Edited version of private advice

Authorisation Number: 1051743973496

Date of advice: 31 August 2020

Ruling

Subject: Cash accounting

Question

Is the income of $XXX,XXX from a company included in the prefill of your income tax return for the year ended 30th June 20XX not an assessable income in the year ended 30th June 20XX?

Answer

Yes

This ruling applies for the following period:

Year ended the 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are a sole trader and deal building materials with a current turnover less than $XXX per year.

You are currently registered for and report for income and GST on a cash (receipts) basis and have always accounted all transactions on this basis.

You issued an Invoice on XX June 20XX to supply a product for an amount of $XXX to a company for their office fit out.

The actual transaction as per the invoice did not occur until after XX June 20XX in the next financial year.

Part of the payment of the invoice amounting to $XXX was credited to your bank account on X July 20XX.

You declared in your income tax returns that you are a personal services business.

The business you were contracted with, accounts on an accrual basis. As a result, the transaction was recorded on the XX of June 20XX on their accounts and Taxable payments annual report (TPAR). This caused a mismatch between when the transaction is reported in the books of the two entities.

You have been advised from the TPAR reporting area, that when such inconsistencies to the basis of reporting are identified in future, you should contact them so the statements/reports can be amended to account for the misalignment of the basis of accounting.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 subsection 6-5(4)

Reasons for decision

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer's assessable income includes income according to ordinary concepts.

Under subsections 6-5(2) and 6-5(3) of the ITAA 1997, taxpayers must include in assessable income any ordinary income derived.

Subsection 6-5(4) of the ITAA 1997 states that, in determining if and when a taxpayer has derived an amount of ordinary income, the taxpayer is taken to have received it as soon as it is applied or dealt with in any way on their behalf or as they direct.

Methods of accounting

The Courts have recognised the following two methods for determining when income is derived in a relevant year of income:

1. The 'receipts' method (or 'cash' method). Under this method, income is derived when it is received, either actually or constructively, under subsection 6-5(4) of the ITAA 1997 (Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418; 71 ATC 4195; (1971) 2 ATR 563 (Brent)), and

2. The 'earnings' method (or 'accruals' method). Under this method, income is derived when it is earned(Henderson v. Federal Commissioner of Taxation (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596(Henderson)). The point of derivation occurs when a 'recoverable debt' is created.That is, income is accounted for when the right to receive it comes into being, when all the events that determine the right have occurred. It is not actual receipt but the right to receive that is critical.

Determining when each accounting method is the correct method

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings (TR 98/1) discusses the factors that are relevant in determining when, in the Commissioner's view, each method is the correct method to bring income to account for tax purposes.

In determining which accounting method is appropriate, we need to consider which method is likely to provide a substantially correct reflex of income in the relevant financial year (paragraph 17 of TR 98/1).

Paragraph 18 of TR 98/1 provides that the receipts method of accounting is likely to be appropriate to determine:

·         income derived by an employee;

·         non-business income derived from the provision of knowledge or the exercise of skill possessed by the taxpayer; and

·         business income where the income is derived from the provision of knowledge or the exercise of skill possessed by the taxpayer in the provision of services (subject to the qualifications listed at paragraph 45).

In your circumstance, you have declared in your income tax returns that you are a personal services business involved in the provision of your knowledge and the exercise of skill.

Paragraph 45 of TR 98/1 states:

However, the presence of any of the following factors to a significant degree, would indicate that the income is not simply a reward for the provision of personal services by the taxpayer:

·         the taxpayer's income producing activities involve the sale of trading stock;

·         the outgoings incurred by the taxpayer, in the day to day conduct of the business, have a direct relationship to income derived;

·         the taxpayer relies on circulating capital or consumables to produce income; or

·         the taxpayer relies on staff or equipment to produce income.

The income declared in the Income Tax Returns to date would suggest none of the abovementioned factors play a significant role in generating your income. You do not buy and sell goods or employ as your income is derived from exercising your skill.

Consistency of method of accounting

Paragraph 31 of TR 98/1 further states that:

·         A taxpayer who accounts for items of income on a receipts basis should continue to adopt that method until it is no longer appropriate'.

Application to your circumstances

You are currently reporting your Income and GST on a cash (receipts) basis. Since the inception of your business you have been registered and always reported on cash basis. You run a sole trader business providing your skills to customers. As you are a small business with a total turnover of less than $XXX it is therefore, appropriate based on your size, type and the nature of the business that the $XXX included in the prefill of your income tax returns from the contracted company, be included in the next financial year ending on 30 June 20XX.

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