Edited version of private ruling

Authorisation Number: 1011658547817

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

1. Are you assessable on lease incentive payments in the year in which they are received?

Yes.

2. Can the assessable lease incentive payments received by you in the 2009-10 income year be spread over the period of the lease agreement?

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You entered into a lease agreement with a landlord to lease commercial premises from which to conduct its business.

As an incentive to enter into the lease the landlord offered to pay a portion of the fit-out expenses of the premises.

The lease contract was entered into in the 2009-10 income year.

You paid for the expenses and then submitted the invoices to the landlord for reimbursement.

The fit-out remains the property of the tenant, although approximately 40% of the fit-out would have no value if it had to be removed from the property.

As specified in the lease agreement, if you cease to lease or occupy the premises before the end of the lease, you must repay a portion of the incentive. The repayment depends on the period of time since the lease commenced.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Reasons for decision

Summary

The lease incentive payments are considered to be assessable when derived in the 2009-10 income year. The payments are made on the basis of you entering into the lease agreement. The amount does not represent a prepayment for any goods or services and therefore cannot be spread over the term of the lease.

Detailed reasoning

Taxation Ruling IT 2631 deals with taxation consequences of lease incentives.

IT 2631 states that in a case where the lessee has responsibility for the fit-out and the landlord pays part or all of the fit-out costs to the contractor, the constructive receipt provisions of section 19 would apply and the lessee will be taken to have derived an assessable amount equal to those payments and any cash incentive.

As such the contribution you received towards the fit-out of the commercial premises constitutes assessable income.

The issue of timing is discussed below.

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) requires an amount of ordinary income to be brought to account as assessable income when it is derived. In the majority of cases this occurs in the income year the payment is received or dealt with on your behalf.

You referred to the case of Arthur Murray (NSW) Pty Ltd v Federal Commissioner of Taxation (1965) 114 CLR 314; (1965) 14 ATD 98; (1965) 9 AITR 673 (Arthur Murray) in your private ruling application.

Arthur Murray is one of the leading cases on whether payments received in advance of the supply of goods or services contracted to be supplied is derived in the year of receipt. The case involved a taxpayer who carried on a business of giving dancing tuition. The taxpayer lodged their income tax returns on the basis that payments received in advance of lessons taught did not form part of its assessable income immediately upon receipt. In this case, the Court found that the payments were only assessable once earned by the giving of the lessons.

The Court noted that the parties agreed that according to established accountancy and commercial principles, amounts received by a business, either selling goods or supplying services, in advance of the goods being delivered or the services being supplied are not regarded as income. The amounts are only transferred to an income account 'when the goods are delivered or the services rendered' for that is when the amounts 'finally acquire the character of income'.

In your case, a portion of the expenses incurred in the fit-out of your leased premises were reimbursed to you by the landlord as an incentive to enter into the lease. The act of entering into the lease agreement gives you the right to receive the contributions.

In the event of you ceasing to lease or occupy the premises within six years of entering the lease, a proportion of the contribution is repayable.

Section 6-1 of the ITAA 1997 provides that the assessable income of an entity for an income year is the sum of the ordinary and statutory income 'derived' by the entity for the year.

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

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.

Therefore, an amount (including an amount which has been received), will not be included in assessable income for an income year, unless it has been derived during that year.

Apart from subsection 6-5(4) of the ITAA 1997, there is no further legislative guidance as to the timing of income derivation. As such, we will now consider the application of case law and taxation rulings to your situation.

In Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418; 71 ATC 4195; (1971) 2 ATR 563, the High Court said at CLR 428; ATC 4200; ATR 570:

It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which is calculated to give a substantially correct reflex of the taxpayers true income (The Commissioner of Taxes (South Australia) v The Executor, Trustee and Agency Company of South Australia Limited (Cardens case) (1938) 63 CLR 108; 1 AITR 416; (1938) 5 ATD 98).

You received the full amount of the contribution in the 2009-10 income year.

If the income is not to be assessed in the year of receipt, the circumstances would have to be similar to those found in Arthur Murray. It is considered that these circumstances do not arise in your particular case.

The payment is made on the basis of you entering into the lease agreement. The amount does not represent a prepayment for any goods or services.

If there is a breach of the lease agreement, there will be a requirement to repay some or all of the money received however the risk of having to make refunds is not determinative in this case. The contingency that some part or all of the contribution towards the fit-out of the store may have to be paid back only exists as a result of certain actions by you as lessee. Unlike Arthur Murray the contingency is not linked to the failure to provide contracted goods or services.

Accordingly, you will be required to include in your assessable income, the full amount of the contribution towards the fit-out of the store in the 2009-10 income year when it was received and fully expended.