Edited version of your written advice

Authorisation Number: 1012865682171

Date of advice: 27 August 2015

Ruling

Subject: Conditional Call Option fee - whether derived as assessable income

Question 1

Is the conditional call option fee considered to be derived as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) by the Trustee in the financial year in which the project approval for Stage 2 is obtained?

Answer

Yes.

This ruling applies for the following periods:

1 July 20xx to 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Trustee of a trust entered into a Deed of Option for Lease (the Deed) with X Co in relation to a property to be developed by the Trustee (the project).

The lease will commence at Stage 2 of the project.

The Trustee received call option fee in relation to the option for the future lease.

The Deed allowed X Co to call upon the Trustee to refund the call option fee any time prior to the Approval Date. The Approval Date is defined in the Deed as the date upon which the Minister approves the Stage 2 project application.

X Co is also given the power under the Deed to terminate the Deed at any time prior to the Approval Date upon giving the Trustee notice of such termination. The Trustee is then required to refund the call option fee within certain days.

The Trustee applied for a private ruling (PBR) in 20xx on the issue of whether the conditional call option fee is considered to be derived as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the financial year in which the project approval for Stage 2 is obtained.

The Tax Office issued a PBR confirming that the conditional call option fee will be considered to be derived as assessable income under section 6-5 of the ITAA 1997 in the financial year in which the project approval for Stage 2 is obtained. The PBR expired in the financial year ended 30 June 20xx.

The Trustee now applied for an extension of the PBR and has provided the following facts:

• the project is currently in progress

• the project is not sufficiently progressed to enable the Trustee to apply for Stage 2 approval and accordingly at present, approval for Stage 2 of the project has not been received

• there has not been any changes to the Deed

• by a letter (copy attached with the PBR application), X Co advised the Trustee that it continues to retain all of its rights under the Deed

• the Trustee continues to be subject to the terms and conditions of the Deed it entered with X Co.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Under subsection 6-5(2) of the ITAA 1997, a taxpayer is required to include in assessable income the ordinary income it derives during the income year.

It is an accepted principle of income tax law that the method under which a taxpayer accounts for its business or income producing activities for the purposes of income tax must 'give a substantially correct reflex of the taxpayer's true income' (see Dixon J in The Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Ltd (1938) 63 CLR 108 at 154; (1938) 5 ATD 98 at 131 (Carden).

Taxation Ruling TR 97/15 - Income tax: conditional contracts: derivation of income; allowable deductions; trading stock on hand deals with issues relating to the tax treatment of conditional contracts and states that based on the decisions in J Rowe & Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421, Carden and Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130 (Gasparin), it is clear that the income is derived when the when all contingencies are satisfied.

In Gasparin, the Full Federal Court determined the following:

• the trading stock was real property and the allotments remained registered in the name of the vendors until settlement

• until settlement the vendors had not lost dispositive power and had not ceased to have proprietary interest in the land

• the allotments remained trading stock on hand until each transaction proceeded to the point where a debt accrued due from the purchaser, and

• it was only when all contingencies and uncertainties are satisfied that a debt, being a sum certain, accrued due to the taxpayer and it was at that point that income was derived for the purpose of levying taxation (that is, at settlement).

Based on the findings in Gasparin, an amount is not receivable if it is subject to any contingency. This point was considered in AAT Case 8284 (1992) 24 ATR 1085; Case Z37 93 ATC 342 where a joint-venturer contracted to buy property from the joint-venturers on the condition that the local council issued the necessary building permit. The taxpayer was one of the joint-venturers and the issue was whether the final sum paid in July 1988 was derived in the year in which the contract was executed or in the year in which the contract became unconditional. It was held that the contract for the sale was either conditional or contingent upon the issue of the building permit, and that the taxpayer did not derive income under the contract until it became unconditional.

The situation where income was taken to be derived at a point after a receivable debt arose, because the taxpayer had not completed all steps required in order to become entitled to the debt, was also examined by the Full High Court in the case of Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation 114 CLR 314; 14 ATD 98;(1965) 39 ALJR 262;(1965) 9 AITR 673 (Arthur Murray).

The Court in that case found that the taxpayer was not assessable on the income received in advance of services being provided. The advance receipts were held not to form part of the taxpayer's assessable income at the time of the receipt, but became assessable as and when the dance lessons were given.

In Arthur Murray, the Court held that income could not be taken to have come home to the taxpayer if the services had not been provided and if the possibility existed that any part of the advance receipts would need to be repaid.

Your case

The principles examined in Gasparin and Arthur Murray is applicable in determining the timing of derivation of the conditional call option fee.

Until approval is granted for Stage 2 of the project, the Trustee is obligated to refund the amount of the conditional call option fee to X Co if X Co terminates the Deed. According to the Deed, X Co may terminate the Deed at any time prior to the Approval Date requiring the Trustee to refund the fee.

Once the approval is granted at Stage 2 of the project, X Co can no longer terminate the Deed and at this time the Trustee becomes absolutely entitled to the call option fee.

In accordance with the principles in Gasparin and Arthur Murray, the income from a conditional call option fee would be derived by the Trustee for the purposes of section 6-5 of ITAA 1997, when the Deed is free of contingencies and uncertainties, being at the time when Stage 2 of the project is given approval.

Your request for extension

Based on the above legal reasoning, the Commissioner issued a PBR in 20xx that the conditional call option fees would be considered to be derived as assessable income under section 6-5 of the ITAA 1997 in the hand of the Trustee in the income year in which the project approval for Stage 2 is obtained. The PBR expired in 20xx.

In the request for extension of the PBR, the Trustee has informed that as of present date, the project has not progressed sufficiently to enable the Trustee to apply for Stage 2 approval.

The Trustee has also informed that none of the terms and conditions of the Deed has changed since the issue of the previous PBR and X Co retains all of its rights under the Deed. An attached letter from X Co further substantiates this fact.

Since none of the facts on which the previous PBR was issued has changed, the request for an extension of the ruling is granted based on the above reasons for decision.