Edited version of private advice

Authorisation Number: 1051821395305

Date of advice: 31 March 2021

Ruling

Subject: Right to future income for the purpose of tax consolidation rules

Question 1

Is the FMA a CGT asset of AAA Co (AAA) for the purposes of the tax consolidation rules under paragraph 701-67(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the FMA a 'right to future income' (RTFI) under subsection 701-63(5) of the ITAA 1997?

Answer

Yes

Question 3

Is the FMA a retained cost base asset for tax cost setting purposes pursuant to paragraph

705-25(5)(d) of the ITAA 1997?

Answer

Yes

Question 4

Is the terminating value of the FMA equal to zero, being its cost base just before the joining time pursuant to subsection 705-30(4) of the ITAA 1997?

Answer

Yes

Question 5

Does the 'unbilled income asset' of AAA of $8,621,461 at the joining time meet the definition of 'WIP amount asset' in subsection 701-63(6) of the ITAA 1997?

Answer

Yes

Question 6

If the answer to Question 5 is yes, will HoldCo be entitled to a tax deduction in accordance with section 25-95 of the ITAA 1997 equal to the tax cost setting amount of the unbilled income asset of AAA as at the date of acquisition?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

28 October 20XX

Relevant facts and circumstances

AAA is an Australian unlisted resident company. AAA and BBB Co (BBB) are both wholly owned by CCC Co (CCC).

HoldCo Pty Ltd (HoldCo), an Australian resident company, is the head company of a tax consolidated group (TCG) consisting of MidCo and BidCo.

On xx/xx/20xx, HoldCo acquired 100% of the shares in CCC through BidCo (the Acquisition). On the same date, CCC and its subsidiaries joined the HoldCo TCG as wholly owned subsidiaries ('joining time' or 'joining date') of HoldCo.

Immediately prior to the Acquisition, AAA, BBB and CCC were not members of a TCG.

HoldCo, as the head company of a TCG is required to carry out a tax cost setting process in respect of the assets held by CCC and its wholly owned subsidiaries as at the joining date. Two of the assets to which the HoldCo TCG is required to allocate the allocable cost amount (ACA) to are the FMA and the unbilled income assets.

Facilities Management Agreement (FMA) Asset

The FMA is an agreement entered into between AAA, XYZ Funds Pty Ltd (XYZ) and each of the partners in the AAA Partnership (the Partnership). It governs the conduct between the entities in an arrangement in which the Partnership conducts the business and agrees to exclusively use AAA to provide facilities management services for which AAA receives a Management Fee payable by the Partnership.

The Management Fee is calculated as follows:

MF = [SF x 0.XXXX] + OC + IS - BSA

Where:

SF - Net Service Fees which represents the total billings net of any bad debts

OC - On-costs which represents the cost of other specialists and staff

IS - Investor share which represents the profits from the Partnership that receivable by XYZ; and

BSA - Budgeted Shortfall Amount

The Management Fee calculation shows xx% of the revenue of the Partnership is paid to AAA under the FMA for management services AAA provides with respect to the operation of the business centres.

In receiving Management Fees, AAA must in accordance with the FMA, provide a number of facilities management services to the Partnership.

As part of its purchase price allocation, HoldCo obtained an independent valuation to determine the fair value of the intangible assets acquired as part of the acquisition of CCC. The intangible assets were identified and valued as at xx/xx/20xx, which is the completion date of the Share Purchase Agreement for the acquisition of CCC. The valuation for the purchase price allocation will be used in determining the market values of the intangible assets for the purposes of completing the ACA calculation.

The valuation report identified the FMA as a key intangible asset acquired. The valuation report provides a range of valuations for the FMA.

The valuation report separately identified that the business of AAA also included residual goodwill.

Unbilled Income Asset

The FMA provides AAA the right to charge and receive Management Fees on an annual basis, as consideration for providing management services. However, an estimate of the Management Fee for each month is chargeable following the end of a month. The estimate is calculated as the Net Service Fees for the month minus interim partnership drawings payable out of the Partnership Account.

Following the end of each financial year, a reconciliation will be made of the management fee for the financial year, against all charges raised (including estimate of the management fee for each month by AAA to the Partnership for the financial year.

