Edited version of private advice

Authorisation Number: 1051835902694

Date of advice: 11 May 2021

Ruling

Subject: Annual turnover under subsection 328-120(1) of the ITAA 1997

Question

Should Company X include the component of fees received from end clients which is remitted to unrelated third parties under a service agreement in its annual turnover under subsection 328-120(1) of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following periods:

1 July 2019 to 30 June 2024

The scheme commences on:

1 July 2019

Relevant facts and circumstances

Company X is the head company of a tax consolidated group. Subsidiary A is a wholly owned subsidiary of Company X and is the member of Company X tax consolidated group.

Subsidiary A is engaged by a number of unrelated third parties (intermediaries) to perform specific services on behalf of the intermediary and its end clients under a service agreement. The intermediary is required to pay Subsidiary A for all the fees and charges in performing specific services as set out in the service agreement. Subsidiary A has the necessary license to give effect to the transactions.

Under the service agreement, Subsidiary A collects all fees payable from the end client, including commission fees charged by the intermediary to the end client for services it provides. Subsidiary A does not have any input into the commission fees charged by the intermediary and acts as an agent for the collection of those fees. After deducting its fees, Subsidiary A remits the remainder of the commission fees to the intermediary.

There is no service agreement between Subsidiary A and the end client.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 328-120

Reasons for decision

The meaning of 'annual turnover' is outlined in section 328-120 of the ITAA 1997.

Subsection 328-120(1) states that:

An entity's annual turnover for an income year is the total *ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business.

The annual turnover amount excludes amounts relating to GST and sales of retail fuel. For amounts derived from dealings with associates, the amount of ordinary income is the amount of ordinary income the entity would derive from the dealing if it were at arm's length.

Ordinary income is defined in section 995-1 and section 6-5 of the ITAA 1997 as 'income according to ordinary concepts'. A significant body of case law has considered the meaning of this phrase.

For instance, in Scott v. Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215, Jordan CJ held that the meaning of 'income' was to be determined according to 'ordinary concept and usages' at 219 as follows:

'The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts: A.-G. for British Columbia v. Ostrum ([1904] AC 144 at 147); Lambe v. Inland Revenue Commissioners ([1934] 1 KB 178 at 182-3).'

In relation to the phrase 'in the ordinary course of carrying on a business', Doutch v FC of T [2016] FCAFC 166 considered the extrinsic materials to the inclusion of subsection 328-120(1) of the ITAA 1997 and referred to the Explanatory Memorandum to the Bill. It was established that income is derived in the ordinary course of carrying on a business where:

a.    The income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event; and

b.    The income, although not regularly derived, is derived as a direct result of the normal activities of the business.

In addition, it is understood that a taxpayer must be beneficially entitled to an amount of income as set out in Taxation Determination TD 2008/9 Income tax: are amounts mistakenly paid as salary or wages to employees (or as income support payments or worker's compensation amounts to persons), to which they are not beneficially entitled, but are obliged to repay, 'ordinary income' under section 6-5 of the Income Tax Assessment Act 1997?:

10. For an amount to be income according to ordinary concepts it must be income derived by the taxpayer. The proposition that a taxpayer will not derive ordinary income unless they are beneficially entitled to the amount has longstanding judicial support.

14. The decisions in these cases demonstrate that a taxpayer must be beneficially entitled to an amount for the amount to be derived by the taxpayer as ordinary income. Reiter illustrates the application of this proposition in a situation where the taxpayer's lack of beneficial entitlement coincided with the taxpayer not being legally entitled to the amounts they had received. It was not a case where the court found that the taxpayer had in any sense become a trustee in relation to these amounts (at FCR 499; ATC 4508; ATR 539-540).

Taxation Ruling TR 93/36 deals with the assessability of commissions paid by investment funds to intermediaries. Paragraph 19 of TR 93/36 states that if an intermediary has a legal right to receive a commission from an investment fund but does so on the client's behalf, the intermediary has no beneficial interest in the commission but merely serves as a conduit for the passing on of the commission for the investment fund to the investor.

Taxation Ruling TR 2004/5: Income Tax: taxation treatment of volume rebates paid to retailer association (TR 2004/5) sets out the Commissioner's view on deductibility of contributions and derivation of income where it involves an agency in relevant circumstances. Paragraph 37 lists examples of factors supporting the conclusion that there is at least an implied agency which includes

an agreement between the association and the wholesaler stating that the association would receive the rebates 'on behalf of' the retailer. That this implies an agency agreement is supported by Bonette v. Woolworths Ltd (1937) 37 SR (NSW) 142 at 150 per Jordan CJ (Halse Rogers and Bavin JJ concurring):

Evidence that a person is purporting to do acts on behalf of a principal in some capacity in such circumstances that the knowledge and approval of the principal may fairly be inferred is evidence that the principal has authorised him to act in the particular capacity.

Paragraph 51 of TR 2004/5 further states that 'Money held by an agent on a principal's behalf is in the dominion of the principal'.

Application to Company X's circumstances

Under the service agreement, Subsidiary A provides services for the intermediaries and charges them the relevant fees for the different services performed. The service agreement provides for Subsidiary A to collect the commission from the end client. The service agreement further states that the intermediary agrees for Subsidiary A to receive the commission as the agent of the intermediary which implies an agency relationship for this specific purpose.

The total commission collected by Subsidiary A from the end client does not all relate to services provided by Subsidiary A but it also comprises of commission which the intermediary has charged the end client for services it had provided.

Subsidiary A does not have input or discretion over the commission the intermediaries charge the end client. The agreement setting out the total commission paid by the end client is between the intermediary and the end client.

Further, the service agreement creates an obligation for Subsidiary A to remit the commission due to the intermediary net any amounts owing to Subsidiary A from the intermediary.

Subsidiary A is not beneficially entitled to the commission charged by the intermediaries from the end client. The brokerage is collected and remitted to the intermediaries under an agency relationship.

This amount remitted to the intermediaries is not considered Subsidiary A's ordinary income, and thus, should not be included in Company A's annual turnover for the purpose of section 328-120(1).

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