Edited version of your private ruling

Authorisation Number: 1012550170273

Ruling

Subject: Determination of income

Question 1

Can the amount received on dd/mm/yyyy, as payment for a product, be put on hold as income until the outcome of current legal proceedings?

Answer

No.

Question 2

For the purposes of deductibility under section 8-1 of the Income Tax Assessment Act 1997, can the legal costs incurred during 20XX, as a result of the abovementioned legal proceedings, be backdated to the year ended 20YY in keeping with the closure of business as at 30/06/20YY?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Your business involved the selling and/or assembly of a certain product. You traded using the 'receipts' method of accounting. You sold a product for an amount on the dd/mm/yyyy for which you issued a receipt. The receipt issued advises that the amount received was deposited into your bank account on dd/mm/yyyy.

Upon purchase of the product, the new owner (purchaser) arranged for the product to be moved to a new site. During this movement the product was involved in an incident.

The purchaser has now commenced legal proceedings against you in respect of the product stating it was faulty.

Your business ceased trading effective from 30/06/20YY.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 subsection 6-5(3)

Income Tax Assessment Act 1997 subsection 6-5(4)

Income Tax Assessment Act 1997 section 70-10(a)

Income Tax Assessment Act 1997 section 70-80(1)

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Question 1

Summary

Division 6 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out what is included in the assessable income of an entity. Section 6-5 of the ITAA 1997 includes in assessable income amounts of ordinary income derived, directly or indirectly, from all sources, whether in or out of Australia, during the income year. Subsection 6-5(4) of the ITAA 1997 states that an entity derives an amount of ordinary income as soon as it is applied or dealt with in any way on the entity's behalf or as directed by it. The facts of this case indicate that the income was received on the dd/mm/yyyy and that the business operates on the 'receipts' method of accounting. Accordingly the amount received on the dd/mm/yyyy as payment for the product can not be put on hold as income until the outcome of current legal proceedings. The income must be declared in the year ended 20YY.

Detailed reasoning

Section 70-10(a) of the ITAA 1997 provides that the term trading stock includes: (a) anything promoted, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of business. Under this definition the sale of the product would be considered as trading stock. Section 70-80(1) of the ITAA 1997 further provides "When you dispose of an item of trading stock in the ordinary course of business, what you get for it is included in your assessable income (under section 6-5) as ordinary income.

Section 6-5 of the ITAA 1997 states that:

(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia during the income year.

(3) If you are a foreign resident, your assessable income includes:

(a) the ordinary income you derived directly or indirectly from all Australian sources during the income year; and

(b) other ordinary income that a provision includes in your assessable income for the income year on some basis other than having an Australian source.

(4) In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

The Commissioner's views on when income is derived are clarified in Taxation Ruling TR 98/1. Paragraph 8 states that under the receipts method (which is sometimes called the 'cash' basis), income is derived when it is received, either actually or constructively, under subsection 6-5(4) of the ITAA 1997. The effect of this subsection is that income is taken to be derived by a person when it is dealt with on his/her behalf or as he/she directs.

Accordingly the amount you received as payment for the product on dd/mm/yyyy is classified as income received during the 20YY financial year and must be declared in your income tax return for the year ended 20YY.

Question 2

Summary

To qualify for a deduction under section 8-1 of the ITAA 1997, a loss or outgoing must have been incurred. Generally, you incur an outgoing at the time you owe a present money debt which you cannot escape. Furthermore, the outgoing must also be properly referable to the year of income in which the deduction is sought. Where some legal expenses have been incurred during the 20XX tax year, they should be claimed as a deduction in the 20XX tax year.

Detailed reasoning

The Commissioner's view on when an outgoing is incurred is contained in Taxation Ruling TR 97/7. A taxpayer is not required to have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Therefore, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. According to the High Court in New Zealand Flax Investments v FC of T (1938) 61 CLR 179 'incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon…it does not include a loss or expenditure which is no more than impending threatened or expected". In the current scenario, whilst as at 30 June 20YY some legal expenses encountered in the 20XX taxation year may have been considered to have been impending, threatened or expected - this does not equate to them having been incurred. Indeed for the purposes of section 8-1, it is sometimes not enough that a loss or outgoing has been incurred. The outgoing must also be properly referable to the year of income in which the deduction is sought (Coles Myer Finance Pty Ltd v FC of T 93 ATC 4214 at 4222). It is clear in the current circumstances that any legal expenses are to be encountered in the 2014 tax year and are properly referrable to that year.