As at xx/xx/20xx (date of the acquisition), AAA had provided management services to the Partnership in accordance with the FMA, however, these services were not completed to the stage where a recoverable debt had arisen. The GST exclusive value of this unbilled income asset is $xxxx. This amount is calculated by determining the proportion of work days in the period xx/xx/20xx - xx/xx/20xx (xx days) over the total work days in the month of xx/xx/20xx (xx days) and then multiplied the proportion by the total unbilled income as at xx/xx/20xx.

An analysis of the proportion of direct labour costs incurred by AAA in the provision of its services to the Partnership under the FMA for a number of years shows that approximately xx% of the total costs incurred by AAA during this period related to labour expenses.

The analysis also shows that an amount of $xxxx relates to overhead costs that are not considered to be attributed labour cost.

Relevant legislative provisions

Income Tax Assessment Act 1936, paragraph 177C(1)(a)

Income Tax Assessment Act 1997, section 25-95

Income Tax Assessment Act 1997, subsection 25-95(1)

Income Tax Assessment Act 1997, subsection 25-95(3)

Income Tax Assessment Act 1997, paragraph 25-95(3)(a)

Income Tax Assessment Act 1997, Division 70

Income Tax Assessment Act 1997, subsection 108-5(1)

Income Tax Assessment Act 1997, paragraph 108-5(1)(b)

Income Tax Assessment Act 1997, Division 230

Income Tax Assessment Act 1997, subsection 230-45(1)

Income Tax Assessment Act 1997, subsection 230-45(2)

Income Tax Assessment Act 1997, section 230-50

Income Tax Assessment Act 1997, Subdivision 230-J

Income Tax Assessment Act 1997, section 701-10

Income Tax Assessment Act 1997, section 701-55

Income Tax Assessment Act 1997, subsection 701-55(5C)

Income Tax Assessment Act 1997, section 701-60

Income Tax Assessment Act 1997, section 701-63

Income Tax Assessment Act 1997, subsection 701-63(5)

Income Tax Assessment Act 1997, paragraph 701-63(5)(d)

Income Tax Assessment Act 1997, subsection 701-63(6)

Income Tax Assessment Act 1997, section 701-67

Income Tax Assessment Act 1997, paragraph 701-67(a)

Income Tax Assessment Act 1997, Division 705

Income Tax Assessment Act 1997, Subdivision 705-A

Income Tax Assessment Act 1997, subsection 705-25(1)

Income Tax Assessment Act 1997, subsection 705-25(4B)

Income Tax Assessment Act 1997, subsection 705-25(5)

Income Tax Assessment Act 1997, paragraph 705-25(5)(d)

Income Tax Assessment Act 1997, section 705-30

Income Tax Assessment Act 1997, subsection 705-30(4)

Income Tax Assessment Act 1997, section 705-35

Income Tax Assessment Act 1997, subsection 705-35(1)

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1

Is the FMA a CGT asset of AAA for the purposes of the tax consolidation rules under paragraph 701-67(a)?

Detailed reasoning

Section 701-67 limits the application of the consolidation rules affecting tax consolidated groups (TCG) to an asset if the asset is one or more of the following:

•                     a CGT asset

•                     a revenue asset

•                     a depreciating asset

•                     trading stock, or

•                     a thing that is or is part of a Division 230 financial arrangement

The effect of section 701-67 is that assets of a joining entity that are not ordinarily recognised for taxation purposes will be disregarded or excluded from the tax cost setting process. They will not have a tax cost allocated to them from the group's ACA for the joining entity.

A CGT asset as defined in subsection 108-5(1) as any kind of property or a legal or equitable right that is not property. For avoidance of doubt, subsection 108-5(2) states that the following are CGT assets:

(a)          part of, or an interest in, property or a legal or equitable right that is not property;

(b)          goodwill or an interest in it;

(c)           an interest in an asset of a partnership, and

(d)          an interest in a partnership that is not covered by (c).

The word 'property' in the definition of a CGT asset conveys either an object of proprietary rights (e.g. pieces of land, domesticated animals and machines), or the proprietary right itself. Proprietary rights may exist in relation to physical objects or to intangible things such as debts or patent rights (Jordan CJ in McCaughey v Commr of SD (1945) 46 SR (NSW) 192 at p 201).

