Edited version of your private ruling

Authorisation Number: 1012600750943

Ruling

Subject: Income Tax: Assessable income - derivation of income

Question 1

In relation to the Funds paid in the prior income year, is any amount referable to the partly-paid shares derived by Company X as assessable income under section 6-5 of the Income Tax Assessment Act 1997 in the relevant income year?

Answer

We decline to give a private ruling on this matter because we have already given Company X a ruling on this issue.

Question 2

In relation to the Funds paid in the relevant income year, is any amount referable to the partly-paid shares derived by Company X as assessable income under section 6-5 of the Income Tax Assessment Act 1997 in the relevant income year?

Answer

Yes.

Question 3

If an amount referable to the partly-paid shares is derived by Company X as assessable income for the relevant income year, what principles should Company X use to determine the amount derived?

Answer

Decline to rule.

Question 4

If the amount to be included in assessable income is determined (in whole or in part) by reference to the market value of the shares, should that market value be determined by taking into account the contractual rights enjoyed by and obligations imposed on Company X in relation to the receipt of the shares and the restrictions imposed on the sale of these shares during the term of the relevant Projects under the Project Agreements?

Answer

Decline to rule.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commences on:

In the year ended 30 June 2012

Relevant facts and circumstances

Company X manages and operates a co-operative centre (the Centre).

The Centre was established under a programme (CRC program).

Company X receives funding to operate the Centre.

The terms and conditions of the funding are documented in the Agreement.

Apart from administrative matters, the activities of the Centre are conducted by way of project agreements made between Company X and participants and/or third-party project participants.

The Projects

Company X entered into two project agreements.

These project agreements were the first project agreements under which Company X obtained a right to receive shares rather than a conditional right to receive royalties from the commercialisation of project intellectual property.

Project A

A project participant agreed to issue shares to Company X with an agreed issue price per share, being its right to proceeds from the commercialisation of project intellectual property by the project participant.

The terms of the share issue are documented in the Project A Agreement.

Company X agreed to pay a set amount of Funding in accordance with the Project A Agreement.

The project participant issued the shares as partly-paid to Company X in the prior income year.

The issue price per share for the issued shares shall be satisfied by the payment of the Funding in accordance with the Project A Agreement such that the amount paid by Company X on each issued share shall be the proportion of the issue price represented by the proportion of Funding advanced relative to the total amount of the Funds.

If Company X have not paid the Funds to the project participant in their entirety within the timetable outlined in the Project A Agreement, Company X agree and acknowledge that Company X are only entitled to retain that number of issued shares represented by the total amount of Funding Company X have provided to the project participant in accordance with the Project A Agreement divided by the nominal value of those issued shares (being the issue price per share).

Under the terms of the Project A Agreement, the shares issued under that agreement are taken to be paid up to $X.XX at the end of the prior income year.

A portion of the Funding was paid by Company X to Project A in the relevant income year.

Under the terms of the Project A Agreement, the shares issued under that agreement are taken to be paid up to $Y.YY at the end of the relevant income year.

Project B

A project participant agreed to issue shares to Company X with an agreed issue price per share, being its right to proceeds from the commercialisation of project intellectual property by the project participant.

The terms of the share issue are documented in the Project B Agreement.

Company X agreed to pay a set amount of Funding in accordance with the Project B Agreement.

The project participant issued the shares as partly-paid to Company X in the prior income year.

The issue price per share for the issued shares shall be satisfied by the payment of the Funding in accordance with the Project B Agreement such that the amount paid by Company X on each issued share shall be the proportion of the issue price represented by the proportion of Funding advanced relative to the total amount of the Funds.

If Company X have not paid the Funds to the project participant in their entirety within the timetable outlined in the Project B Agreement, Company X agree and acknowledge that Company X are only entitled to retain that number of issued shares represented by the total amount of Funding Company X have provided to the project participant in accordance with the Project B Agreement divided by the nominal value of those issued shares (being the issue price per share).

Under the terms of the Project B Agreement, the shares issued under that agreement are taken to be paid up to $X.XX at the end of the prior income year.

