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Ruling

Subject: Capital gains tax treatment of payments received pursuant to the Deed

Question 1:

Does the disposal of the right to future commissions constitute capital gains tax (CGT) event A1?

Answer: Yes.

Question 2:

Are the amounts received by the taxpayer pursuant to the Deed assessable on capital account being the proceeds from the disposal of a CGT asset?

Answer: No, by virtue of the anti overlap provisions contained in section 118-20 of the Income Tax Assessment Act 1997 (ITAA 1997).

Question 3:

On the basis the amounts received are capital proceeds in relation to the disposal of a CGT asset, is the capital gain eligible for the 50% CGT discount?

Answer: Not applicable.

Question 4:

On the basis the amounts received are capital proceeds in relation to the disposal of a CGT asset, is the asset disposed of an active asset for the purposes of the small business CGT concessions?

Answer: Not applicable.

This ruling applies for the following periods:

1 July 2007 to 30 June 2008.

The scheme commences on:

1 July 2007.

Relevant facts and circumstances

The business commenced several years ago.

You received income by way of commission payments.

Recently, a purchaser signalled their interest to buy the rights to the existing commissions.

The purchaser calculated a payout formula in exchange for you giving up the rights to the existing commissions with regards to your particular circumstances.

Rather than receiving a lump sum, the payment was increased by a set percentage and you received monthly payments for a period.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 Division 108

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

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

Question 1 and Question 2:

A capital gain or capital loss may be made if a capital gains tax event (CGT event) happens to a capital gains tax asset (CGT asset). Division 108 of the ITAA 1997 refers to CGT assets. Section 108-5 of the ITAA 1997 describes a CGT asset as any kind of property or legal or equitable right that is not property.

Your right to future commissions is a CGT asset and the disposal of your right to future trail commissions will be a CGT event A1. A CGT event A1 happens if you dispose of a CGT asset and the time of the event is when you enter into the contract for the disposal. You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base.

Whilst the payments received by you for the disposal of the right to future commissions may have been assessable under the CGT provisions, the anti overlap provisions contained in section 118-20 of the ITAA 1997 reduce any capital gain to zero to prevent the taxing of the same amount twice. The amount is otherwise assessable under another provision, section 6-5 of the ITAA 1997.

In your case, the payments have been found to be ordinary income and assessable under section 6-5 of the ITAA 1997. The payments will be included in your income tax return for the year in which they are received. Therefore even though a CGT event A1 will happen to a CGT asset, any capital gain will be reduced to nil.

The nature of the payment

Subsection 6-5(1) of the ITAA 1997 defines ordinary income as income 'according to ordinary concepts'. Under subsection 6-5(2) of the ITAA 1997, the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources during the income year.

The tax legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics.

In determining whether an amount is ordinary income, the courts have established the following principles:

· what receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as a statute dictates otherwise

· whether the payment received is income depends upon a close examination of all relevant circumstances

· whether the payment received is income is an objective test.

Relevant factors in determining whether an amount is ordinary income include:

· whether the payment is the product of any employment, services rendered, or any business

· the quality or character of the payment in the hands of the recipient

· the form of the receipt, that is, whether it is received as a lump sum or periodically

· the motive of the person making the payment, but noting that this latter factor is rarely decisive, as a mix of motives may exist.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413 at 4420; (1990) 21 ATR 1 the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The whole of the circumstances must be considered.

Amounts that are periodical, regular or recurrent, relied upon by the recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income. In addition, receipts from property or investments that are on commercial terms and/or that indicate an intention to make a profit from an activity are also likely to be ordinary income.

Commissions form a significant part of the income you derive in carrying on a business. Commissions are earned, expected, relied upon and are paid on a regular basis. These commissions form part of your assessable income under subsection 6-5(2) of the ITAA 1997.

In your case, the purchaser calculated an amount to compensate you for future earnings based on a number of factors relevant to your particular circumstances. However, you chose not to receive a lump sum amount but instead to increase the payment by a set percentage and receive monthly payments for a period.

Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v FC of T 79 ATC 4641; (1979) 10 ATR 411).

The monthly payments have the character of income because the commissions themselves had the character of income. Future income has simply been converted to present income (and then received as monthly payments for a period) - as stated in paragraph 65 of Taxation Ruling TR 92/3:

Thus, an amount received for the transfer of a right to an income stream severed from the property to which it relates is income according to ordinary concepts. Future income is simply converted into present income. This is the case even if the income stream is produced by a contractual right rather than by the relevant property.

Therefore the monthly payments under the terms of the settlement are assessable as ordinary income under section 6-5 of the ITAA 1997. The amounts are assessable in the income year in which they are received.

Question 3 and Question 4:

As the monthly payments are assessable under section 6-5 of the ITAA 1997 and section 118-20 of the ITAA 1997 has the effect of reducing the capital gain to nil, access to the general 50% CGT discount and small business CGT concessions are not available.