected to be generated from future customers.

These intangible assets represent the premium paid on the acquisition of the portfolio within the accounts.

No consideration was paid for the use of trademarks as part of the agreement.

The agreement allowed for commission to be paid for distribution services provided in relation to the credit cards to be issued and funded by the taxpayer.

The taxpayer prepares audited statutory financial reports under Australian Accounting Standards (A-IFRS).

The Intangible assets are being amortised to zero on a straight line basis over an effective life of 15 years.

This treatment for accounting purposes has been confirmed by the taxpayer’s independent auditors of financial statements.

The taxpayer elected the following TOFA elections in years prior to the transaction:

● Fair value

● Foreign exchange retranslation – general retranslation election

● Reliance on financial reports

● Portfolio treatment under section 230-150 of the Income Tax Assessment Act 1997

The taxpayer expects that gross interest income alone from the portfolio to be well in excess of the consideration paid.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Subsection 230-45(1)

Income Tax Assessment Act 1997 Subsection 230-55(4)

Income Tax Assessment Act 1997 Subsection 230-410(1)

Income Tax Assessment Act 1997 Section 230-420

Income Tax Assessment Act 1997 Section 230-165

Income Tax Assessment Act 1997 Subsection 230-130(3)

Income Tax Assessment Act 1997 Subsection 230-110(1)

Reasons for decision

The taxpayer acquired a portfolio of credit card receivables. For Division 230 to apply to a credit card receivable it must be a financial arrangement. Financial arrangement is defined by 995-1 to be the meaning given by sections 230-45 to 230-55. Relevantly, a credit card account is a financial arrangement as it represents a cash settlable legal right to receive a financial benefit as per section 230-45(1)(a) (or 230-45(1)(b) where the account is in credit) and does not meet the exemptions within section 230-45. Additionally, each account would constitute one arrangement rather than separate arrangements in accordance with subsection 230-55(4):

230-55(4) For the purposes of this Division, whether a number of rights and/or obligations are themselves an *arrangement or are 2 or more separate arrangements is a question of fact and degree that you determine having regard to the following:

(a) the nature of the rights and/or obligations;

(b) their terms and conditions (including those relating to any payment or other consideration for them);

(c) the circumstances surrounding their creation and their proposed exercise or performance (including what can reasonably be seen as the purposes of one or more of the entities involved);

(d) whether they can be dealt with separately or must be dealt with together;

(e) normal commercial understandings and practices in relation to them (including whether they are regarded commercially as separate things or as a group or series that forms a whole);

(f) the objects of this Division.

In applying this subsection, have regard to the matters referred to in paragraphs (a) to (f) both in relation to the rights and/or obligations separately and in relation to the rights and/or obligations in combination with each other.

Example 2.6: Interest bearing bank account in Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 - Explanatory Memorandum - REPS - Chapter 2 Definition of 'financial arrangement' provides a similar fact pattern that is applicable to the credit card receivables. That is, the rights and obligations under the credit card arrangement are dealt with together. The terms and conditions reflect that commercially this is treated as a single arrangement and treating a credit card account as a single arrangement would be consistent with the objects of Division 230.

Subdivision 230-F

Given that the taxpayer has made the election to rely on its financial reports subdivision 230-F applies to its financial arrangements. Section 230-410 outlines the financial arrangements to which the election applies. Specifically, subsection 230-410(1) below states:

An *election to rely on financial reports applies in relation to a *financial arrangement that you have if:

(a) the arrangement is a *Division 230 financial arrangement; and

(b) you start to have the arrangement in the income year in which you make the election or in a later income year; and

(c) the arrangement is recognised in financial reports of the kind referred to in paragraph 230-395(2)(a) that are audited as referred to in paragraph 230-395(2)(b); and

(d) if the arrangement is a financial arrangement under section 230-50- the arrangement is an asset or liability that you are required (whether or not as a result of a choice you make) by: (i) the *accounting principles; or (ii) if the accounting principles do not apply to the preparation of the financial report - comparable standards for accounting that apply to the preparation of the financial report under a *foreign law; to classify or designate, in the financial reports, as at fair value through profit or loss; and
(e) it is reasonably expected that the following is, or will be, the same: (i) the amount of the overall gain or loss you make from the arrangement (as determined in accordance with the financial reports); (ii) the amount of the overall gain or loss you make from the arrangement (as determined in accordance with the provisions of this Division if the election under this subsection did not apply to the arrangement); and

(f) the differences between the results of the following methods would reasonably be expected not to be substantial:

(i) the method used in your financial reports to work out the amounts of the gain or loss you make from the arrangement for each income year;

(ii) the method that would be applied by this Division to work out the amounts of those gains or losses if the election did not apply to the arrangement.

