Edited version of your private ruling

Authorisation Number: 1012525965086

Ruling

Subject: Derivation of income

Question

Should the income relating to the subscription be treated as if it were derived proportionately on a straight line basis over the term of the subscription?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

You are a commercial software company.

You provide online programmes to customers across Australia.

Your service is based on the internet with your server.

When customers purchase your products they buy licences of access to one of your platforms and different modules. Each module can be added on or removed from the platform separately.

The price of the platforms and modules is comprised of two parts:

· startup package fee - an upfront and once off payment, and

· subscription fee - this is a subscription fee of the hosted access to the program for a period of 12 months.

The subscription fee is refundable.

When a customer terminates the subscription at any time during the subscription period, the amount of the subscription attributable to the remaining period is refunded. The customer is required to give you notice when cancelling a subscription.

You do not supply the customer with additional services.

You send invoices to customers in advance and record sales when the invoices are sent.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Summary

The income relating to the subscriptions should be treated as if it was derived proportionately on a straight line basis over the term of the subscription. This is due to the existence of a contingency of repayment requiring you to refund customers an amount relating to the unused portion of the subscription in the event the subscription is cancelled.

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that, if you are an Australian resident, your assessable income includes ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Proceeds from carrying on a business are income according to ordinary concepts and are included in assessable income.

Draft Taxation Ruling TR 2013/D2 outlines the Commissioner's view on how commercial software developers derive income from agreements for the right to use proprietary software and the provision of related services.

TR 2013/D2 states that where an amount properly attributable to a contractual obligation is subject to a 'contingency of repayment', the amount is derived for the purposes of section 6-5 of the ITAA 1997 when the obligation is fully performed or the contingency of repayment otherwise lapses.

A 'contingency of repayment' in the event of non-performance refers to there being either:

(i) a contractual obligation to make a refund

(ii) a demonstrated commercial practice to make a refund, or

(iii) contractual exposure exists for damages.

Where a 'contingency of repayment' exists, it may be valid for income tax purposes to defer all or part of the contractual fee for:

(i) the granting of the proprietary licence

(ii) the hosted arrangement, and/or

(iii) other 'additional services' which may or may not be bundled together with (i) or (ii) in the contract.

When the underlying obligation is fully performed, or the contingency of repayment otherwise lapses, the amount properly allocated to the obligation converts from 'unearned income' to 'earned income'.

Where no 'contingency of repayment' exists, the amount is derived when a recoverable debt arises in respect of the contractual fee.

In your case, you grant hosted access to software programs to customers. The customers pay a subscription fee in advance. Access to the program may be cancelled by a customer with notice. In the event of cancellation, you refund that portion of the prepaid subscription fee attributable to the remaining period of the contract. You do not provide any other services with the subscription other than the hosted access. You use the accruals method of accounting as evidenced by your method of recording sales when invoices are sent to customers.

Your situation is similar to that of Example 11 in TR 2013/D2:

Example 11: Where the access fee is for the hosted access only and a contingency of repayment does exist in relation to the access fee

75. Cloudy Pty Ltd is an Australian hosted access company. It employs the accruals method of recognising income.

76. On 1 July 2012, Cloudy Pty Ltd enters into an agreement which provides ABC Pty Ltd with the right to access and use a proprietary software product, remotely hosted by Cloudy Pty Ltd, for a period of three years in consideration for the payment by ABC Pty Ltd of an access fee of $80,000. The terms of the agreement do not require Cloudy Pty Ltd to provide any additional services. That is, Cloudy Pty Ltd is required only to provide access to the software product. Cloudy Pty Ltd is not required under the agreement to provide any user support services or user training.

77. However, under the agreement, ABC Pty Ltd is entitled to terminate the agreement with one month's notice at any time during the access period. Upon termination, ABC Pty Ltd is entitled to a refund of so much of the access fee as relates to the amount of the access period yet to elapse.

78. In circumstances such as these, a contingency of repayment exists in relation to the access fee. That contingency of repayment lapses proportionately on a monthly basis. In circumstances such as these it is fair and reasonable to treat the access fee as derived proportionately on a straight line basis over the term of the agreement.

As a contingency of repayment exists in relation to the subscription fee and you do not provide any additional services to the hosted access, the subscription fee should be treated as being derived proportionately on a straight line basis over the term of the subscription.