A portion of the Funding was paid by Company X to Project B in the relevant income year.

Under the terms of the Project B Agreement, the shares issued under that agreement are taken to be paid up to $Y.YY at the end of the relevant income year.

Treatment of shares from an accounting perspective

Company X has decided to recognise the shares in its balance sheet for the relevant year to the extent that they were treated as paid up under the relevant agreements. However, an impairment provision was made in view of several matters taken into account by the Board.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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

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

Taxation Administration Act 1953 section 359-35

Taxation Administration Act 1953 subsection 359-40(1)

Reasons for decision

Question 1

Summary

We decline to give a private ruling on this matter because we have already given Company X a ruling on this issue.

Question 2

Summary

The value of the amount referable to the increase in the paid-up value of the partly-paid shares as at the end of the relevant income year is derived by Company X as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant income year.

Detailed reasoning

Under subsection 6-5(2) of the ITAA 1997, assessable income includes ordinary income derived during the income year.

In the present circumstances, Company X's business involves the receipt and expenditure of Funds, the management of research projects, the receipt and use or expenditure of contributions from project participants and the commercialisation or oversight of the commercialisation of the results project. The shares issued to Company X were as a direct result of these business activities.

As an Australian resident, under subsection 6-5(2) of the ITAA 1997, Company X's assessable income includes the ordinary income derived directly or indirectly from all sources during the income year.

Subsection 6-5(4) of the ITAA 1997 tells us that in working out whether an amount has been derived and when you have 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.

Further guidance as to the timing of income derivation comes from consideration of relevant case law and taxation rulings.

In Brent v. FC of T (1971) 125 CLR 418; (1971) 71 ATC 4195; (1971) 2 ATR 563, the High Court said at CLR 428; ATC 4200; ATR 570:

It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which is calculated to give a substantially correct reflex of the taxpayers true income (The Commissioner of Taxes (South Australia) v The Executor, Trustee and Agency Company of South Australia Limited (Carden's case) (1938) 63 CLR 108; 1 AITR 416; (1938) 5 ATD 98).

In Arthur Murray (NSW) Pty Ltd v. FC of T (Arthur Murray) (1965) 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673, the High Court affirmed the proposition from Carden's case, that in relation to the question of when income should be considered to have been derived, it was appropriate to have regard to the application of ordinary business and commercial principles. Barwick CJ and Kitto and Taylor JJ said in Arthur Murray case at CLR 318, ATD 99-100, AITR 688:

As Dixon J observed in Carden's Case: 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 realized or immediately realizable form. The word gains is not here used in the sense of 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 received 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.

The reference by the High Court in Arthur Murray to the significance of an amount not being income unless it had been earned was critical in this case. It was for this reason that prepaid fees, in relation to dancing lessons not yet delivered, were not treated as income derived at the time of receipt. In reaching this conclusion the High Court said at CLR 319, ATD 100, AITR 689:

But those circumstances nevertheless make it surely necessary, as a matter of business good sense, that the recipient should treat each amount of the fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back, even if as only damages, should the agreed quid pro quo not be rendered in due course. The possibility of having to make such payment back (we speak, of course, in practical terms) is an inherent characteristic of the receipt itself. In our opinion, it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company.

In Case U7 87 ATC 127; Tribunal Case 20 (1986) 18 ATR 3120 a company received, at the discretion of the grantor, an 'advance' of grant monies to which it would become entitled upon expenditure on the agreed research and development (R&D) activities. These monies were repayable if this expenditure was not made, or was less than the amount advanced. The AAT referred to the decision in Arthur Murray and considered that, in the relevant year, the company had not done all that was required of it to earn the full amount prepaid to it.

The above passages were made in relation to subsection 25(1) of the Income Tax Assessment Act 1936 (ITAA 1936). Section 6-5 of the ITAA 1997 replaced subsection 25(1) of the ITAA 1936, and these passages can be accepted as having equal relevance to the operation of section 6-5 of the ITAA 1997.

