Edited version of your written advice

Authorisation Number: 1051206209548

Date of Advice: 30 March 2017

Ruling

Subject: Small Business Concessions Intangible Active Asset Look-through Earnout

Question 1

Are the intangible assets active assets for the purposes of Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Should the taxpayer include the purchase price instalment payments for the intangible assets as assessable capital gains after they are received by the taxpayer in accordance with the look-through earnout provisions in Subdivision 118-I and section 116-120 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods:

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

The scheme commences on:

24 October 2016

Relevant facts and circumstances

The taxpayer is a financial advisory group that operates using the Australian Financial Services Licence of the purchaser. The taxpayer is an Authorised Representative of the purchaser. The taxpayer carries on a business of providing financial advice and related services.

On a date in 201X, the taxpayer entered into an agreement with the purchaser to transfer the rights to provide services under several contractual arrangements to the purchaser. The transfers were completed on a date in 201X.

The sale was initiated by the taxpayer as part of a strategy to refocus their business.

Four separate sets of intangible assets were transferred to the purchaser at certain prices.

The transfer of the intangible assets includes the transfer of client servicing rights, client records and client revenue.

The company one intangible assets transfer agreement breaks the payment up into three tranches over a period of time.

The company one agreement makes the first, second and third purchase price instalments conditional. If company one ceases to receive services from the purchaser within a period of time the entire first instalment less 50% of revenues received from company one by the purchaser will be refundable.

If company one is still receiving services from the purchaser at the end of a period of time, the second instalment payment will become payable. If the services cease to be provided to company one within the next time period, the taxpayer will need to refund the second payment and the third will not be payable. If the company is still receiving services from the purchaser at the end of the second time period, the third instalment becomes payable.

If company one puts the provision of services to tender, the instalments will be suspended until after the purchaser wins the tender.

The taxpayer will also receive transition payments - an amount on the completion date, and a smaller amount at the end of both the first and second periods. If the taxpayer ceases to be an Authorised Representative of the purchaser within a period of time after the Completion Date, the Transition Payments must be refunded to the purchaser. The transition payments are paid to the taxpayer as compensation for provision of a number of support services to the purchaser during the time period.

The remaining three intangible assets have a payment on the completion date and a second payment after the first period of time. The second payments will be suspended where an intangible asset goes to tender, and reinstated if the purchaser win the tender.

The intangible assets have various dates of acquisition dates by the taxpayer, all longer than 12 months ago.

Income from the intangible assets is derived as a percentage of the member balances in the superannuation and insurance premiums, and from fees from the companies.

For the purposes of the ruling, the Transfer Agreement and other documents describing the intangible assets form part of the facts.

Assumption(s)

For the purposes of this ruling, the taxpayer is assumed to pass the maximum net asset value test and the small business entity test.

For the purposes of this ruling, it is assumed that the sale price represents a fair market value price for the income streams and associated rights.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 118-I

Income Tax Assessment Act 1997 Section 116-120

Reasons for decision

Question 1

Summary

The intangible assets are all intangible active assets. The taxpayer owned the intangible assets and they were inherently connected with the carrying on of the taxpayers business.

Detailed reasoning

Section 152-40 of the ITAA 1997 provides the meaning of active asset.

An asset of a business will be an active asset under subsection 152-40(1)(b) of the ITAA 1997 at a given time if: the asset is an intangible asset, the business owns it and it is inherently connected with the business that is carried on by the taxpayer. Where a business is engaged in providing a service, the rights to collect income arising out of the provision of the service can be reasonably seen as being an asset that is inherently connected with the business. The intangible assets are therefore intangible assets inherently connected with the business and so satisfy paragraph 152-40(1)(b) of the ITAA 1997.

The taxpayer will still need to satisfy the other basic tests and the specific rules before they can apply the small business concessions.

Question 2

Summary

The purchase price instalments are look-through earnout rights. The taxpayer should include the proceeds they receive from the purchase price instalments as taxable capital gains in the income year in which CGT event A1 occurred. The taxpayer will do this by amending their income tax return for the year the sale occurred in each subsequent year when the earnout amounts are paid.

Detailed reasoning

When a taxpayer has a look-through earnout right they include the proceeds received from the right as taxable capital gains in the income year in which they receive them.

A right will be a look-through earnout right where it is:

i. A right to future financial benefits that are not reasonably ascertainable at the time the right is created;

ii. The right is created as part of an arrangement for the disposal of a CGT asset and this disposal causes CGT event A1 to happen;

iii. The asset was an active asset of the entity disposing of it just before the CGT event;

iv. All the financial benefits that can be provided under the right are provided within five years of the end of the income year in which the event happens;

v. The benefits are contingent on the economic performance of the CGT asset, and the value of the financial benefits reasonably relate to the economic performance; and

vi. The parties to the arrangement are dealing with each other at arms-length with regards to the arrangement.

The intangible assets were active assets of the taxpayer immediately before sale to the purchaser. When the taxpayer sells the intangible assets to the purchaser, CGT event A1 occurs and the rights come into existence at the time of the sale. Part of the proceeds of the sale are the rights to the instalment payments, which are future financial benefits.

Whether the instalments will be paid is dependent on future events and cannot be determined at the time of the sale. The payments are conditional on the purchaser continuing to keep the right to provide services around the intangible assets and collecting the income from the rights. The amount paid in the instalments will vary depending on the level of recurring income the purchaser receives from the intangible assets. The instalments, if payable, should all be finalised within three years of the sale taking place.

The last criteria that needs to be satisfied is that the parties must be dealing with each other at arms-length. An arms-length transaction is one where parties act as they would with unrelated parties, there is real bargaining and they reach a price that unrelated parties would reach - the asset is disposed of at market value.

The taxpayer and the purchaser have a business relationship. The taxpayer uses the purchaser's financial services licence and as a licenced agent for them. They market the purchaser's products and access the purchaser's resources to provide advice. The purchaser receives a share of revenue from the taxpayer. The two parties are not strangers in an anonymous marketplace. However it is not necessary that the parties to an arms-length transaction be entirely unrelated, they merely need to deal with each other at arms-length as if they were unrelated, and the negotiation result in a sale on terms that unrelated parties would reach.

The Transfer Agreement contains arms-length commercial conditions of sale. The sale was entered into for business purposes, and the prices agreed to for the intangible assets reflect their future income earning potential. The taxpayer states that the sale is at market value. It follows that the transfer of the intangible assets is at arms-length.

As the transfer of the intangible assets meets all the necessary conditions, the purchase price instalments will be considered to be look-through earnout rights, and the payments will be taxable capital gains in the income year that the income year that the CGT event A1 took place. The taxpayer will report these gains by amending their return for that year to take account of these gains.