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Ruling

Subject: Income Tax: Trade incentives - determination of income

Question 1

Are discounts for prompt payment included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936) when the purchase invoice is paid?

Answer

Yes

Question 2

Are guaranteed rebates included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 when the purchase is made?

Answer

No, the amount of the guaranteed rebate is to be treated as a reduction in the cost of the purchase of the trading stock by the trust.

Question 3

Are volume rebates included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 when the conditions are satisfied and an invoice has been issued to the supplier?

Answer

Yes

Question 4

Are advertising contributions included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 when the invoice is issued to the supplier?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

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.

The trust is a retailer.

The trust accounts for income on an accruals basis for both income tax and GST purposes.

As part of the business operations of the trust, the trustee has entered into agreements with a number of suppliers offering rebates on the cost of purchases of stock. These rebates include:

· Discounts for prompt payment

· Guaranteed rebates

· Volume rebates for orders beyond certain aggregate thresholds; and

· Advertising contributions.

Whilst each supplier have slightly different terms, the common features are as follows:

· Prompt payment discounts are claimed at the time of payment of the relevant invoice by paying the net amount owing after the discount.

· Guaranteed rebates are based on orders placed with the supplier for the quarter. The supplier does not take into account any rebate when issuing invoices for payment by the trustee during the quarter. After the end of each quarter, the supplier calculates the amount of the rebate and advises the trustee of the amount. The trustee then issues an invoice to the supplier for the rebate amount.

· Volume rebates are based on aggregate orders placed with that supplier for the quarter and are received in the form of a cash payment after the end of the quarter. For the quarter ended 30 June these rebates are generally received in September or October of that year. The volume rebate is calculated by the trustee following the end of the quarter and an invoice is issued to the supplier. This calculation can not be performed prior to the end of the quarter as it is necessary to make adjustments for returns of stock in order for the rebate to be based on actual purchases made. Under the various agreements, the suppliers do not pay the rebate until they receive an invoice.

· Advertising contributions are not necessarily linked to any particular advertising campaign, but instead recognise the general link between advertising and increased sales. As a consequence the advertising contributions are calculated as a percentage of the orders placed with a particular supplier for a quarter. As with volume rebates, these contributions are calculated by the trustee following adjustments to purchases for returns of stock after the end of the quarter. An invoice is then issued to the supplier along with evidence that there has actually been advertising of the supplier's products. The advertising contribution is received as a cash payment following the issuing of the invoice, after the end of the relevant quarter.

Copies of the relevant agreements with suppliers have been provided with your application.

The ruling is limited to the suppliers and rebates listed in the relevant agreements. Note that whilst the period for these agreements may extend beyond 30 June 2010, this ruling only applies to discounts received up to and including 30 June 2010.

The rebates received by the trust are only based on the orders placed for stores which it owns. They are not dependant on the activities of the other stores within the buying group.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95(1)

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

Income Tax Assessment Act 1997 subsection 6-5(4)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 70

Reasons for decision

Question 1

Summary

The amount of the prompt payment discount would not be included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936) until the time that the invoice is paid and the discount offer is taken up.

Detailed reasoning

Calculation of net income of the trust estate

The "net income" of a trust estate is defined in subsection 95(1) of the ITAA 1936 as the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except:

· deductions under Division 393 of the Income Tax Assessment Act 1997 (ITAA 1997) (Farm management deposits) and

· in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the ITAA 1997 in respect of such of the tax losses of previous years as are required to be met out of corpus.

Therefore, the net income would include amounts of ordinary income (under section 6-5 of the ITAA 1997) or statutory income (under section 6-10 of the ITAA 1997) that would be included in the assessable income of a resident taxpayer. The net income of the trust is taxed in the year in which it is derived by the trustee of the trust, regardless of whether it is actually distributed to beneficiaries in that income year.

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.

Receipts and accruals method

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 and have identified two methods: the receipts method and the earnings (or accruals) method.

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 (or Accruals)

· 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. (Henderson v. FCT (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596 (Henderson's case); Henderson v. FCT 69 ATC 4049; (1969) 1 ATR 133).

