Edited version of private advice

Authorisation Number: 1051646420434

Date of advice: 13 March 2020

Ruling

Subject: Trailing commissions - emerging profit basis of reporting income

Question 1

Can you calculate your taxable income, consisting of trailing commissions from purchased loan books, on a profit emerging basis?

Answer

Yes.

Question 2

Does the Commissioner have a preferred method of calculating the emerging profit?

Answer

No.

Question 3

Will the proceeds from the sale of the right to receive trailing commissions from the loan book be assessable under the capital gains tax (CGT) provisions?

Answer

Yes.

Question 4

Will the proceeds from the sale of the right to receive trailing commissions from the loan book be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 5

Is the right to receive trailing commissions an active asset under the small business CGT concessions provisions in Subdivision 152-A of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You operate a loan broking business.

You acquired a loan book from another loan broker.

You receive trailing commissions on the loans within the loan book that existed when you purchased the loan book.

You propose using the straight line amortisation method to calculate your assessable income from received in relation to your right to receive trailing commissions from the loan book.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subdivision 152-A

Reasons for decision

Question 1

Profit emerging basis

Your assessable income includes income according to ordinary concepts, which is called ordinary income under section 6-5 of the ITAA 1997.

ATO ID Interpretative Decision ATO ID 2008/39 Income tax: Acquisition of debt ledgers outlines that a profit emerging basis is the appropriate method of determining assessable income for the purposes of section 6-5 of the ITAA in relation to a taxpayer carrying on a business of acquiring and recovering receipts from abandoned debt ledgers.

Application to your situation

When you entered into the agreement to acquire the loan book, you acquired a legal chose in action giving you the right to receive trailing commissions (the Right).

You entered into the transaction with the expectation of making a profit where the proceeds from the trailing commissions would exceed the cost of the acquired right to receive them. The consideration paid on acquisition of the Right is funded by capital being either debt, equity or a mixture of both. Any receipts from collections therefore comprise a return in the form of a partial recovery of your investment, being a return of capital, and a profit component.

When you collect money in respect of the outstanding trailing commissions, you recover your capital, and in part realise a profit. You do not receive them as an income stream, but as receipts of money, rather than ordinary income. Therefore, only part of the receipts can be considered income. As such, the gross receipts used in the calculation of the net profit are themselves not ordinary income.

Your profit-making scheme extends over more than one income year. The bringing to account for tax purposes of the difference between receipts and disbursements in any one particular income year will not give a true reflection of the profit or loss sustained for that year.

Based on the information provided, the Commissioner considers it appropriate to apply the principles outlined in ATO ID 2008/39 to your situation. Therefore, it is viewed that the profit emerging basis the most appropriate method in determining your assessable income from the Right under section 6-5 of the ITAA 1997.

Question 2

Appropriate method of calculating the emerging profit

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings provides guidance on the accounting method likely to provide a substantially correct reflex of income in a relevant year. While this ruling is mainly concerned with distinguishing between a cash receipts basis and an earnings basis, it states the following at paragraph 17:

When accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. A method of accounting is appropriate if it gives a substantially correct reflex of income. 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.

The Commissioner does not have a preferred method that should be adopted when using the profit emerging basis of assessment of income. Any method will suffice so long as it produces a substantially correct reflex of the taxpayer's true assessable income. Whether a method gives a substantially correct reflex and therefore is appropriate is a conclusion to be made from all the circumstances relevant to the taxpayer and the income.

Possible methods that could be adopted include the straight line and the first in/first out (FIFO) methodologies.

A further method for consideration is a formula used in the calculation of income from debt ledgers:

A - (A x B/C)

Where A = Collections from the ledger; B = Cost of the ledger; and C = Total anticipated collections from the ledger.

The result of the calculation is the amount of assessable income for the financial year and the remainder of the collections is a return of capital. This method could equally apply to the receipt of trailing commissions.

Application to your situation

A calculation of the emerging profit from the trailing commissions using the straight line amortisation method has been provided with the ruling.

In the absence of any direct guidance as to the method to be adopted when using the emerging profit basis of assessment of income, it is viewed that any method will suffice so long as it produces a substantially correct reflex of the taxpayer's true assessable income as outlined in TR 98/1.

In this case, it is considered that the methodology proposed by you is an appropriate method of returning the profit derived from the Right as this method gives a 'substantially correct reflex of income in the relevant year. Therefore, you can use the straight line amortisation method to calculate the emerging profits arising in relation to the trailing commissions.

Questions 3 and 4

Assessability on the sale of the right to future trailing commissions

A CGT asset is any kind of property, or a legal or equitable right that is not property.

Taxation Ruling TR 2000/1 Income tax: insurance registers provides guidelines on the taxation consequences of acquiring or disposing of an insurance register. For the purpose of the ruling an insurance register is a record of the rights of an insurance agent to future commissions and a record of policyholders that an agent has an exclusive right to deal with on behalf of an insurance company.

TR 2000/1 considers that an insurance register is a capital asset where it is held as part of the profit making structure of a business. Loan books are comparable to insurance registers.

Paragraph 18 in TR 2000/1 states when a chose in action consisting of a right to renewal, CPI and/or orphan policy commissions is severed from an agency agreement and assigned to a purchaser, there is a disposal of a CGT asset.

The cost base of the severed chose in action is worked out under subsections 112-30(2) and (3) of the ITAA 1997. The capital proceeds for the CGT event are the amount received from the purchaser, or if no amount is received the market value of the CGT asset at the time of the event under section 116-30 of the ITAA 1997. The capital gain (or loss) is then worked out under subsection 104-10(4) of the ITAA 1997 by subtracting the (reduced) cost base from the capital proceeds.

Application to your situation

In this case you purchased the Right which is considered a chose in action that is a legal right and not property. The Right is a CGT asset and CGT event A1 will occur when the right is sold.

The amounts received for the disposal of the Right will be of a capital nature that will constitute capital proceeds for the disposal of a CGT asset. Any gain made on that disposal will be assessed under the CGT provisions and will not be assessable as ordinary income.

Question 5

Active asset

A CGT asset is an active asset at a time if, at that time, you own the asset (whether the asset is tangible or intangible) and it is used or held ready for use, in the course of carrying on a business that is carried on by you, your affiliate or another entity that is connected with you.

If the asset is an intangible asset it will be an active asset if, at that time, you own it and it is inherently connected with a business that is carried on by you, your affiliate, or another entity that is connected with you.

Application to your situation

The Right is an intangible CGT asset that is inherently connected with your loan broking business. Therefore, it is viewed as an active asset.

Note: To be eligible for the small business CGT concessions, you will need to satisfy the basic conditions contained in Subdivision 152-A 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).