Edited version of your private ruling

Authorisation Number: 1012442508976

Ruling

Subject: Rights to future income (RTFI)

Question 1

Does Company A satisfy the conditions under subitem 50(3)(a) of Part 4 of Schedule 3 of the Tax Laws Amendment (2012 Measures No.2) Act 2012 in respect of the 200X and 20YY assessments which issued on or after 12 May 2010 and on or before 30 March 2011?

Answer

Yes.

Question 2

If the answer to question 1 is yes, is Company A eligible for a deduction under section 716-405 of the interim rules of the Tax Laws Amendment (2012 Measures No.2) Act 2012 in respect of the tax cost of the client contracts under the Z Agreement for the 200X and 20YY income years?

Answer

Yes, to the extent to which the value of the right to future income (RTFI) is attributable to the compensation payable under the Z Agreement by reference to the notice period in the Z Agreement which provides for the termination of the agreement.

Question 3

Is Company A entitled to further deductions under section 716-405 of the interim rules of the Tax Laws Amendment (2012 No 2) Act 2012 in subsequent years of income in respect of deductions which are spread over more than one year of income in respect of the Z Agreement?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2009;

Year ended 30 June 2010;

Year ended 30 June 2011;

Year ended 30 June 2012; and

Year ended 30 June 2013.

The scheme commences on:

Year ended 30 June 2009

Relevant facts and circumstances

1 Company A is the Head Company of a tax consolidated group.

2. During the year ended 30 June 200X, Company A completed the acquisition of Company B and its subsidiaries and formed a tax consolidated group.

3. Company A provides services in Australia. All services provided are fee based services as agreed by the client for each transaction. These services are provided by the subsidiaries of Company B.

4. Client contracts

4.1 The Client contracts were entered into with various subsidiary members at various dates. The cost setting process for the 200X year of income resulted in a tax cost setting amount being allocated to acquired client contracts with their market value based on the discounted cash receipt of revenue over V years as at the date of acquisition.

4.2 Most contracts are for fixed term periods at the time of acquisition.

4.3 Generally, the contracts do not contain a renewal clause. The taxpayer receives fee based revenue. Clients have the ability to remove Company A before the contract matures, or the role ceases. There can also be cases of early termination of contracts, for example, assets under the transactions are disposed.

4.4 Clients can remove Company A by giving 3 to 6 months notice and in most cases there are no penalties, however, Company A is entitled to be paid fees during the notice period.

4.5 Multiple contracts are signed for each program where one client may have one or more programs.

4.6 The Z Agreement will be the subject of this private ruling.

5. The Z Agreement

5.1 The Z Agreement is between Customer C and Company A. Customer C appoints Company A. Company A accepts its appointment.

5.2 The Z Agreement contains clauses in relation to termination, resignation or removal of Company A; Fees and expenses; Appointment of Successor to Company A; Indemnification; and Merger, Consolidation or Sale of Business by Company A.

5.3 Further, the Z Agreement entitles Company A to compensation in the event of termination of appointment, allowing for the payment of all fees and expenses owed to it and the reimbursement of all reasonable out-of-pocket expenses incurred in connection with all services rendered by it under the agreement.

6. Tax cost setting amount of client contracts

6.1 The tax cost setting amount was calculated on the basis of the market value of the future income that was estimated to be generated from client contracts available at the acquisition time of Company B and its subsidiaries.

6.2 There is no additional value ascribed to any contract that can be said to be contingent on the renewal of the contracts (such as renewal clauses) which may give rise to the extension of an existing contract, or to a future contract, under which income would be receivable.

6.3 The market value of the client contracts comprising the RTFI value introduced to the tax consolidated group by the various subsidiary members was adjusted by virtue of the tax cost setting ACA allocation.

Relevant legislative provisions

Income Tax Assessment Act 1997 (Tax Laws Amendment (2010 Measures No 1) Act 2010)

Income Tax Assessment Act 1997 section 701-55(5C) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3)

Income Tax Assessment Act 1997 section 701-63 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3)

Income Tax Assessment Act 1997, subsection 701-63(5)

Income Tax Assessment Act 1997 section 716-405 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Pre rules Part 1 in Schedule 3)

Income Tax Assessment Act 1997 section 701-55(5C) of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Interim rules Part 2 in Schedule 3)

Income Tax Assessment Act 1997 section 701-63 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Interim rules Part 2 in Schedule 3)

Income Tax Assessment Act 1997, subsection 701-63(4)

Income Tax Assessment Act 1997, subsection 701-63(5)

Income Tax Assessment Act 1997 section 716-405 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (The Interim rules Part 2 in Schedule 3)

Income Tax Assessment Act 1997 item 49 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3)

Income Tax Assessment Act 1997 item 50 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3)

Income Tax Assessment Act 1997 item 51 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3)

Income Tax Assessment Act 1997 item 52 of Tax Laws Amendment (2012 Measures No 2) Act 2012 (Application Part 4 in Schedule 3)

Income Tax Assessment Act 1997, subsection 995-1(1)

Reasons for decision

All legislative references in this Ruling are to the ITAA 1997 unless otherwise stated.

