Edited version of private advice

Authorisation Number: 1012655703567

Ruling

Subject: Consolidation - Right to future income

Question 1

Is the right of the Company to receive the quarterly payments in relation to work already performed from the State Authority (SA) under the Agreement a 'right to future income' as defined in subsection 701 63(5) of the Income Tax Assessment Act 1997 (ITAA 1997), as inserted by Part 1 of Schedule 3 to the Tax Laws Amendment (2012 Measures No. 2) Act 2012 (the pre rules)?

Answer

Yes

Question 2

Is the right identified in question 1 an 'unbilled income asset' as defined in subsection 701 63(6) of the ITAA 1997, as inserted by the pre rules?

Answer

Yes

Question 3

Is HC, the head company of the consolidated group, entitled to a deduction under section 716 405 of the ITAA 1997, as substituted by the pre rules, in relation to any amount that becomes due and payable to the Company under the right identified in question 1 after the time the Company became a subsidiary member of the consolidated group?

Answer

Yes

This ruling applies for the following period:

From the income year ended 31 December 2009 to the income year in which the Agreement ends

The scheme commences on:

1 June 2009

Relevant facts and circumstances

HC is the head company of the consolidated group.

The Company became a subsidiary member of the consolidated group on 1 June 2009 (the joining time).

The principal business of the Company has been to complete the agreed works under an arrangement with the State Authority (SA).

The arrangement between the Company and the SA is as stipulated under the Agreement.

Under the Agreement, the Company, must complete the agreed works.

The agreed works were completed on 1 October 2007, known as the completion date.

The quarterly payment by the SA to the Company includes payment for work already performed (WPP). Under the terms of the Agreement, the SA has no obligation to pay the WPP until the work is complete, that is after the completion date.

Following the completion date, the WPP is paid to the Company every quarter continuing until the end of the Agreement.

The WPP amount applicable to each relevant quarter is stipulated in the Agreement.

The net present value (NPV) at the joining time of the right to receive the WPP for all quarters beginning after the joining time up to and including the final quarter in 2027 was calculated and used as the market value of the right for the purpose of the tax cost setting calculations in relation to the assets of the Company at the joining time.

The tax cost setting amount of the right to receive the WPP of the quarterly payments was worked out on the basis of the above market value.

Neither the Company nor HC as head company of the consolidated group has made an election under subitem 103(2) of Schedule 1 to Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 to apply Division 230 of the ITAA 1997 to its financial arrangements from 1 July 2009. Nor has either of them elected under subitem 104(2) of Schedule 1 to Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 to bring its financial arrangements already existing at 1 July 2010 within that Division.

Relevant legislative provisions

Income Tax Assessment Act 1997 as amended by Part 1 of Schedule 3 to the Tax Laws Amendment (2012 Measures No. 2) Act 2012 (the pre rules):

Subsection 701 55(5C)

Subsection 701 63(4)

Subsection 701 63(5)

Subsection 701 63(6)

Section 716 405

Section 716 410

Reasons for decision

Detailed reasoning

Question 1

The pre rules apply to the HC pursuant to sub-item 50(2) of Part 4 of Schedule 3 to the Tax Laws Amendment (2012 Measures No. 2) Act 2012) because the Company became a member of the HC's income tax consolidated group before 12 May 2010, and none of the other application rules in Part 4 of Schedule 3 to the Tax Laws Amendment (2012 Measures No. 2) Act 2012) apply.

A right to future income is defined in subsection 701 63(5) as follows:

• A right to future income is a valuable right (including a contingent right) to receive an amount for the performance of work or services or the provision of goods if:

• The valuable right forms part of a contract or agreement; and

• The *market value of the valuable right (taking into account all the obligations and conditions relating to the right) is greater than nil; and

• The valuable right is neither a *Division 230 financial arrangement nor part of a Division 230 financial arrangement.

• The right of the Company to receive the WPP of the quarterly payments is a valuable right to receive an amount for the performance of work or services.

The right arises directly from the Agreement, so the condition in paragraph 701 63(5)(a) is satisfied. The market value of the right at the joining time, based on the NPV calculation, is greater than nil, so the condition in paragraph 701 63(5)(b) is satisfied. The condition in paragraph 701 63(5)(c) is also satisfied, as per the facts provided.

Therefore, the right of the Company to receive the WPP of the quarterly payments is a right to future income as defined in subsection 701 63(5).

Question 2

Detailed reasoning

An unbilled income asset is defined in subsection 701 63(6) as follows:

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

the asset:

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

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

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

As the work stipulated in the Agreement had already been completed at the joining time, and the future quarterly payments of the WPP had not, as at that time, matured into recoverable debts, the right to receive those payments, being a right to future income as defined in subsection 701 63(5), is an unbilled income asset as defined in subsection 701 63(6).