The Commissioner expresses his opinion on the two methods commonly used to determine when income is derived in Taxation Ruling TR 98/1. Ordinarily a receipt of cash is derived when it is received. In reference to the earnings method, the Commissioner states:

9. The earnings method is often referred to as the accruals method or the cash and credit method. Under the earnings method, income is derived when it is earned. The point of derivation occurs when a recoverable debt is created.

10. The term recoverable debt is used to describe the point of time at which a taxpayer is legally entitled to an ascertainable amount as the result of having performed an agreed task. A taxpayer may have a recoverable debt even though, at the time, they cannot legally enforce recovery of the debt.

11. Whether there is, in law, a recoverable debt is a question to be determined by reference to the contractual agreements that give rise to the legal entitlement to payment, the general law and any relevant statutory provisions.

Project A

As per the Project A Agreement, the project participant agreed to issue shares in the project participant to Company X (being its right to proceeds from the commercialisation of project intellectual property by the project participant), and Company X agreed to pay a set amount of Funding.

The project participant issued the shares to Company X as partly-paid shares in the prior income year. The shares were treated as partly-paid based on the proportion of the issue price represented by the proportion of Funding paid during the prior income year.

During the relevant income year Company X paid a proportion of the agreed amount of Funding to Project A.

At the end of the relevant income year, the paid-up value of each share had increased in value from the previous year. The increase in the paid-up value is based on the proportion of issue price represented by the proportion of total Funding paid during the relevant income year.

The Project A Agreement does not stipulate that the Funding must be conditionally applied for the shares to be issued.

All that is required is that Company X pay Funding in accordance with the Project A Agreement.

Payments are made quarterly in arrears, so the payment amounts relate to funds already expended by the participants in relation to the project and work already undertaken. Company X does not make payments of Funding unless it is satisfied with the reports provided in relation to Project A.

The Agreement provides in certain circumstances for a refund of the Funding at the end of the contract period when the funds have not been applied by the Company to the 'Activities' or the funds have not been acquitted.

Whilst the Funding may have to be repaid by Company X at some future date if it does not meet conditions under the Agreement, it does not make the Funding paid to Project A conditional.

Conclusion

Company X paid an amount of Funding during the relevant income year in accordance with the Project A Agreement. Consequently, the value of the amount referable to the increase in the paid-up value of the shares as at the end of the relevant income year is taken to have been derived by Company X in the relevant income year.

Project B

As per the Project B Agreement, the project participant agreed to issue shares in the project participant to Company X (being its right to proceeds from the commercialisation of project intellectual property by the project participant), and Company X agreed to pay a set amount of Funding.

The project participant issued the shares to Company X as partly-paid shares in the prior income year. The shares were treated as partly-paid based on the proportion of the issue price represented by the proportion of Funding paid during the prior income year.

During the relevant income year Company X paid a proportion of the agreed amount of Funding to Project B.

At the end of the relevant income year, the paid-up value of each share had increased in value from the previous year. The increase in the paid-up value is based on the proportion of issue price represented by the proportion of total Funding paid during the relevant income year.

The Project B Agreement does not stipulate that the Funding must be conditionally applied for the shares to be issued.

All that is required is that Company X pay Funding in accordance with the Project B Agreement.

Payments are made quarterly in arrears, so the payment amounts relate to funds already expended by the participants in relation to the project and work already undertaken. The Company does not make payments of Funding unless it is satisfied with the reports provided in relation to Project B.

The Agreement provides in certain circumstances for a refund of the Funding at the end of the contract period when the funds have not been applied by the Company to the 'Activities' or the funds have not been acquitted.

Whilst the Funding may have to be repaid by Company X at some future date if it does not meet conditions under the Agreement, it does not make the Funding paid to Project B conditional.

Conclusion

Company X paid an amount of Funding during the relevant income in accordance with the Project B Agreement. Consequently, the value of the amount referable to the increase in the paid-up value of the shares as at the end of the relevant income year is taken to have been derived by Company X in the relevant income.

Question 3

Summary

We decline to give a private ruling on this matter because it is not a question of law.

Question 4

Summary

We decline to give a private ruling on this matter because the Commissioner has not been asked to determine the value of the shares or provided with a valuation to review.