Question 1

Summary

Company A satisfies the conditions under subitem 50(3)(a) of Part 4 of Schedule 3 of the Tax Laws Amendment (2012 Measures No.2) Act 2012 (TLAA 2012 No.2) in respect of the 200X and 20YY assessments which issued on or after 12 May 2010 and on or before 30 March 2011.

Detailed reasoning

The application rules in TLAA 2012 No.2 are relevant in ascertaining which rules apply to the head company of a consolidated group in respect of an entity that becomes a member of that group at a particular time.

Subitem 50(1) provides that:

The pre rules, interim rules or prospective rules apply to an assessment of the head company of a consolidated group or MEC group for an income year in respect of an entity (the joining entity) that becomes a member of the group at a time (the joining time), in accordance with subitems (2), (3), (4) and (5).

As a general rule, subitem 50(2) or the pre rules will apply for the income year in respect of a joining entity that joined the group before 12 May 2010 (or where the arrangement under which the entity joined the group commenced before 10 February 2010).

Subitem 50(3)(a) provides for an exception to this general rule, allowing the interim rules to apply, for the income year in respect of the joining entity, if:

(a) both of these conditions are satisfied:

(i) apart from this subitem, the pre rules would apply, for the income year in respect of the joining entity, in accordance with subitem (2);

(ii) the head company's latest notice of assessment, for the income year, that relates to the application of the original 2010 law in respect of the joining entity, was served on the head company by the Commissioner on or after 12 May 2010 and on or before 30 March 2011; or

In accordance with subitem 50(2), the pre rules would, in the first instance apply to Company A on the basis of the interest in Company B and its subsidiaries having been acquired during the year ended 30 June 2009. Therefore, the first condition in subitem 50(3)(a)(i) is satisfied.

The second condition in subitem 50(3)(a)(ii) is satisfied on the basis of notices of assessment, for the 200X and 20YY income years, relating to the application of the original 2010 law, having been served on Company A on or after 12 May 2010 and on or before 30 March 2011.

Question 2

Summary

Company A is eligible for a deduction under section 716-405 of the interim rules in respect of the tax cost of the client contracts under the Z Agreement for the 200X and 20YY income years to the extent that the value of the RTFI is attributable to the compensation payable under the Z Agreement by reference to the notice period in the Z Agreement which provides for the termination of the agreement.

Detailed reasoning

Subsection 701-55(5C) of the interim rules outlines the conditions under which section 716-405 may apply in relation to the asset after the particular time. Subsection 701-55(5C) states:

If:

(a) the asset's tax cost is set because an entity becomes a *subsidiary member of a *consolidated group at the particular time; and

(b) section 716-410 (rights to amounts that are expected to be included in assessable income) covers the asset at the particular time; and

(c) the asset is not a *non-deductible right to future income in relation to the entity;

the expression means that section 716-405 may apply in relation to the asset after the particular time.

The rights under the client contracts under the Z Agreement satisfy the conditions in paragraphs (a) and (b) of subsection 701-55(5C). It is then necessary to consider whether the rights, or any part of the rights, are non-deductible rights to future income.

Subsection 701-63(4) defines a non-deductible right to future income as:

A *right to future income that is a right of an entity under a contract or agreement with another entity (the customer) is a non-deductible right to future income in relation to the entity to the extent that the value of the right to future income:

(a) is contingent on the renewal of the contract or agreement; or

(b) is attributable to a period (if any) during which the customer can unilaterally cancel the contract or agreement without paying compensation or a penalty; or

(c) if there is a period during which the customer can unilaterally cancel the contract or agreement, but must pay compensation or a penalty-is attributable to that period, but not to that compensation or penalty.

Subsection 701-63(4) limits the application of section 716-405 to a right to future income that is not a non-deductible right to future income. (Any non-deductible right to future income is treated as an asset forming part of goodwill under paragraph 701-63(3)(c).)

Under the Z Agreement, Customer C may terminate the appointment of Company A at any time by giving written notice to Company A and specifying the effective date of such termination.

Further, the Z Agreement effectively entitles Company A to compensation in the event of termination of appointment, allowing for the payment of all fees and expenses owed to it and the reimbursement of all reasonable out-of-pocket expenses incurred in connection with all services rendered by it under the agreement.

The Explanatory Memorandum to Tax Laws Amendment (2012 Measures No.2) Bill 2012 (the EM) provides some guidance with respect to the operation of subsection 701-63(4) and in particular the reference to the unilateral cancellation of a contract or agreement. Paragraph 3.77 states:

A right to future income under a contract or agreement entered into by a joining entity with the customer is uncertain if the customer can unilaterally cancel the contract or agreement at any time without paying compensation or penalty. In this regard, the right is not an existing right to future income but is a mere expectation that cannot be attributed to those existing rights. Therefore, the right is a non-deductible right to future income that is treated as goodwill.

Paragraph 3.78 further states:

If the customer can unilaterally cancel the contract or agreement at any time but must pay compensation or a penalty, the value of the contract or agreement that is attributable to the compensation or a penalty, is not a non-deductible right to future income.