This subsection has effect subject to section 230-415.

The first three criteria (a, b and c) are met as it is a financial arrangement, it was obtained in the correct income year, and the asset is recognised in the accounts. The fourth criterion in paragraph (d) is not relevant as the arrangement is not a section 230-50 financial arrangement (which pertains to equity interests). Consideration then needs to be given to the final two criteria - (e) and (f). To determine whether these are met we need to consider how the gains/losses would be calculated under subdivision 230-F compared to how they would be calculated if the financial reports election did not apply.

How the gains/losses calculated under 230-F

Section 230-420 outlines the effect of an election to rely on financial reports. Relevantly, 230-420(1)(a) indicates that the gain or loss you make from the arrangement for TOFA purposes is that which is recognised in the profit or loss from that arrangement.

In regards to the premium paid by the taxpayer this was treated in the accounts as a depreciation expense straight line over 15 years. Therefore, under subdivision 230-F, these gains and losses would be recognised for TOFA purposes in accordance with the accounting treatment. We note this expense was calculated in reference to the difference between the fair value of the receivables and the amount paid. This is because the difference was treated in the accounts as a depreciating asset.

As explained below, the calculation for 230-B purposes where a premium election has been made is between the face value of the receivables and the amount paid and therefore there is a difference in treatment.

Additionally, credit card receivables also give rise to various sources of income, primarily including interest income and fees. It is noted that there will be little, if any difference in the treatment of interest income and fees under subdivisions 230-B and 230-F and therefore this has not been considered further.

Gains/Losses where no financial reports election

If subdivision 230-F did not apply then 230-B (the accruals/realisation method of calculation) would apply.

As the taxpayer has made the portfolio election, whether section 230-165 (within 230-B) applies needs to be considered.

Subsection 230-165(1) states:

This section applies in relation to a *financial arrangement if:

(a) you have made an election under section 230-150 in an income year; and

(b) you start to have the financial arrangement in that income year or a later income year; and

(c) the financial arrangement is part of a portfolio of similar financial arrangements; and

(d) a gain or loss to which subsection 230-130(3) applies arises in part from a premium or discount in starting to have the portfolio; and

(e) the gain or loss is not expected to be significant relative to the amount of the gain or loss on the portfolio.

The first three criteria clearly apply i.e. the taxpayer has made the election, the financial arrangements were purchased in the correct year and it is a credit card portfolio comprising similar financial arrangements.

230-165(1)(d)

For (d) to apply we need to consider 230-130(3):

230-130(3)

If you have a sufficiently certain gain or loss from a *financial arrangement under subsection 230-110(1), the period over which the gain or loss is to be spread is the period to which the gain or loss relates. Have regard to the pricing, terms and conditions of the arrangement in working out the period to which the gain or loss relates. This subsection has effect subject to subsections (4) and (5).

Which in turn requires us to consider 230-110(1):

230-110(1)

You have a sufficiently certain gain or loss from a *financial arrangement at a particular time if it is sufficiently certain at that time that you make, or will make, a gain or loss from the arrangement of:

(a) a particular amount; or

(b) at least a particular amount;

when one of the following occurs:

(c) you receive a particular *financial benefit under the arrangement or one of your rights under the arrangement ceases;

(d) you provide a particular financial benefit under the arrangement or one of your obligations under the arrangement ceases.

The amount of the gain or loss is the amount referred to in paragraph (a) or (b).

The taxpayer paid a significant amount for credit card receivables with a face value lower than the amount paid. At this point, there is a sufficiently certain loss of a particular amount, being approximately 3% on what was paid, which occurred when the taxpayer made the payment, satisfying paragraph 230-110(1)(d).

