Edited version of private advice

Authorisation Number: 1052103997897

Date of advice: 31 March 2023

Ruling

Subject: Section 6-5 of the ITAA 1997

Question

Will the portion of the amount generated by the Property as received by Y pursuant to the 'Section 90C Financial Agreement' be assessable income to Y under section 6-5 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commenced on:

XX MMM 20XX

Relevant facts and circumstances

The Section 90C Financial Agreement between X and Y, as redacted and provided to the Commissioner on 9 February 2023, (the Financial Agreement) forms part of, and is to be read with, the facts and circumstances as set our below.

X and Y (X and Y) were married and separated recently.

X together with their parent, Z, are tenants in common in relation to the Property.

The Property, which is agricultural land, is currently tenanted, with leasing income being generated by the Property.

In 20XX the Financial Agreement was entered into by X and Y that determined the division of assets between the parties.

The Financial Agreement refers to both:

•         the Property (described in the Agreement as 'land owned with Z'); and

•         L1 and L 2 (the farm properties), being additional land in the area owned solely by X.

As at the date of this Ruling:

•         50% of the farm properties was transferred to Y pursuant to the terms of the Financial Agreement.

•         However, X's interest in the Property has not been transferred, sold or disposed of.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-1

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Assessable income is defined in subsection 6-1(1) of the ITAA 1997 as consisting of ordinary income and statutory income.

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 6-5 of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources.

Income according to ordinary concepts

Subsection 6-5(1) of the ITAA 1997 states the following:

"Income according to ordinary concepts (ordinary income)

(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income."

The legislation does not provide any specific guidance on what is meant by "income according to ordinary concepts". The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 4) of 1996 (Cth) states that it has been left to the courts to develop principles for determining what is "ordinary income".

Case law has identified various factors which may be relevant in determining whether an amount is income according to ordinary concepts. These include:

•         whether the amount has the characteristics of periodicity, recurrence or regularity;

•         whether it is convertible into money or money's worth;

•         whether it is associated with business activities or services rendered, as distinct from the mere sale of property, and

•         whether it is solicited, as distinct from a windfall.

There is no single test to determine whether an amount is 'income according to ordinary concepts'. However there are three principal categories in which income is considered ordinary income:

•         income from rendering personal services, including employment income;

•         income from property, such as rent, interest and dividends; and

•         income from carrying on a business.

The income generated by the Property is in the nature of rent. Therefore it is considered to be income according to ordinary concepts.

Derivation

Ordinary income is included in a taxpayer's assessable income when it is "derived".

Subsection 6-5(2) of the ITAA 1997 states:

"(2) If you are an Australian resident, your assessable income includes the * ordinary income "you * derived directly or indirectly from all sources, whether in or out of Australia, during the income year."

Section 995-1 of the ITAA 1997 states:

""derive" has a meaning affected by subsection 6-5(4)."

Subsection 6-5(4) of the ITAA 1997 states:

"(4) In working out whether you have derived an amount of * ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct."

In determining whether Y derives the income to which they are entitled under the Financial Agreement, the question is whether the Financial Agreement has resulted in X assigning the right to that income to Y, or if X should instead more appropriately be regarded as having derived that income themself, being later required to apply that income - as per the terms of subsection 6-5(4) - for Y's benefit.

Where income is to be alienated, so that it is derived by another, the nature of the rights needs to be considered. If there is an assignment of a presently existing right to income, with an assignment of the underlying interest, then the assignee rather than the assignor derives the income attributable to that underlying interest. Without an assignment of the underlying property, the mere expectancy or possibility of a future receipt of income may, depending on the facts, result in the assignor deriving the income rather than the assignee.

Assignment of a right to income

A presently existing right to income is a chose in action (i.e. an intangible right enforceable by legal or equitable action) and can be assigned. A legal chose in action may be assigned either at law or in equity. When a right to income is assigned, it transfers an existing chose in action which entitles the assignee to the income when that income arises. Upon assignment of the right, the income which subsequently arises from that right is derived by the assignee.

