Edited version of private ruling

Authorisation Number: 1011614922552

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Ruling

Subject: determination of income

Issue 1

Question 1

Will the accruals basis (earnings method) be the most appropriate method of determining assessable income for the purpose of subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period

Financial year ended 30 June 2009

Financial year ended 30 June 2010

The scheme commences in

July 2008

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it.

The fact sheet has more information about relying on your private ruling

As provided by the private ruling application:

· the taxpayer is a service provider of Company A.

· each month Company A pays the taxpayer their booking fees earned in the previous month.

· once a year the taxpayer is also entitled to receive an incentive payment, if certain customer satisfactions and sales targets are achieved.

· the bookings fees and incentive payments are determined by Company A on completion of a reconciliation process before approving the payments.

· only upon approval by Company A and providing the taxpayer with the entitlement amounts, is the taxpayer able to determine their entitlement to income.

· the taxpayer is notified on the completion of the process and is required to issue a valid tax invoice.

· the taxpayer is paid by the XXth of the following calendar month upon timely receipt of a tax invoice.

Relevant legislative provisions

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

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'Part IVA general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you understand how we reached our decision.

Question 1

Summary

The accruals basis (earnings method) is the most appropriate method of determining assessable income for the purpose of subsection 6-5(2) of the ITAA 1997.

Detailed reasoning

Discussion of the law

Under subsection 6-5(2) of the ITAA 1997, 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.

The courts have looked at the question of when income is derived for tax purposes, that is, to consider when an amount of income becomes assessable for income purposes, and have identified two methods. Taxation Ruling TR 98/1 sets out the Commissioner's guidelines on the receipts and earnings methods for the treatment of income. The taxpayer must adopt the method that is the most appropriate, that is, the method of accounting that gives a substantially correct reflex of income.

The two methods are outlined as follows:

Receipts:

· under the 'receipts' method, income is derived when it is received, either actually or constructively, under subsection 6-5(4) of the ITAA 1997.

Earnings:

· under the 'earnings' method, income is derived when it is earned. The point of derivation occurs when a `recoverable debt' is created.

· the term 'recoverable debt' is used to describe the point of time at which a taxpayer is legally entitled to an ascertainable amount as the result of having performed an agreed task.

· whether there is, in law, a recoverable debt is a question to be determined by reference to the contractual agreements that give rise to the legal entitlement to payment, the general law, and any relevant statutory provisions.

· all that is required is that there must be a present right to receive a quantified amount without the presence of any element of contingency or defeasibility.

Paragraph 39 of TR 98/1 deals specifically with incorporated entities and clarifies that the earnings method is preferred except where that method gives an 'artificial, unreal and unreasonably burdensome method of arriving at the income derived'. Furthermore, paragraph 53 provides:

the larger the business structure, the more likely is the reliance on employees and capital equipment to generate income and the more likely the earnings method of account is appropriate. In this regard, the size and function of any related entity should be taken into consideration.

Application to your circumstances

The taxpayer is an incorporated entity and along with its representatives supply services to Company A, in areas as determined by the contract.

Representatives of the taxpayer include professional sales staff. As provided in the contract one of the required Key Performance Indicators (KPIs) of the taxpayer is the recruitment of professional sales staff in order to have sufficient representatives engaged to perform the agreed services.

The point of derivation occurs when a 'recoverable debt' is created, that is, once there is a presently existing right to demand payment. The term 'recoverable debt' is used to describe the point of time at which the taxpayer is entitled to an ascertainable income amount on performance of the agreed task.

The following is provided by the contract:

The Service Supplier will submit a claim for payment to Company A monthly for the Services conducted during the previous calendar month.

Company A will attempt to verify a Claim.

Conclusion

The size and structure of the incorporated entity together with its reliance on sales representatives to achieve KPIs, and in turn income, are indicators that the earnings method of accounting is the most appropriate. As this is the method of accounting that will give a substantially correct reflex of income under the circumstances.

Once the claim forwarded by the taxpayer is verified by Company A, all obligations required by the taxpayer have taken place to become entitled to payment and it is at this point that the income is derived. As all conditions precedent to make the demand for payment have been satisfied a recoverable debt' will result.

The mere existence of a payment agreement, allowing for deferral of payment until after the provision of services, cannot be regarded as a contingency which defers derivation of the sale amount. A payment arrangement is a financial arrangement which does not alter the income transaction and therefore it is not considered that the contractual requirement of the taxpayer to provide an invoice in order to claim payment will defer the point at which income is derived. The invoice is not required in order to create a recoverable debt, and therefore cannot be regarded as a contingency which defers derivation of the payment amount.