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Ruling

Subject: Derivation of income

Question 1

If the entity were to receive three years worth of income in advance, would it be considered to be derived under Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the year of income in which it was received?

Answer

No

Question 2

If the answer to Question 1 above is "No", if the entity were to receive three years worth of income in advance, would it be considered to be derived under Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant years of income when services were performed to qualify for an amount of income directly attributable to the performance of those services?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

01 July 2011

Relevant facts and circumstances

The Taxpayer carries on a business and operates on an accruals basis for both income tax and Goods and Services Tax (GST).

The Taxpayer is an authorised representative of Company C which was, until recently owned by Company A. As a result of the recent acquisition of Company A by Company B, various arrangements/options were offered by Company B to the Taxpayer to remain with Company B.

One of the options offered was the ability to access X year(s) income in advance. These payments of income in advance are based on business activity over a 6 month period and are normally paid every 6 months upon qualifying for such payment.

Should the Taxpayer leave Company B then any brought forward payments (payments received in advance) would need to be repaid.

In the financial statements of the Taxpayer, the income would be treated as a liability (unearned income) and reported as income each six months as and when the Taxpayer satisfies the relevant conditions to recognise the payment as income.

The Taxation of Financial Arrangements rules contained in Division 230 of the Income Tax Assessment Act 1997 are not considered by the applicant to apply.

Relevant legislative provisions

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

Reasons for decision

Question 1

Summary

If the entity were to receive X years worth of income in advance, it will not be considered, under Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), to derive the total amount in the income year it is received.

Detailed reasoning

Discussion of law

Under the accrual method a taxpayer derives income when they have earned the right to payment, that is, when the amount is receivable or recoverable. This can be either when the work has been completed, or when a client is billed for work performed. Under the accruals method, the time of the actual receipt of money is of no relevance.

Taxation Ruling 93/11 deals with the assessability of income on an accruals basis: when professional fees are derived.

TR 93/11 states at paragraph 12:

'When fee income is derived

The Australian courts have held that income assessable on an accruals basis is 'derived' under subsection 25(1) of the Income Tax Assessment Act when a recoverable debt is created, such that the taxpayer is not obliged to take any further steps before becoming entitled to payment (Farnsworth v FC of T (1949) 78 CLR 504; (1949) 9 ATD 33; Henderson v FC of T (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596; FC of T v Australian Gas Light Co. 83 ATC 4800; (1983) 15 ATR 105). A fee is 'recoverable' in the relevant sense even if time to pay has been allowed (Henderson's Case per Barwick CJ 119 CLR at 651; 70 ATC at 4020; 1 ATR at 601). An exception to the position that income is derived when a recoverable debt arises can apply if amounts are received or receivable in advance of goods being supplied or services being provided - see paragraph 8 above (Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314; (1965) 14 ATD 98)."

TR 93/11 states at paragraph 8:

'Receipt of fee in advance of work done

A professional person will sometimes receive fee income in advance of the work to which it relates. If the contract or arrangement requires that the fee be paid in advance, the fee income is derived in the income year in which the professional person completes the work (or the part of the work) to which the fee relates. On the other hand, if the client simply pays early, the fee income is derived when a recoverable debt arises or would have arisen if the client had not paid early.'

Application of the law to your circumstances

The Taxpayer carries on a business and operates on an accruals basis for income tax, and is an authorised representative of Company which was, until recently owned by Company A.

As a result of the recent acquisition of Company A by Company B, the option to access X year(s) worth of income in advance has been offered to the Taxpayer to remain with Company B. If the Taxpayer leaves Company B then any brought forward payments (payments received in advance) would need to be repaid.

Under the accrual method a taxpayer derives income when they have earned the right to payment, that is, when the amount is receivable or recoverable. This can be either when the work has been completed, or when a client is billed for work performed.

The Taxpayer operates on an accruals basis for income tax and has stated that in their financial statements, the income would be treated as a liability (unearned income) and reported as income each six months as and when the Taxpayer satisfies the relevant conditions to recognise the payment as income.

Usually these payments are paid on a six monthly basis after vesting for six months in January and July each year. This is the point at which the Taxpayer will have earned the right to payment and is not obliged to take any further steps before becoming entitled to payment

Conclusion

Under the accruals method, the time of the actual receipt of money is of no relevance, therefore if the entity were to receive X years in advance it would not be considered to be derived in the year of income in which it was received but when the Taxpayer satisfies the relevant conditions to recognise the income and earned the right to payment.

Question 2

Summary

If the entity were to receive X year(s) worth of income in advance, it will be considered to be derived under Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant years of income when services were performed to qualify for an amount of income directly attributable to the performance of those services.

Detailed reasoning

Discussion of law

Under the accrual method a taxpayer derives income when they have earned the right to payment, that is, when the amount is receivable or recoverable. This can be either when the work has been completed, or when a client is billed for work performed. Under the accruals method, the time of the actual receipt of money is of no relevance.

Taxation Ruling 93/11 deals with the assessability of income on an accruals basis: when professional fees are derived.

TR 93/11 states at paragraph 12:

'When fee income is derived

The Australian courts have held that income assessable on an accruals basis is 'derived' under subsection 25(1) of the Income Tax Assessment Act when a recoverable debt is created, such that the taxpayer is not obliged to take any further steps before becoming entitled to payment (Farnsworth v FC of T (1949) 78 CLR 504; (1949) 9 ATD 33; Henderson v FC of T (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596; FC of T v Australian Gas Light Co. 83 ATC 4800; (1983) 15 ATR 105). A fee is 'recoverable' in the relevant sense even if time to pay has been allowed (Henderson's Case per Barwick CJ 119 CLR at 651; 70 ATC at 4020; 1 ATR at 601). An exception to the position that income is derived when a recoverable debt arises can apply if amounts are received or receivable in advance of goods being supplied or services being provided - see paragraph 8 above (Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314; (1965) 14 ATD 98)."

TR 93/11 states at paragraph 8:

'Receipt of fee in advance of work done

A professional person will sometimes receive fee income in advance of the work to which it relates. If the contract or arrangement requires that the fee be paid in advance, the fee income is derived in the income year in which the professional person completes the work (or the part of the work) to which the fee relates. On the other hand, if the client simply pays early, the fee income is derived when a recoverable debt arises or would have arisen if the client had not paid early.'

Application of the law to your circumstances

The Taxpayer carries on a business and operates on an accruals basis for income tax, and is an authorised representative of Company C which was, until recently owned by Company A.

As a result of the recent acquisition of Company A by Company B, the option to access X year(s) worth of income in advance has been offered to the Taxpayer to remain with Company B. If the Taxpayer leaves Company B then any brought forward payments (payments received in advance) would need to be repaid.

Under the accrual method a taxpayer derives income when they have earned the right to payment, that is, when the amount is receivable or recoverable. This can be either when the work has been completed, or when a client is billed for work performed.

The Taxpayer operates on an accruals basis for income tax and has stated that in their financial statements, the income would be treated as a liability (unearned income) and reported as income each six months as and when the Taxpayer satisfies the relevant conditions to recognise the payment as income.

Usually these payments are paid on a six monthly basis after vesting for six months in January and July each year. This is the point at which the Taxpayer will have earned the right to payment and is not obliged to take any further steps before becoming entitled to payment

Conclusion

Under the accruals method, the time of the actual receipt of money is of no relevance, therefore if the entity were to receive X year(s) worth of income in advance it would not be considered to be derived in the year of income in which it was received but when the Taxpayer satisfies the relevant conditions to recognise the income and earned the right to payment.