Everett's case

In FC of T v Everett 80 ATC 4076, a solicitor assigned to his wife part of his share in a partnership (including the right to an appropriate share of the profits). This was held by the majority of the Full High Court to be effective. It was held that the taxpayer had not assigned future income dissociated from the property or proprietary right to which that income was attributable. Rather, the taxpayer assigned present property, a chose in action, being a share of his interest in the partnership which carried with it the right to a proportionate share of future income attributable to that interest.

Barwick C.J; Stephen, Mason and Wilson JJ. found:

"The distinction between present property and future property or mere expectancy gives rise to some borderline cases. For present purposes the point to be made is that an equitable assignment of present property for value, carrying with it a right to income generated in the future, takes effect at once whereas a like assignment of mere future income, dissociated from the proprietary interest with which it is ordinarily associated, takes effect when the entitlement to that income crystallizes or when it is received, and not before."

Therefore, the future income attributable to the underlying property, being a part share in a partnership, was derived by the solicitor's wife, the assignee, rather than the solicitor, the assignor.

Howard's case

In Howard v FC of T 2014 ATC 20-457 (Howard's case), the High Court found the taxpayer to be assessable in respect of damages awarded as compensation for joint venture losses. The taxpayer argued unsuccessfully that he had assigned the right to receive the damages to an associated company under a litigation agreement.

French CJ and Keane J found that the assignment of mere future income apart from the associated proprietary interest was not effective to prevent the income from being derived:

"The appellant rightly accepted that, for him to succeed in this branch of his argument, the litigation agreement must be construed as assigning to Disctronics the right to receive what was ultimately paid to him. If the litigation agreement provided for the present assignment for value of something to be acquired in the future, it must be "construed as an agreement to assign the thing when it is acquired" (emphasis added). If the litigation agreement provided for the assignment of future income, dissociated from the proprietary interest which produced the income, the proceeds of the action, when received in 2005, were income in the hands of the appellant."

Hayne and Crennan JJ, with Gageler J agreeing, found that the better construction of the litigation agreement was that it provided for the assignment of the proceeds of the action and not for the underlying rights to receive those sums. At paragraph 104. of the Judgment it is stated:

"The better construction of the litigation agreement is that it provided for the assignment of any proceeds of the action, not for the assignment of the appellant's rights under any judgment obtained in the proceedings. The reference to "on revenue or capital account," coupled with the reference to the "ultimate outcome" of the proceedings, more readily fits with understanding the expression "any award of damages ... costs or interest made in their favour" as referring to sums received rather than the underlying rights to receive those sums. And although the litigation agreement was made before this court's decision in Campbells Cash & Carry Pty Ltd v Fostif Pty Ltd, adopting this preferred construction would not have presented any question of maintenance or champerty. Disctronics was no mere bystander to the litigation; it was itself a party to that litigation and it agreed to pay the costs of the litigation."

The application of the law in the present case

While it is clear that Y is entitled to a portion of the income generated by the Property until its sale pursuant to the Financial Agreement, the question is whether their entitlement is restricted merely to the income itself at the point in time at which it is produced; that is, to the 'assignment of future income, dissociated from the proprietary interest which produced the income', akin to the character of the relevant right in Howard's case.

We consider that the asset conferred on Y under the terms of the Financial Agreement is more than the right to future income; that the agreement had the effect of providing Y with an equitable interest in the Property, which carries with it the right to a proportionate share of future income attributable to that interest.

The following facts are considered to be material in this regard:

•         It may be inferred from the objective of the Financial Agreement that the relevant asset sought to be effectively divided under the agreement is X's share of his interest in the Property as a whole rather than (solely) the income generated by the Property.

•         This is confirmed by clause X of the Financial Agreement, which deems the holding on trust by X for themself and Y in equal shares of 'X's interest in the land owned with Z' (rather than merely income from the land).

•         Consistently with the above, clause Z of the Financial Agreement provides for the division in equal shares between X and Y for liabilities rising from and associated with the ownership of the Property as a whole.

With reference to the section 6-5 of the ITAA 1997 and case law discussed above, the terms of the Financial Agreement have provided for an assignment of a presently existing right to income, with an assignment of an underlying proprietary interest. Therefore, the assignee, Y, would 'derive' the portion of the amount they received under the Financial Agreement as generated by the Property. It follows that this amount would form part of Y's assessable income.

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