Edited version of private ruling

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Ruling

Subject: Determination of income

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)?

Advice/Answers

Yes

Scheme

The Company is a private company that has XX employees to assist supply services to the Australian Security Industry.

The major operations of the Company are reselling (as per their current Services Agreement (the Agreement)) an inbound service that security alarm systems utilise to report events to a monitoring centre.

The monitoring service transmits alarm data from monitored premises to the Company's control room using a telecommunications network (the Provider), providing the Company with a single access number which is used with an autodialler monitored control room of the Company.

As provided by the Agreement the Provider will pay the Company a rebate for calls terminating on the Service if a minimum call volume of X is maintained each month, failure to maintain this call volume may result in the Company being charged.

Before calls can be invoiced and paid the Provider must establish which calls qualify for a rebate by analysing the call data to generate a report based on specific call parameters to determine which calls qualify.

The Company know the number of calls, but do not know which calls have qualified for a rebate as this information is only available to the Provider.

Once the manual report is completed to establish which calls qualify for a rebate the Provider raises and forwards a Recipient Created Tax Invoice (RCTI) to the Company which indicates the full rebate amount for the applicable month.

Relevant legislative provisions

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

Reasons for decision

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 Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Discussion of 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 of the law to your circumstances

The Taxpayer Company (the Company) is an incorporated entity that relies on employees to supply services to the Australian Security Industry. The major operations of the entity are selling Voice Services (the Service) as per their Services Agreement (the Agreement).

The Service is a security product, an inbound service that security alarm systems utilise to report events to a monitoring centre. The security monitoring service transmits alarm data from monitored premises to the Company's control room using a telecommunications Network Provider (the Provider).

Services and payment is in accordance with the Agreement which stipulates services are ordered, supplied and billed against the nominated accounts.

As provided by the Agreement, the Company must maintain a minimum call volume each month to be entitled and paid a rebate for qualifying calls. Failure to maintain this minimum call volume may result in the Company being charged. Before calls can be invoiced and paid the Provider must reconcile which calls qualify by manually analysing data to generate a report based on specific call parameters.

The Company have information indicating the number of calls however this information does not include which calls qualify for a rebate as this is only available to the Provider. Once the reconciliation is completed the Provider raises and forwards a Recipient Created Tax Invoice (RCTI) to the Company.

Until the reconciliation is completed and the RCTI raised the amount is not known, only upon receiving the RCTI is the amount quantifiable and ascertained by the Company. The Network then arrange an electronic funds transfer of the amount to a nominated account within 28 days following the end of the month in which the amounts are earned.

Conclusion

The size and structure of the incorporated entity, together with its reliance on employees, 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 telecommunications company completes the manual report for qualified calls and raises a RCTI a `recoverable debt' is created (a presently existing right to demand payment), the Company will have become entitled to an ascertainable income amount on performance of an agreed task.

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 does not alter the income transaction and therefore it is not considered that the contractual requirement to provide payment of the RCTI within 28 days following the end of the month in which the amounts are earned will defer the point at which income is derived. The RCTI cannot be regarded as a contingency which defers derivation of the payment amount.