· A taxpayer may have a recoverable debt even though, at the time, they cannot legally enforce recovery of the debt. (Barratt & Ors v. FC of T 92 ATC 4275; (1992) 23 ATR 339 (Barratt's case)).

· 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.

It has already been determined that the trust accounts for income on an accruals basis for both income tax and GST purposes. It is considered that the accruals (or earnings) basis is the most appropriate method for determining when income is derived by the trust.

Paragraph 49 of TR 98/1 deals specifically with business income from trading and clarifies that the earnings method is generally preferred because the book debts represent what was previously trading stock or circulating capital.

Furthermore, paragraph 55 provides:

Where a taxpayer relies, to a significant extent, on circulating capital or consumables to produce income it is likely that the appropriate method for determining income is the earnings method. (Carden's case; Dunn's case; Barratt's case). Similarly, where a taxpayer's employees directly generate significant income, the earnings method is likely to be appropriate to account for that income in the relevant year. (Henderson's case; Barratt's case). Also, where other variable costs of the taxpayer's business have a direct relationship, and significantly contribute, to the income produced, that income should be brought to account using the earnings method.

Discounts for prompt payment

Taxation Ruling TR 96/20 discusses the assessability and deductibility of prompt payment discounts offered by traders of goods to their customers and certain other discounts. It provides the following in relation to a customer's allowable deductions:

1. A customer purchasing trading stock of a business is allowed a deduction, under section 8-1 of the ITAA 1997, for its purchase price. Broadly speaking, the deduction is allowable in the year in which the purchase price is incurred.

2. For it to be incurred, a liability must be a presently existing one to which the customer is definitively committed. A liability may still be incurred even though it remains unpaid or it may later be defeased.

3. The price for which goods are purchased under a contract of sale is the full invoice price. There is nothing uncertain or contingent at the time of purchase about the price for which the contract has been made. The full invoice price is the liability to which the customer is obligated by the purchase. The accompanying availability to a customer of a discount to the purchase price in consideration for prompt payment does no more than provide an opportunity for the customer to acquire the goods at an actual cost less than their contracted price. But this opportunity cannot operate retrospectively to reduce the original liability created at the time of the purchase by the contract of sale.

4. The customer should therefore, claim at the time of purchase, the full invoice price as an allowable expenditure under section 8-1 of the ITAA 1997.

Taxation Ruling TR 2009/5 discusses the treatment of discounts, rebates and other trade incentives offered by sellers to buyers in relation to trading stock. It provides the following in relation to the tax consequences for a buyer:

1. Trade incentives that relate directly to the purchase of trading stock, so as to reduce the purchase price, are treated as a reduction in the cost of acquiring the trading stock for the buyer for the purposes of section 8-1 and Division 70.

2. An incentive that is subject to a condition that has not been satisfied at the time of the purchase does not relate directly to the purchase of trading stock and does not reduce the cost of acquiring trading stock for a buyer.

3. A seller may provide a trade incentive that subsidises, compensates, reimburses or rewards a buyer for carrying out activities or performing services (such as promotional services) or, in the absence of such activities or services, secures a real commercial benefit for the seller in relation to its brand or future sales of its goods. Such a trade incentive does not reduce the cost of acquiring trading stock for the buyer.

4. Where a trade incentive does not reduce the buyer's cost of acquiring trading stock, the trade incentive is ordinary income of the buyer. On the assumption that the buyer returns income on an accruals basis, the income will be derived in the income year in which it is earned.

Where a trade incentive is provided in respect of future acts and/or services (such as promotional services) to be performed by a buyer, and where the buyer is required to repay or in practice repays any part of the trade incentive attributable to any acts and/or services not performed, the trade incentive will be derived by the buyer for the purposes of section 6-5 at the time the relevant acts and/or services are performed.

You have advised that you receive discounts for prompt payment from your suppliers.

TR 96/20 provides the following in relation to the effect of accepting discount by a customer:

17. A liability incurred on the purchase of trading stock is a revenue expense. Where the liability is incurred on credit, the amount required to extinguish that liability may not be finally determined until it is paid.

18. If the offer of a discount is accepted and the liability is extinguished by the payment of an amount less than the amount of the liability, the amount of the difference gives rise to a revenue gain because it has the character of income under ordinary concepts.

