Edited version of your written advice

Authorisation Number: 1012905167035

Date of advice: 6 November 2015

Ruling

Subject: How receipts of a trailing commission are treated

Question 1

Is the right to receive trailing commissions from a trail book considered a CGT asset under Subdivision 108-A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does CGT event A1 occur when the right to receive trailing commissions from a trail book is sold?

Answer

Yes

Question 3

Is the right to receive trailing commissions from a trail book considered an active asset for the purposes of section 152-40 of the ITAA 1997?

Answer

Yes

Question 4

Are you entitled to a deduction for income no longer available when loans associated with trailing commissions are extinguished?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commenced on

1 July 2014

Relevant facts

The entity operates a mortgage broking business.

The entity purchased a right to receive trailing commissions from a trail book. The seller at the time of the sale was presently entitled to receive trailing commissions on the loans in the trail book and to market and provide mortgage broking services to the borrowers of those loans.

Under the sale agreement the seller's right, title and interest in respect to the loans under and pursuant to the appointment, the right to receive future trailing commissions and the right to market and provide mortgage broking services to the borrowers was transferred to the trust.

Since the purchase of the right to receive trailing commissions from a trail book some of the rights have been extinguished or the trust has lost the client and the associated future income stream.

As at 30 June 2015 the percentage of loans still in existence and producing a trailing commission was approximately X%. It is expected that more loans will be extinguished in future income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 152-40

Reasons for decision

Question 1

Section 108-5 of the ITAA 1997 states a CGT asset is any kind of property or a legal or equitable right that is not property.

In Case X85, 90 ATC 615 the AAT held that a Share Price Index future was an asset within the meaning of former s160A. The chose in action was the taxpayer's right, on maturity of the future, to claim the return of his capital and any profits in accordance with the formula in the futures contract.

Upon entering into the agreement to acquire trailing commissions, the entity acquired a legal chose in action giving it the right to receive a sum of money. The transaction was entered into with the expectation of making a profit where the proceeds of collection exceed the cost of the acquired right to receive trailing commissions from loan books. As that right is a chose in action and a legal right which is not property, the right is a CGT asset.

Question 2

Division 104 of the ITAA 1997 sets out all the CGT events for which you can make a capital gain or loss.

Section 104-10 of the ITAA 1997 in part states CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

The right to future trail commissions is a CGT asset and its disposal constitutes CGT event A1. The time of the CGT event is when you enter into the contract for the disposal or if there is no contract - when change of ownership occurs. You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

The tax treatment is no different whether you sell a trail book you created or one you purchased.

Question 3

Section 152-40 defines an active asset and subsection 152-40(1) states, in part that a CGT asset is an active asset at a time if, at that time:

(a) you own the asset ... and:

(i) you, use it, or hold it ready for use, in the course of carrying on a business; or

(ii) it is used, or held ready for use, in the course of carrying on a business by your affiliate, or by another entity that is connected with you

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

The CGT asset (the right to future trail commissions) is an intangible asset that is inherently connected with the business carried on by the entity. Therefore as it satisfies the conditions in paragraph 152-40(1)(b) it is an active asset.

Note: For an active asset to qualify for the CGT small business concessions it must pass the conditions outlined under subdivision 152-A of the ITAA 1997.

Question 4

Section 8-1 of the ITAA 1997 states in part you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, you cannot deduct a loss or outgoing under this section to the extent that it is a loss or outgoing of capital, or of a capital nature.

The purchase price is based on the assumption that not all outstanding loans will exist for the full loan term, in addition some of the loans purchased may be near the end of their existence at the time of purchase. When the payment of a trailing commission is extinguished or the client and future income stream has been lost, it is a dilution of a capital asset. As the dilution of the future income stream is of a capital nature the trust is denied from claiming a deduction under the negative limbs under section 8-1 of the ITAA 1997.