According to Lord Wilberforce in National Provincial Bank Ltd v Ainsworth (1965) AC 1175, before a right or an interest can be admitted into the category of property, or of a right affecting property, it must be 'definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability'. Although assignability is not an essential characteristic of a right of property in all circumstances, it is generally correct to say that a proprietary right must be capable in its nature of assumption by third parties.[1]

Clause xx of the FMA provides that one party may give consent to the other party to:

(a)          transfer, assign, create or dispose of interests in or over their rights, powers and remedies under this agreement, or

(b)          transfer or delegate their obligations in relation to this agreement.

The FMA therefore represents a kind of property, as the rights and obligations under the FMA continue on an indefinite term[2] and are considered to be capable of being assigned or transferred to a third party in accordance with the terms of the agreement.

The FMA represents an agreement under which AAA agrees to provide certain services and the Partnership agrees to pay a certain sum as consideration for the provision of services by AAA.

The FMA is a CGT asset, as it creates certain valuable rights that are recognised and enforceable by law.[3] Some of the rights created include:

•                     the right to receive an annual Management Fee as consideration for providing services under the FMA

•                     the right to prevent the Partnership from using management services provided by other parties

•                     ownership right of any intellectual property created

•                     the right to be reimbursed by the Partnership as part of the Management Fee for any On-Cost amounts paid AAA

•                     the right to withhold any consent or approval or give consent or approval conditionally or unconditionally for the transfer, assign, create or dispose of interests

As a consequence of entering into the FMA, the Partnership agreed to be vest in AAA certain valuable rights that are legally enforceable under law. The FMA falls within the definition of a CGT asset, as any kind of property, in paragraph 108-5(1)(b) and therefore within the tax consolidation rules under paragraph 701-67(a).

Question 2

Is the FMA a 'right to future income' (RTFI) under subsection 701-63(5)?

Detailed reasoning

Section 701-63 was amended by Tax Laws Amendment (2012 Measures No. 2) Act 2012 (TLAA 2012) Schedule 3 and contains three sets of rules (pre-rules, interim rules and prospective rules) that are applied according to when an entity joined the TCG. The prospective rules apply for tax cost setting purposes in relation to CCC and its subsidiaries joining the TCG as the joining time is after 30 March 2011.

Subsection 701-63(5) states:

A right to future income is a valuable right (including a contingent right) to receive an amount if:

(a)          the valuable right forms part of a contract or agreement; and

(b)          the market value of the valuable right (taking into account all the obligations and conditions relating to the right) is greater than nil; and

(c)           the valuable right is neither a Division 230 financial arrangement nor a part of a Division 230 financial arrangement; and

(d)          it is reasonable to expect that an amount attributable to the right will be included in the assessable income of any entity at a later time.

Under the FMA, AAA is obligated to provide certain management services to the Partnership for which the agreement confers upon it the right to receive an annual Management Fee that is payable by the Partnership.

Valuable right and market value greater than nil

The right to receive Management Fee is set out in clause xx of the FMA which operates on the basis that the right is contingent on AAA providing the management services listed in clause xx of the FMA. However, the FMA is intended to operate indefinitely and the right to receive Management Fee is not contingent on the renewal of the contract.

The FMA represents a future economic benefit to AAA in the form of expected income from the annual Management Fee. An independent valuation obtained for the purpose of allocating the purchase price recognised the FMA as an intangible asset of AAA and valued it at a significantly high fair value. Therefore, the FMA satisfies the conditions in both paragraph (a) and (b) of the definition of a RTFI.

Division 230 financial arrangement

Subsection 230-45(1) states:

You have a financial arrangement if you have, under an agreement:

(a)           a cash settlable legal or equitable right to receive a financial benefit; or

(b)           a cash settlable legal or equitable obligation to provide a financial benefit; or

(c)           a combination of one or more

A right to receive or obligation to provide a financial benefit is cash settlable if:[4]

•                     the benefit is money or a money equivalent, or

•                     for rights - you intend to satisfy or settle a right by receiving money, or a money equivalent, or by starting to have, or ceasing to have, another financial arrangement, or

•                     for obligations - you intend to satisfy or settle the obligation by providing money or a money equivalent, or by starting to have, or ceasing to have, another financial arrangement, or