19. A customer should, therefore, include at the time the liability is satisfied the discount amount as assessable income under section 6-5 of the ITAA 1997. This is so whether the substance and effect of the discount is a later variation of the contract price or is a part defeasance of the liability created by the contract of sale.

Example 1 of TR 96/20 provides the following in relation to a prompt payment discount:

82. A wholesale trader of widgets sells $1,000 worth of them to a retail customer on 30 June 2005, offering the customer a 5% discount on the sale price if the balance of the price is paid in full on or before 7 July 2005.

83. Whether the customer takes up the trader's offer of a discount or not:

(a) the trader derives, as assessable income under section 6-5 of the ITAA 1997, the $1,000 sale price on 30 June 2005; and

(b) the customer incurs, as an allowable deduction under section 8-1 of the ITAA 1997, the $1,000 purchase price on 30 June 2005.

84. If the customer takes up the trader's offer of a discount by paying the discounted price of $950 to the trader on 7 July 2005:

(c) the trader incurs, as an allowable deduction under section 8-1 of the ITAA 1997, a loss of $50 ($1,000 sale price less $950 received) on 7 July 2005; and

(d) the customer derives, as assessable income under section 6-5 of the ITAA 1997, a gain of $50 ($1,000 purchase price less $950 paid) on 7 July 2005.

Further, Example 4 of TR 2009/5 provides in part the following in relation to the treatment of prompt payment discounts:

33. …the prompt payment discount is an incentive subject to a condition that has not been satisfied at the time of purchase and will not reduce the cost of acquiring trading stock for the buyer. The amount incurred by the buyer for the purposes of section 8-1 is determined by the contractual terms of trade between the parties, and at the time the transaction is implemented the buyer has no right to the prompt payment discount….

34. The buyer will include the amount of the discount in its assessable income in the income year in which its entitlement to the discount arises.

Therefore, in relation to a prompt payment discounts offered to the trust as part of their trading terms with their suppliers, the amount of the discount would not be included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 until the time that the invoice is paid and the discount offer is taken up.

Question 2

Summary

The guaranteed rebate amount will reduce the purchase price of the trading stock to which it relates for the purposes of Division 70 of the ITAA 1997.

Detailed reasoning

You have advised that you receive guaranteed rebates from your suppliers that are paid to you quarterly in arrears.

Paragraphs 96 and 97 of TR 2009/5 provide the following in relation to upfront volume rebates not subject to aggregate volume thresholds:

96. Where the buyer purchase trading stock that is subject to a volume rebate at the time of purchase based on the quantity purchased, the purchase/sale price of the trading stock is the net amount.

97. The volume rebate is not a condition that has not been satisfied at the time of the purchase/sale. The volume rebate relates directly to the purchase/sale and the price of the trading stock, is a benefit provided to the buyer at the time of purchase for entering into a contract to purchase a particular quantity, and is essentially a reduction in the contract price. Accordingly it reduces the purchase price of the buyer and the sale price of the seller.

Guaranteed rebates are not conditional on you fulfilling a certain quota before you become entitled to the percentage of rebate included in your trade agreements. The trustee is aware upfront that at the end of each quarter an amount will be owing to them from the supplier based on a percentage of the goods purchased during that quarter.

Section 70-1 of the ITAA 1997 states that Division 70 of the ITAA 1997 deals with 'amounts you can deduct, and amounts included in your assessable income' where 'you acquire an item of trading stock'. Section 70-15 of the ITAA 1997 states that "This section tells you in which income year you can deduct under section 8-1 (about general deductions) an outgoing incurred in connection with acquiring an item of trading stock." This is the income year in which you incur the outgoing, provided the item becomes part of your trading stock on hand before or during that income year. Otherwise, it is:

· The income year during which the item becomes part of your trading stock on hand, or

· The income year in which the amount is included in the assessable income from the disposal of that item.

Paragraph 70 of TR 2009/5 provides the following in relation to acquiring an item of trading stock:

70. Subsection 70-15(1) refers to 'an outgoing incurred in connection with acquiring an item of trading stock.' The deductible amount (the 'gross outgoing' referred to section 70-5) is the actual cost to the trader of acquiring the item. All elements that contribute to the actual cost of the item of trading stock, such as trade incentives that in reality reduce the cost, are intended to be taken into account.