Question 3

Detailed reasoning

The provision that may give rise to a deduction in relation to a right to future income that is an unbilled income asset is section 716 405. Subsection (1) of this section states that:

This section applies if:

• an entity (the joining entity) became a subsidiary member of a *consolidated group at a time (the joining time); and

• subsection 701 55(5C) applies in relation to the asset at the joining time.

Note: Subsection 701 55(5C) deals with assets covered by section 716 410 (Rights to amounts that are expected to be included in assessable income after joining time).

The reference to 'the asset' in paragraph (1)(b) of section 716 405 is taken to be a reference to the asset mentioned in subsection 701 55(5C), as that subsection is the only provision that references and enlivens section 716 405.

Section 701 55 determines what subsection 701 10(4) means by the expression: 'Each asset's *tax cost is set at the time the entity becomes a *subsidiary member of the group at the asset's *tax cost setting amount' by prescribing for each kind of asset how the asset's tax cost setting amount is to be used in applying other provisions in the income tax law to the asset after the joining time. In particular, subsection 701 55(5C) specifies, via section 716 405, how the tax cost setting amount of an asset of a kind that meets the conditions in paragraphs (a), (b) and (c) of that subsection is to be used.

Subsection 701 55(5C) states:

If:

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

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

• the asset is not a *non-deductible right to future income;

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

Paragraph 701-55(5C)(b) requires consideration of section 716-410. Section 716 410 covers an asset at a time if:

• the asset is a right to future income; and

• the asset is held by an entity just before the time (the joining time) it became a *subsidiary member of a * consolidated group; and

• it is reasonable to expect that an amount attributable to the asset will be included in the assessable income of the entity or any other entity after the joining time; and

• Division 230 does not apply in relation to the asset (disregarding section 230 455).

To satisfy paragraph 701-55(5C)(c) the asset must not be a non-deductible right to future income. A non-deductible right to future income is defined in subsection 701 63(4) as being 'a right to future income that is not an *unbilled income asset.'

Where section 716 405 applies, subsection (2) of that section permits the head company of the group to deduct an amount in relation to the asset for an income year ending after the joining time if and only if it held the asset at a time in that income year (whether because of the single entity rule in subsection 701 1(1) or otherwise) and one of the following applies:

• The head company expects that a recoverable debt will arise in respect of the work, goods or services mentioned in subsection 701 63(6) in relation to the asset within 12 months of the joining time.

Paragraph (a) does not apply and one or more recoverable debts arise, in that income year, in respect of the above work, goods or services in relation to the asset.

If paragraph (a) applies, the head company may deduct the 'unexpended tax cost setting amount' for the asset for that income year. If paragraph (b) applies, the head company may deduct the lesser of the unexpended tax cost setting amount for the asset for that income year and the total of the recoverable debts that arise in that income year.

The unexpended tax cost setting amount for the asset for an income year is defined in subsection (4) of section 716 405 as being the tax cost setting amount for the asset reduced by the total of the amounts (if any) of all deductions under that section in respect of the asset for previous income years ending after the joining time.

Application of paragraph 701 55(5C)(a)

The right's tax cost was set at the joining time under subsection 701 10(4) in the manner set out in Subdivision 705 A as a result of the Company becoming a subsidiary member of the consolidated group at the joining time. Therefore, the condition in paragraph (a) of subsection 701 55(5C) is satisfied.

Application of paragraph 701 55(5C)(b)

The condition in paragraph (a) of section 716-410 is satisfied, that is the right is a right to future income. The right was held by the Company just before it became a subsidiary member of the consolidated group, so the condition in paragraph (b) of section 716-410 is satisfied.

It would have been reasonable to expect (as at the joining time) that the quarterly WPPs paid in accordance with the Agreement by the SA to the Company would be included in the assessable income of HC, as the head company of the consolidated group, after the joining time, so the condition in paragraph (c) of section 716-410 is satisfied.

Division 230 would not have applied in relation to the right because the arrangement giving rise to the right began before Division 230 began to operate and no election was made to bring that pre-existing arrangement within the rules in Division 230. Therefore the condition in paragraph (d) of section 716 410 is satisfied.

Hence, section 716 410 covers the right at the joining time, and so the condition in paragraph (b) of subsection 701 55(5C) is satisfied.

Application of paragraph 701 55(5C)(c)

As the right is a right to future income that is an unbilled income asset, the right is not a non-deductible right to future income, and so the condition in paragraph (c) of subsection 701 55(5C) is satisfied, and so subsection 701-55(5C) applies in relation to the right.

Application of section 716 405

The conditions in paragraphs (1)(a) and (1)(b) of section 716 405 are thereby satisfied, and therefore section 716-405 applies.

Under the Agreement, the Company is entitled to receive amounts under the right on a quarterly basis over a period of approximately 18 years after the joining time. Therefore, paragraph (2)(b) of section 716 405 applies. For the income years ending after joining time, HC is entitled to deduct the lesser of the total of any amounts that become recoverable debts in respect of the work or services in relation to the right to the quarterly payment of the WPPs during the income year and the unexpended tax cost setting amount for the right for the income year.