•                     you have a practice of satisfying or settling similar rights or obligations in the manner mentioned in the second and third dot points above (whether or not the taxpayer intends to satisfy or settle the right or obligation in that way), or

•                     you deal with the right or obligation, or similar rights or obligations, in order to generate a profit from short-term fluctuations in price, from a dealer's margin, or from both, or

•                     none of the above applies but:

−                   the financial benefit is readily convertible into money or a money equivalent or there is a market for the financial benefit that has a high degree of liquidity, or

−                   you do not have, as its sole or dominant purpose for entering into the arrangement under which the taxpayer is to receive or provide the financial benefit, the purpose of receiving or delivering the benefit as part of its expected purchase, sale or usage requirements in the ordinary course of business, or

•                     the taxpayer is able to settle the right or obligation as mentioned in the second and third dot points above (whether or not the taxpayer intends to satisfy or settle the right or obligation in that way) and the taxpayer does not have, as its sole or dominant purpose for entering into the arrangement under which it is to receive or provide the financial benefit, the purpose of receiving or delivering the financial benefit as part of its expected purchase, sale or usage requirements in the ordinary course of business.

AAA has under the FMA cash settlable rights to receive financial benefits, that is, the right to receive certain amounts from the Partnership. However, AAA also has ongoing obligations to provide management services to the Partnership which are not cash settlable or insignificant when compared to AAA's cash settlable rights to receive financial benefits under the FMA. Accordingly, the FMA would not be regarded as a financial arrangement under subsection 230-45(1).

Furthermore, the FMA does not give rise to an equity interest (or rights and/or obligations in relation to an equity interest).[5] It is also not a contract of a kind included in Subdivision 203-J. It follows that the FMA is neither a Division 230 financial arrangement nor a part of a Division 230 financial arrangement. Therefore, the condition in paragraph 701-63(5)(c) is satisfied.

Reasonable to expect that an amount attributable to the right will be included in assessable income of any entity

The expression 'reasonable to expect' is not defined for the purposes of the income tax acts nor explained in any explanatory materials. Judicial guidance is usually referred to the joint judgement of Bowen CJ and Beaumont J in Attorney-General's Department v Cockcroft (1986) 64 ALR 97 where the term 'could reasonably be expected to prejudice the future supply of information to the Commonwealth'[6] was said to require:

"a judgement to be made by the decision-maker as to whether it is reasonable, as distinct from something that is irrational, absurd or ridiculous" and that "it is undesirable to consider the operation of the provision in terms of probabilities or possibilities or the like. To construe s 43(1)(c)(ii) as depending in its application upon the occurrence of certain events in terms of any specific degree of likelihood or probability is, in our view, to place an unwarranted gloss upon the relatively plain words of the Act. It is preferable to confine the inquiry to whether the expectation claimed was reasonably based (see Kioa v Minister for Immigration & Ethnic Affairs (1985) 62 ALR 321 per Gibbs CJ and Mason J.

In reference to capital allowances provisions, paragraph 28 in Taxation Ruling TR 2005/20 states for it to be 'reasonable to expect' something to occur requires a sufficiently reliable prediction that it will occur, or at least an expectation or prediction based on reasonable grounds. The ruling refers to a number of court decisions including the judgment in Peabody v Commissioner of Taxation[7] where Hill J considered the meaning of reasonable expectation in the context of a determination under paragraph 177C(1)(a) of the ITAA 1936. Hill J found that in the context, expectation is not used in the sense of prediction as to the future but rather in the sense of a supposition or hypothesis. But what is clear is that the expectation must be one which is reasonable and not one which is unreasonable, irrational or absurd. Hill J stated:

The meaning of words such as "reasonable expectation" depends upon the context in which they appear. Nevertheless, in the present context, as in Cockcroft, the words were intended to receive, and should receive, their ordinary meaning. So too, as in Cockcroft, the word "reasonable" is used in contradistinction to that which is "irrational, absurd or ridiculous". The word "expectation" requires that the hypothesis be one which proceeds beyond the level of a mere possibility to become that which is the expected outcome. If it were necessary to substitute one ordinary English phrase for another, it might be said that it requires consideration of the question whether the hypothesised outcome is a reasonable probability.

The 'reasonable to expect' test in paragraph 701-63(5)(d) is applied at the joining time, as this is the time when the tax cost setting amount for an asset whose tax cost is set under Subdivision 705-A.