Whether or not the rebate is included on the sales invoice or is separately invoiced does not affect the income tax consequences. The rebate is in substance simply a reduction in the purchase/sale price, and the manner in which it is invoiced does not alter its character.

Therefore, in relation to guaranteed rebates received by the trust under the terms of your trade agreements with your suppliers, the rebate amount will reduce the purchase price of the trading stock to which it relates for the purposes of Division 70 of the ITAA 1997.

Question 3

Summary

The amount of the volume rebates would not be included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 until the time that the conditions have been met and an invoice is issued to the supplier.

Detailed reasoning

You have advised that you receive volume rebates from your suppliers that are paid to you quarterly in arrears once it has been determined by the suppliers that you have meet your targeted amount for the quarter in question.

As stated at paragraph 5 of TR 2009/5, an incentive that is subject to a condition that has not been satisfied at the time of the purchase does not relate directly to the purchase of trading stock and does not reduce the cost of acquiring trading stock for a buyer. Paragraph 7 of the Ruling goes on to say that where a trade incentive does not reduce the buyer's cost of acquiring trading stock, the trade incentive is ordinary income of the buyer. On the assumption that the buyer returns income on an accruals basis, the income will be derived in the income year in which it is earned.

Volume rebates subject to an aggregate volume threshold are subject to a condition that has not been satisfied at the time of the sale, and it is not certain at the time of sale that the condition will be satisfied. A later satisfaction of that condition does not retrospectively alter the purchase/sale price applicable to the earlier transactions at the time the transactions were undertaken.

In your case the volume rebates are conditional on reaching a certain dollar amount of purchases/sales from the supplier. The rebate is then either calculated as a percentage of the value of all purchases made for the quarter or as a percentage of the value of purchases above the threshold amount.

Therefore, in relation to volume rebates received by the trust under the terms of your trade agreements with your suppliers, the amount of the rebate would not be included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 until it has been determined that the volume rebate conditions have been met and an invoice has been issued to the supplier.

Question 4

Summary

The amount of the advertising contributions would not be included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 until the time that the invoice is issued to the supplier.

Detailed reasoning

You have advised that you receive various advertising contributions from your suppliers that are paid to you quarterly in arrears once proof of the advertising has been supplied along with an invoice for the amount.

Example 11 of TR 2009/5 provides in part the following in relation to the treatment of an advertising allowance:

59. Under the terms of trade with a seller, a buyer is entitled to an advertising allowance for including the seller's products in its advertising material a minimum number of times a year….

60. The advertising allowance is a payment for services which the buyer provides to the seller. For the buyer the allowance is ordinary income and is not a reduction in the cost of acquisition of trading stock for Division 70 purposes.

Paragraphs 102 and 103 of TR 2009/5 provide the following in relation to promotional incentives:

102. Although in the course of its normal retail activities a buyer may be expected to promote certain popular brands of goods more intensively than other brands, if the buyer claims an incentive payment from a seller in association with buyer's promotional activities, it is reasonable to conclude that the buyer is being rewarded by the seller for services performed in relation to the seller's goods from which the seller is benefiting.

103. A seller's purpose in paying a promotional incentive is to increase its sales and sales revenue. This purpose is directed to things that occur after the seller sells the trading stock to the buyer. For this reason a promotional rebate lacks the necessary connection to the sale to be categorised as an adjustment to the sale price. The promotional rebate does not reduce the sales proceeds for the seller or the outgoing incurred by the buyer in acquiring the trading stock

The payment to you as an advertising contribution from the supplier is contingent on you undertaking advertising during a quarter and then being able to provide evidence of the advertising to the supplier.

Despite the contribution amount being calculated in most cases as a percentage of the purchases you made from a supplier during a quarter, the payment is for services you have provided to the supplier by way of advertising and does not effect the value of trading stock.

Therefore, in relation to advertising contributions received by the trust under the terms of your trade agreements with your suppliers, the amount of the contribution would not be included as assessable income for the purpose of determining the net income of the trust in accordance with subsection 95(1) of the ITAA 1936 until the time that the supplier is issued with an invoice in relation to the advertising and your onus of proof has been extinguished.