Edited version of your private ruling

Authorisation Number: 1012532869388

Ruling

Subject: Income tax treatment of retail gift cards

Question

Is income derived under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) by the taxpayer under the gift card arrangement earned at the time the merchandise is provided to the consumer?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20YY

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The taxpayer is in the retail trading business.

The goods generally exchanged for payments in stores. However, consumers have the option to purchase gift cards and load them with a particular value.

The gift card confers rights on the bearer being the merchants promise to provide goods up to the stored value at all stores around Australia within 12 months of its issue date. Any remaining stored value on the gift card at the expiry date is forfeited.

The gift card is not reloadable. Once the stored value of the gift card has been redeemed the gift card cannot be re-activated. The gift card cannot be refunded or exchanged for cash.

The gift card can be used by any person (bearer) who holds it. If the gift card is lost or stolen it cannot be replaced and may still be used by whoever holds it.

For accounting purposes, the taxpayer records the receipt in relation to a gift card as deferred revenue in a deferred revenue account in the balance sheet. It then returns as income for accounting purposes a portion of the deferred revenue as merchandise is provided in exchange of presenting the gift card by the gift card holder.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Reasons for decision

Summary

The Commissioner considers that income derived by the taxpayer as provided for by section 6-5 of the ITAA 1997 under the gift card arrangement is income earned at the time the merchandise is provided to the consumer.

Detailed reasoning

Subsection 6-5(2) of the ITAA 1997 provides that assessable income includes ordinary income derived by the taxpayer during the income year.

Subsection 6-5(4) of the ITAA 1997 provides that income is derived when the taxpayer is taken to have received the amount as soon as it is applied or dealt with in any way on its behalf or as is directed.

Taxation Ruling TR 98/1: Income tax: determination of income; receipts versus earnings, provides that there are two methods of tax accounting namely the receipts basis and the accrual basis. Under the receipts basis, income is not derived until it has been received by the taxpayer as provided for by subsection 6-5(4) of the ITAA 1997. However a taxpayer may have received an amount not yet derived, for example where amounts received in advance of the supply of goods and services which are contracted to be supplied. This was a subject of consideration by the Commissioner for a period of time.

However, the position was clarified by the decision of the Full High Court in Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314; 14 ATD 98 (Arthur Murray) which, subject to certain qualifications, has been accepted and applied by the Commissioner. In Arthur Murray, the Full High Court considered the question as to whether amount received but not yet earned constitute assessable income of a taxpayer in the year they are received or earned.

In Arthur Murray case, the taxpayer carried on a business of giving courses of tuition in dancing for fees of varying amounts per hour. The basic courses of tuition consisted of 5, 15 or 30 hours of private tuition to be taken by appointment within a year, although some students contracted for a course of 1,200 hours tuition to be taken at any time during the student's lifetime. Payment of course of lessons was often made in advance, either in the form of a lump sum or by instalments, a variable discount being allowed for immediate payment. The student was given no contractual right to a refund in the event of not completing the course and the form of contract in general use denied any such right but, in practice, refunds were sometimes given. In the taxpayer's books, fees were credited immediately upon receipt to an account styled "Unearned Deposits - Untaught Lessons Account" and from that account amounts corresponding with lessons given were periodically transferred to the credit of an account styled "Earned Tuition Account". The taxpayer prepared its income tax return on the footing that fees received in advance of tuition did not form part of its assessable income at the moment of receipt but became assessable as and when earned by the giving of lessons.

The Commissioner assessed the taxpayer on the basis that fees received in advanced of tuition had the character of assessable income in the taxpayer's hands from the moment of receipt so that, in respect of a given year of income, there was no need to distinguish between fees for which lessons had been given during the year and fees for which, at the end of the year, lessons still remained to be given.

In the Full High Court, the judges distinguished between the Arthur Murray case and Cardin's case (C of T (SA) v Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108; 5 ATD 98: 27-030). In Cardin's case, the question was whether fees earned by a doctor in his medical practice might be treated as assessable income in the year in which they were earned even though not received, whereas, in the present case, the question was whether, in the circumstances, it might properly be held that receipt without earning resulted in the derivation of assessable income.

Their Honours in the Arthur Murray case referred to the observations of Dixon J in Carden's case where his Honour said (5 ATD at p 132):

Speaking generally in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realisable form.

Their Honours then said (14 ATD at p 99):

The word `gains' is not here used in the sense of the net profits of the business, for the topic under discussion is assessable income, that is to say gross income. But neither is it synonymous with `receipts'. It refers to amounts which have not only been received but have `come home' to the taxpayer; and that must surely involve, if the word `income' is to convey the notion it expresses in the practical affairs of business life, not only that the amounts received are unaffected by legal restrictions, as by reason of a trust or charge in favour of the payer - not only that they have been received beneficially - but that the situation has been reached in which they may properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived.