At the joining time, the FMA represents a future economic benefit to AAA through the expectation of future income arising from the services that AAA continues to provide to the Partnership in accordance with the agreed terms. The future income and economic benefits are the main focus in placing a significantly high fair value on the FMA through an independent valuation process. The assessment of fair value is also based on the HoldCo's forecast of revenue through the FMA.

In assessing the key rationale for the acquisition of CCC by HoldCo, the valuation noted that AAA revenue had grown from $xxxx in 20xx to around $xxxx in 20xx with prospect of growth in an industry that is expected to grow at a rate of xx% over the financial year 20xx to 20xx period.[8]

Based on the above factors, it is considered reasonable to expect that an amount attributable to the FMA will be included in the assessable income of HoldCo at a later time. Therefore, the final condition in paragraph 701-63(5)(d) is satisfied.

As all of the conditions in subsection 701-63(5) has been satisfied, the FMA is considered to be a RTFI for the purpose of tax cost setting rules.

Question 3

Is the FMA a retained cost base asset for tax cost setting purposes pursuant to paragraph

705-25(5)(d)?

Detailed reasoning

For tax cost setting amount purposes, an asset of a joining entity will either be a retained cost base asset, a reset cost base asset or an excluded asset.

The definition of a retained cost base asset in subsection 705-25(5) includes in paragraph (d) the right to future income (other than a WIP amount asset).

The definition of a RTFI was introduced as an amendment under theTLAA 2012 to ensure only RTFI that are WIP amount assets and consumables stores are deductible and non-deductible RTFI that arises under a contract are treated as retained cost base assets.[9] Paragraph 3.107 of the Explanatory Memorandum (EM) states:

Under the prospective rules, a right to future income (other than a WIP amount asset) will be a retained cost base asset, with a tax cost setting amount equal to the joining entity's terminating value for the asset.

As discussed in Question 2 above, the FMA is considered to be a RTFI asset of AAA under paragraph 701-63(5) and not a WIP amount asset under subsection 701-63(6). Accordingly, the FMA will be a retained cost base asset for tax cost setting purposes pursuant to paragraph 705-25(5)(d).

Question 4

Is the terminating value of the FMA equal to zero, being its cost base just before the joining time pursuant to subsection 705-30(4)?

Detailed reasoning

Where an entity joins a TCG, the rules for determining the tax cost setting amount of an asset of a joining entity are set out in Division 705.[10]

Section 705-25 sets out what the tax cost setting amount is for a retained cost base asset.[11] Where the retained cost base asset is a RTFI under paragraph 705-25(5)(d), subsection 705-25(4B) states that 'its tax cost setting amount is equal to the joining entity's terminating value for the asset.'

Section 705-30 sets out what is the terminating value of an asset, and includes:

•                     Trading stock

•                     Registered emissions units

•                     Qualifying securities

•                     Depreciating assets

•                     Financial arrangements to which Subdivision 250-E applies

•                     Division 230 financial arrangements

•                     Other CGT assets, and

•                     Other assets

As discussed in Question 1 above, the FMA is a CGT asset for the purpose of the CGT provisions. From the above list, the FMA would fall under 'Other CGT assets'.

Subsection 705-30(4) states:

If an asset of the joining entity is a *CGT asset that is not covered by any of the above subsections, the joining entity's terminating value for the asset is equal to the asset's *cost base just before the joining time.

We agree with Applicant's view that cost base for the FMA will be 'nil' or a minimal amount, reflecting any cost incurred in connection to the preparation and execution of the agreement.

Question 5

Does the 'unbilled income asset' of AAA of $xxxx at the joining time meet the definition of 'WIP amount asset' in subsection 701-63(6)?

Detailed reasoning

The TLAA 2012 modified the tax cost setting and RTFI rules to ensure that under the 'prospective rules':[12]

•                     the tax costs amount for RTFI asset held by the joining entity at the joining time that are WIP amount assets are deductible to the Head Company, and

•                     RTFI that are not WIP amount assets are treat as retained cost base assets.