The words 'to the extent that' in subsection 701-63(4) indicate that the value of a contractual RTFI is capable of being apportioned such that section 716-405 may apply to only a portion of the value of the RTFI.

Therefore, Company A is eligible for a deduction under section 716-405 of the interim rules in respect of the tax cost for the client contracts under the Z Agreement for the 200X and 20YY income years to the extent that the value of the RTFI is attributable to the compensation payable under the Z Agreement by reference to the notice period in the Z Agreement which provides for the termination of the agreement.

Question 3

Summary

Company A is not entitled to further deductions in subsequent years of income in respect of deductions which are spread over more than one year of income in respect of the Z Agreement.

Detailed reasoning

The application rules in TLAA 2012 No.2 are relevant in ascertaining which rules apply to the head company of a consolidated group in respect of an entity that becomes a member of that group at a particular time.

Subitem 50(1) provides that:

The pre rules, interim rules or prospective rules apply to an assessment of the head company of a consolidated group or MEC group for an income year in respect of an entity (the joining entity) that becomes a member of the group at a time (the joining time), in accordance with subitems (2), (3), (4) and (5).

As a general rule, subitem 50(2) or the pre rules will apply for the income year in respect of a joining entity that joined the group before 12 May 2010 (or where the arrangement under which the entity joined the group commenced before 10 February 2010).

Subitem 50(3)(a) provides for an exception to this general rule, allowing the interim rules to apply, for the income year in respect of the joining entity, if:

(a) both of these conditions are satisfied:

(i) apart from this subitem, the pre rules would apply, for the income year in respect of the joining entity, in accordance with subitem (2);

(ii) the head company's latest notice of assessment, for the income year, that relates to the application of the original 2010 law in respect of the joining entity, was served on the head company by the Commissioner on or after 12 May 2010 and on or before 30 March 2011; or

The interim rules apply to Company A for the 200X and 20YY income years on the basis of the conditions in subitem 50(3)(a) being satisfied.

The EM at paragraphs 3.122 and 3.123 provides further guidance on the application of the interim rules where the conditions of subitem 50(3)(a), namely (i) and (ii) are satisfied.

Importantly, where apart from subitem 50(3)(a) the pre rules would apply, the interim rules will only apply to a claim that satisfies these conditions for the income year that relates to the application of the original 2010 law in respect of the joining entity.

Therefore, the pre rules will apply to the tail of claims for deductions in subsequent years.

Relevantly, paragraph 3.123 of the EM provides the following case scenario:

Therefore, if the joining time was before 12 May 2010 or the arrangement under which the joining entity joined the group commenced before 10 February 2010 (so that the pre-rules generally apply) and the joining time holds, for example, a right to future income that is not unbilled income, then:

· if the Commissioner has served a notice of assessment or amended assessment for an income year on the head company between 12 May 2010 and 30 March 2011 allowing a deduction for the claim, the interim rules will apply for that income year so that the deduction is allowed; and

· the pre-rules will apply to the tail of the claims for deduction in subsequent income years (and therefore a deduction may not be allowed in those subsequent income years).

Company A has made a claim in the 2011 income year in respect of which the Commissioner served a notice of assessment after 30 March 2011. Further deductions in subsequent years of income have not been claimed.

As the notice of assessment for the 2011 income year was served after 30 March 2011 and the joining time was before 12 May 2010, the pre rules will apply to Company A for the 2011 income year and for subsequent years of income.

Subsection 701-55(5C) of the pre rules outlines the conditions that need to be satisfied for section 716-405 to apply in relation to the asset after the particular time. It states:

If:

(a) the asset's tax cost is set because an entity becomes a *subsidiary member of a *consolidated group at the particular time; and

(b) section 716-410 (rights to amounts that are expected to be included in assessable income) covers the asset at the particular time; and

(c) the asset is not a *non-deductible right to future income in relation to the entity;

the expression means that section 716-405 may apply in relation to the asset after the particular time.

Subsection 701-63(4) defines a non-deductible right to future income as a right to future income that is not an unbilled income asset.

In essence, the pre rules limit deductions for rights to future income to unbilled income assets. This is confirmed by the EM at paragraph 3.33:

That is, if an entity joins a consolidated group holding an unbilled income asset that is expected to be included in the head company's assessable income after the joining time, then the head company will be able to apply section 716-405 to deduct the reset tax cost for the asset.

Under subsection 701-63(6):

An asset that is a *right to future income is an unbilled income asset if:

(a) the asset:

(i) is in respect of work (but not goods) that has been performed, or partially performed, by an entity for another entity; or

(ii) is in respect of goods (other than *trading stock) or services that have been provided, by an entity to another entity; and

b) a recoverable debt has not yet arisen in respect of the work, goods or services.

Applying the pre rules, Company A is not entitled to further deductions in subsequent years of income in respect of the unexpended tax cost setting amount (equivalent to the tail of claims) for the client contracts under the Z Agreement on the basis that the rights under the contracts are not unbilled income assets.

The unexpended tax cost setting amount for the client contracts is a non-deductible right to future income that is treated as an asset forming part of goodwill (paragraph 701-63(3)(c)).