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Ruling

Subject: Lump sum payment - company service agreement

Question 1

Is the lump sum payment you received assessable as ordinary income?

Answer: Yes

Question 2

Is the lump sum payment you received included in your assessable income as a net capital gain?

Answer: No

Question 3

If the lump sum payment is assessable as a capital gain, will the 50% active asset reduction concession apply to reduce the capital gain?

Answer: No, as the payment is not assessable as a capital gain

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You run a medical practice.

You have entered into a 3 year fixed term service agreement with another company to provide the services of your employee.

You received a lump sum one-off payment in consideration for acceptance of the agreement. You supplied an invoice to the company for this amount.

The terms of the agreement, among other things, contains the following conditions:

§ you must complete the term of the agreement

§ you must not be involved directly or indirectly in any business or activity that is the same or substantially similar to, or in competition with, the business as conducted by the company.

If the terms of the agreement are breached, you are required to pay an amount to the company for each whole month remaining until the term of expiry of the agreement.

You have provided a copy of the service agreement dated in the 2011-12 financial year.

Relevant legislative provisions

Income tax Assessment Act 1997 Section 6-5

Income tax Assessment Act 1997 Section 104-35

Income tax Assessment Act 1997 Section 118-20

Reasons for decision

Assessable as ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

In your case, the one-off payment received was in consideration for the provision of medical services to be provided by your employee. Although the payment was an isolated transaction, the fact remains that the payment is an advance on the services to be performed by your employee who usually provides these medical services in the ordinary course of your business. Thus, the payment was received in the course of carrying on your business.

Taxation Ruling TR 92/3 discusses whether a profit made on an isolated transaction is considered assessable income. Paragraph 35 of TR 92/3 states:

A profit from an isolated transaction is therefore generally assessable income when both of the following elements are present:

§ The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

§ The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In your case, we consider that your intention or purpose in entering into the transaction was to make a profit or gain and, the profit or gain was made in carrying out a business operation or commercial transaction. Accordingly, the lump sum payment would be considered ordinary income and therefore assessable under section 6-5 of the ITAA 1997.

Assessable as a capital gain

Part IIIA of the ITAA 1997 applies to include in your assessable income a net capital gain made on the disposal of assets. A net capital gain is the total of your capital gains for that year, less certain capital losses you made. A capital gain may be disregarded or reduced where an exemption applies. You can make a capital gain or loss only if a CGT event happens: Section 100-20 of the ITAA 1997.

Under section 104-35 of the ITAA 1997, Capital Gains Tax (CGT) event D1 happens when you create a contractual right or other legal or equitable right with another entity. Such events may include when you enter into a service agreement with another entity which contains specific conditions that you must adhere to.

In your case, you have entered into an agreement with another entity for a fixed term of 3 years. As part of the agreement, you are prohibited from becoming involved directly or indirectly in any business or activity that is the same or substantially similar to, or in competition with, the business as conducted by the other entity. As consideration for entering into the agreement you received a lump sum payment of $65,000 plus GST. This payment is deemed to be a CGT event D1 and is therefore liable to capital gains tax.

However, section 118-20 of the ITAA 1997 is aimed at preventing double taxation by reducing a capital gain arising from a CGT event to the extent that an amount has already been included as assessable income of a taxpayer in any income year.

Therefore, any capital gain in respect of this payment you have made is reduced to nil as the payment will be assessed as ordinary income under section 6-5 of the ITAA 1997 (as detailed above).