Under the consolidation tax costing setting rules the 'tax cost is set' at the time an entity becomes a subsidiary member of a consolidated group for each asset of the entity that would be an asset of the entity at that time if the single entity rule did not apply.[13]

Section 701-55 states what is meant by the expression the asset's 'tax cost is set' for certain assets. Where the asset is a WIP amount asset, subsection 701-55(5C) states

If:

(a)             the asset's tax cost is set because an entity becomes a *subsidiary member of a *consolidated group at the particular time; and

(b)            the asset is a *WIP amount asset;

the expression means that section 25-95 applies as if the *head company had paid a *work in progress amount for the income year in which the particular time occurs equal to the *tax cost setting amount of the asset.

The definition of WIP amount asset in subsection 701-63(6), is similar to the definition in subsection 25-95(3), states:

WIP amount asset means an asset that is in respect of work (but not goods) that has been partially performed by a recipient mentioned in paragraph 25-95(3)(b) for a third entity but not yet completed to the stage where a recoverable debt has arisen in respect of the completion or partial completion of the work.

The effect of the modification to the tax cost setting rules is that subsection 701-55(5C) is not activated until such time as there is a subsection 701-63(6) WIP amount asset at a particular time.

Subsection 25-95(1) allows a deduction in respect of 'work in progress amount' to the extent that a recoverable debt has arisen or is expected to arise in respect of the partial completion of work to which the amount relates. Subsection 25-95(3) defines an amount as a work in progress amount to the extent that:

(a)          an entity agrees to pay the amount to another entity (the recipient); and

(b)           the amount can be identified as being in respect of work (but not goods) that has been partially performed by the recipient for a third entity but not yet completed to the stage where a recoverable debt has arisen in respect of the completion or partial completion of the work.

The combined effect of subsections 25-95(1), 701-55(5C) and 701-63(6) is that on consolidation the amount of any asset of a subsidiary in respect of such work (but not goods) is deductible to the head company.

The meaning of 'Work (but not goods)'

In considering whether an asset is a WIP amount asset, it necessary to determine what is the meaning of 'work' for the purposes of subsection 701-63(6).

As the definition of WIP amount asset in subsection 701-63(6) is similar to that in subsection 25-95(3), consideration of the term 'work' and other elements of the definition will be referenced to guidance provided in the EM to Taxation Laws Amendment Bill (No 5) 2002 that introduced section 25-95.

Section 25-95 was introduced in order to allow a deduction for a professional service partnership where a partner exits the partnership and is paid an amount in respect of work on hand at that time. This suggests 'work' is used in its ordinary sense of referring to exertion, labour or toil by natural persons.

The ordinary meaning of the term 'work' was described by the Full Federal Court in Minister for Immigration, Local Government and Ethnic Affairs v Montero (1991) 31 FCR 50 at 58 as follows:

work in its ordinary sense describes exertion directed to produce or accomplish something, labour or toil.

...

It is a term which frequently connotes activity of the mind or body undertaken in exchange for monetary reward and may aptly be used to describe a person's occupation or employment, which again will usually be pursued by that person for monetary reward.

Pursuant to the EM to Taxation Laws Amendment Bill (No. 5) 2002, to qualify as 'work' in terms of 'WIP amount' under subsection 25-95(3) (and thus a WIP amount asset under subsection 701-63(6)), the (asset) must be in respect of work performed by one (or more) natural person(s) for a third entity (or customer) but not yet completed to a stage where a recoverable debt has arisen. The amount must have arisen (accrued) as a result of the mental and/or physical activities/exertion of one (or more) natural persons who, in the case of subsection 701-63(6) will (generally) have performed this work (for the customer) as an employee, contractor or subcontractor of a company (the recipient mentioned in paragraph 25-95(3)(a)). The company being the joining entity.

However, the term 'work' in the context of 'work in progress amount' under subsection

25-95(3) and a WIP amount asset under subsection 701-63(6) does not cover work in progress that is goods, e.g. the work in progress of a manufacturer which is normally trading stock. In this regard, the intention of the '(but not goods)' exclusion pursuant to paragraph 2.14 of the EM to Taxation Laws Amendment Bill (No. 5) 2002 is to ensure amounts subject to (and dealt with by) the Division 70 trading stock provisions are excluded from the definition of a 'work in progress' amount in subsection 25-95(3). This does not mean that a variety of accounting accrued (unbilled) income amounts (assets) may access section 25-95 (or subsection 701-63(6)) treatment simply because the non-labour content of the asset is not subject to the Division 70 trading stock provisions. Similarly, certain goods in progress will often have a component reflecting exertion, but the exclusion of goods means that an amount attributable to such exertion may the asset is excluded.