In other words, the Full High Court held that the fees received were not income while the possibility remained that the whole fee, or a portion of it, would have to be repaid.

According to established accountancy and commercial principles, amounts received in advance of goods being sold, or of services being rendered, are not entered to the credit of any revenue account until the sale takes place or the services are rendered. Their Honours said that there was no reason which should lead the Courts to differ from accountants and commercial experts on that point.

The Commissioner argued that to fail to treat the amounts in question as assessable at the time of receipt would be inconsistent with FC of T v James Flood Pty Ltd (1953) 10 ATD 240, a case concerning the general deduction provisions. The Court explained the essentially different approach that had to be adopted for the purposes of determining ordinary income and allowable deductions so far as the applicability of commercial and accountancy principles or practice are concerned. Their Honours said (14 ATD at p 101):

The Court there [Flood's case] held that, while commercial and accountancy practice may assist in ascertaining the true nature and incidence of an item as a step towards determining whether the item answers the test laid down in the Act for allowable deductions, it cannot be substituted for the test. In so far as the Act lays down a test for the inclusion of particular kinds of receipts in assessable income it is likewise true that commercial and accountancy practice cannot be substituted for the test. But the Act lays down no test for such a case as the present. The word `income', being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs. To apply the concept which the word in that sense expresses is not to substitute some other test for the one prescribed in the Act; it is to give effect to the Act as it stands. Nothing in the Act is contradicted or ignored when a receipt of money as a prepayment under a contract for future services is said not to constitute by itself a derivation of assessable income. On the contrary, if the statement accords with ordinary business concepts in the community - and we are bound by the case stated to accept that it does - it applies the provisions of the Act according to their true meaning.

The decision in Arthur Murray clearly laid down a principle of wide application, that is, in so far as the Act itself lays down a test for the inclusion of particular kinds of receipt in assessable income, the statutory test is decisive and accounting and commercial principles are largely irrelevant and cannot be substituted for it. However, there is no specific statutory test or definition in relation to the question whether the receipt is in the nature or has the character of income derived as provided for by subsection 6-5(1) of the ITAA 1997, this question is to be determined in accordance with established accounting and commercial principles.

Nevertheless, as the Court was careful to point out, this is not merely an inquiry into bookkeeping methods and it would be possible, for example, to defer the treatment of a receipt as assessable income merely by refraining from treating it as such in the books of account, that is, by crediting it to a suspense account, even though it had been earned or in some other way the quid pro quo of the recipient had been performed.

In Arthur Murray case it was agreed that, in the case of a business either selling goods or supplying services, amounts received in advance of the goods being delivered or the services being supplied were not, according to established accounting and commercial principles, regarded as income. Possibly, this admission went further than was necessary for the purposes of the case but this should not affect the general principles to be applied, as the proper approach to be made, in cases of this kind which were laid down by the Court.

Subject to special statutory provision, the inquiry to be made in each case is whether the receipt would, according to established accounting and commercial principles, regarded as income derived. If this is conceded, the principle laid down by the Court applies. If it is not conceded, then it seems that the question in issue would be whether or not, according to established accounting and commercial principles, the particular receipt would be regarded as having the nature and character of income derived.

In the present case, the taxpayer has advised the ATO that in the current circumstances, the merchandise is not exchanged at the time the consumer purchases the gift card. Payments are received up-front for the gift cards but the merchandise is not exchanged until the bearer presents the gift card. The merchant has a liability to provide the merchandise to the bearer of the gift card upon redemption which may occur within 12 months of the consumer paying for the gift card.

The taxpayer had also advised the ATO that for accounting purposes, it records the receipt in relation to a gift card as deferred revenue in a deferred revenue account in the balance sheet. It then returns as income for accounting purposes a portion of the deferred revenue as merchandise is provided in exchange of presenting the gift card by the gift card holder.

Therefore, the Commissioner considers that income derived by the taxpayer as provided for by section 6-5 of the ITAA 1997 under the gift card arrangement is income earned at the time the merchandise is provided to the consumer. Payments received on the issue of gift cards are not earned until the liability to provide the merchandise to the bearer of the gift card on redemption is satisfied. This is despite the fact that the card may have been stolen as the card is redeemed only to the bearer of the card. Again, where the card is expired before it being redeemed within its validity period, the taxpayer is deemed to have derived the income at that point in time when the card has so expired.