For completeness, this is a loss because section 230-60 indicates that a financial benefit is provided under a financial arrangement where it is in relation to that financial benefit even if is not provided to a party to the arrangement. The note to 230-60 explicitly states:

This means that the financial benefits you provide to acquire the financial arrangement (whether to the issuer, a previous holder or a third party) are taken to be financial benefits you provide under the arrangement. The financial benefits you provide may include, for example, fees paid or the forgoing of rights to receive a financial benefit.

This is a loss to which subsection 230-130(3) applies. In order for paragraph 230-165(1)(d) to be satisfied, this must arise in part from a premium or discount in starting to have the portfolio.

As outlined in ATO Interpretative Decision ATO ID 2011/91 Income Tax - Taxation of financial arrangements: meaning of 'premium' in section 230-165 of the Income Tax Assessment Act 1997 (ATO ID 2011/91) premium is not a defined term for the purposes of Division 230. ATO ID 2011/91 also indicates that a premium (or discount) is calculated in nominal terms:

It is consistent with the structure of Division 230 to calculate the discount or premium which arises due to the acquisition of the entire portfolio (rather than being attributable to any specific financial arrangement within that portfolio) in the same manner that a gain or loss referrable to an individual financial arrangement would ordinarily be calculated. That is the net gain or loss in nominal terms is determined by comparing the difference between the outgoings (consideration paid) and receipts (principal outstanding at the time of acquisition).

The facts indicate that the face value/nominal value of the credit card accounts was a lower figure than the consideration paid therefore the premium paid was approximately 3%.

The first four criteria of 230-165(1) are therefore met and we need to consider the last.

230-165(1)(e)

the gain or loss is not expected to be significant relative to the amount of the gain or loss on the portfolio.

The facts indicate that the expected interest for the life of the portfolio will be significant and the premium paid is not significant relative to the gain/loss on the portfolio.

This means 230-165 will apply. Section 230-165 will therefore result in the premium (loss) being spread over 15 years as the accounting treatment is to spread the premium over 15 years (based on the contracts and likelihood of extension)..

Final criteria for 230-410(1) i.e. (e) & (f)

Now that we have determined how Division 230 would calculate the loss on the portfolio if no financial report election was made we can consider the last two remaining criteria for determining whether the financial report election should apply to the credit card receivables, i.e. 230-410(1)(e) & (f)

(e) it is reasonably expected that the following is, or will be, the same: (i) the amount of the overall gain or loss you make from the arrangement (as determined in accordance with the financial reports); (ii) the amount of the overall gain or loss you make from the arrangement (as determined in accordance with the provisions of this Division if the election under this subsection did not apply to the arrangement); and

(f) the differences between the results of the following methods would reasonably be expected not to be substantial:

(i) the method used in your financial reports to work out the amounts of the gain or loss you make from the arrangement for each income year;

(ii) the method that would be applied by this Division to work out the amounts of those gains or losses if the election did not apply to the arrangement.

This subsection has effect subject to section 230-415.

230-410(1)(e)

230-410(1)(e) will be satisfied as the overall gain/loss from the arrangement would be the same as gains on interest etc. are essentially the same and under 230-B and 230-F. Although the premium is calculated differently so there are different losses for the 15 years of the portfolio there would be a balancing adjustment (equal and opposite) once the financial arrangement ends so that the overall gain/loss would be the same.

230-410(1)(f)

As described above the difference between the methods of calculation is that under 230-F there is a higher deduction each year compared to 230-B and a balancing adjustment (when the entity ceases to have the financial arrangements) of the difference. To determine whether this is substantial we need to consider the figures involved.

Specifically, the difference between the financial reporting premium and the accrual is approximately 30%. However, given the expense/loss is spread over 15 years difference per year is insignificant particularly compared to the overall gains/losses expected.

Therefore 230-410(1)(f) is met and the calculation method under 230-F applies.

On this basis the premium amount will be treated as a loss and spread on a straight line basis over the expected 15 year life of the portfolio pursuant to Division 230.

Recognising the loss in accordance with the financial report is consistent with one of the objects of Division 230 which is to align more closely the tax and commercial recognition of gains and losses from financial arrangements, as per paragraph 230-10(b).

We note that as per section 230-15 the loss is deducted as it was necessarily made in carrying on business for the purpose of gaining or producing assessable income.

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