For example, the expression 'in respect of work (but not goods) performed...' clearly exclude accrued (unbilled) income of an energy retailer or wholesaler for the supply of gas and electricity (such as that in FCT v Australian Gas Light Company & Anor (1983) 15 ATR 105 ) or the accrued (unbilled) income in respect of a chattel lease (held by a lessor) or wet lease (for the provision of aircraft plus pilot and crew) or time charter arrangement (for the provision of vessel plus captain and crew) from being work in progress for section 25-95 (or a WIP amount asset for subsection 701-63(6)) purposes.

In relation to the term 'goods', case law generally establishes that the term refers to tangible things. However, the word can have a much wider interpretation and its meaning can be taken from the context in which it is used. Nonetheless, the courts have tended to interpret the term in a manner which is consistent with sale of goods cases.

In the recent decision of Australian Competition and Consumer Commission v Valve Corp (No 3), Edelman J explained why this would be the case, highlighting an important aspect of the meaning of 'goods':

That aspect is sometimes described in theoretical studies as 'thinghood'. The legal meaning of 'goods' can be analogised to the strict definition of 'property', which is 'a description of a legal relationship with a thing'.[14] This explains why a chose in action, such as a debt, is not a 'good'. A chose in action is a right against a person. It is not a right in relation to a thing.[15]

This suggests that for the purpose of subsection 701-63(6), goods are limited to tangible things or at least concern property (rather than personal rights) in the case of intangibles.

To the extent that

In practical terms, there are mixed assets where an amount may reflect an entitlement for work, goods, and possibly other amounts. In this regard, the words 'to the extent that' as they appear in section 25-95 means that although a larger lump sum amount may be paid in some situations, it must be apportioned between that part of the amount that is a work in progress amount and that part that is not.[16]

Subsection 701-63(6) definition of 'WIP amount asset' does not contain the words 'to the extent that'. Rather, it speaks of 'an asset that is in respect of work (but not goods) that has been partially performed by a recipient mentioned in paragraph 25-95(3)(b)'. However, the appearance of the phrase is not necessary where part of a work in progress asset can be attributed to something specific to be provided under a contract and that part can be identified from the remainder to evaluate whether it is in respect of work. In the context of 'work in progress amount' under subsection 25-95(3) (and thus a WIP amount asset under subsection 701-63(6)), the test is whether work, as discussed above was the dominant element with the exclusion of goods performing no function.

Application to AAA's unbilled income asset

Based on the above analysis, the first relevant question is whether the substance of what an amount under the FMA relates to is work and exertion, goods, or something else. The services that AAA is required to provide under the FMA are specified in a number of clauses and can be broadly described as in the nature business accounting and management services. The services are largely provided through AAA's personnel and are directly attributable to labour cost.

The FMA also requires AAA to provide exclusive licence to the Partnership for the use of premises as well as equipment that AAA determines to be necessary to enable the Partnership to provide the services.[17] Amounts that are attributable to the granting of the licences is considered incidental to the provision of goods and therefore will not be included in 'work in progress amount' under subsection 25-95(3) or in WIP amount asset under subsection 701-63(6).

The next question is whether AAA had performed work for the Partnership (the third entity) that is not yet completed to a stage where a recoverable debt had arisen.

Under the terms of the FMA, AAA is entitled to receive a Management Fee for each financial year, payable progressively each month based on an estimate of the Management Fee for the month.

At the joining date (date of the Acquisition), AAA had provided services to the Partnership in accordance with the FMA. However, pursuant to clause xx of the FMA, AAA can only raise a recoverable debt following the end of the month. Accordingly, the services provided by AAA are not at a stage where a recoverable debt had arisen.

The total value of chargeable Management Fee at xx xx 20xx was $xxxx. However, the value of the unbilled income amount at the joining date was $xxxx. This amount is equal to the proportion of workdays in the period xx xx 20xx to xx xx 20xx, divided by the total workdays in the month of xx xx 20xx and multiplied by $xxxx.

The unbilled income amount at the joining date represents a larger lump sum that includes amounts attributable to provision of goods, e.g. licences for the use of premises and equipment. Therefore, as stated above, the amount representing the unbilled income at the joining time must be apportioned to identity that part of the amount that is work for the purpose of section 25-95 and subsection 701-63(6) and that part that is not.

An analysis of the proportion of direct labour costs incurred by AAA in providing services to the Partnership under the FMA for the period from xx xx 20xx to xx xx 20xx shows that approximately xx% of the total costs incurred by AAA during this period related to labour expenses.

The remaining expenditure related to the provision and maintenance of equipment and premises, as well as a range of overheads such as marketing, which ultimately enabled the provision of labour.

Based on a direct labour cost analysis, $xxxx is considered to be in respect of work for the purpose of section 25-95 and subsection 701-63(6). Accordingly, this amount meets the definition of WIP amount asset under subsection 701-63(6) at the joining time.

Question 6

If the answer to Question 5 is yes, will HoldCo be entitled to a tax deduction in accordance with section 25-95 equal to the tax cost setting amount of the unbilled income asset of AAA as at the date of acquisition?

Detailed reasoning

In reference to the expression 'tax cost is set', subsection 701-55(5C) states that in relation to a WIP amount asset of subsidiary becoming a member of a TCG, the expression means that section 25-95 applies as if the head company had paid a work in progress amount for the income year in which the particular time occurs equal to the tax cost setting amount of the asset. This means that where the asset is a WIP amount asset, the head company may be able to claim a deduction equal to it reset tax cost base under section 25-95.

It was determined in Question 5 above that the unbilled income of AAA at the joining date meets the definition of a WIP amount asset in subsection 701-63(6).

A WIP amount asset is a type of RTFI. However, it is treated as a reset cost base asset as paragraph 705-25(5)(d) specifically excludes it from being a retained cost base asset. Therefore, the WIP asset of AAA as at the joining date will be allocated a tax cost setting amount in accordance to section 705-35.

Subsection 705-35(1) states that:

For each asset of the joining entity (a reset cost base asset) that is not a *retained cost base asset, the asset's *tax cost setting amount is worked out by:

(a)            first working out the joined group's *allocable cost amount for the joining entity in accordance with section 705-60; and

(b)           then reducing that amount by the total of the *tax cost setting amounts for each retained cost base asset (but not below zero); and

(c)           finally, allocating the result to each of the joining entity's reset cost base assets in proportion to their *market values.

As at the date of this private ruling application, the tax cost setting amount of the WIP amount asset of AAA has not yet been calculated. However, as previously determined, the unbilled income of AAA meets the definition of WIP amount asset under subsection 701-63(6), the requirements in subsection 701-55(5C) are therefore satisfied. Accordingly, HoldCo, being the head company of the TCG, would be treated as if it had paid for a work in progress amount. HoldCo would therefore, be entitled to a deduction equal to the tax cost setting amount (once calculated) of the WIP amount asset pursuant to section 25-95 in the income year AAA joined the TCG.

[1] Mason J in R v Toohey & Anor; ex parte Meneling Station Pty Ltd & Ors (1982) 158 CLR 327.

[2] FMA, clause xx relating to termination and consequence of termination of the FMA in relation to each partner.

[3] FMA, clause xx and xx the agreement is governed by the laws of Western Australia

[4] Subsection 230-45(2)

[5] Section 230-50

[6] As used in section 43(1)(c)(ii) of the Freedom of Information Act 1982

[7] 181 CLR 359 at 385; 94 ATC 4663 at 4671; (1994) 28 ATR 344 at 353

[8] Valuation report

[9] EM to the TLAA 2012, para 3.88

[10] Item 1, section 701-60

[11] Subsection 705-25(1)

[12] EM to the TLAA 2012, para 3.17

[13] Section 701-10

[14] Yanner v Eaton (1999) 201 CLR 351, 365 366 [17] (Gleeson CJ, Gaudron, Kirby and Hayne JJ).

[15] Australian Competition and Consumer Commission v Valve Corp (No 3) (2016) 337 ALR 647, 674 [128].

[16] Explanatory Memorandum to the Tax Laws Amendment (No.5) 2005, para 2.11.

[17] FMA - clause xx.

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