Edited version of your written advice

Authorisation Number: 1051417344925

Date of advice: 27 August 2018

Ruling

Subject: Timing of deductible and assessable fees

Question 1

(a) Will the Agent’s Fees payable by the taxpayer under the Agreement be an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997?

(b) If yes to question 1(a) when will they be incurred?

Answer

(a) Yes.

(b) The Agent’s Fees will be incurred under section 8-1 in the year of income when the taxpayer has a pecuniary (monetary) obligation under the Agreement to pay the Agent’s Fee

Question 2

Will the Agent’s Fees that are deductible for the taxpayer in a relevant year of income be determined in accordance with the formula in section 82KZMD of the Income Tax Assessment Act 1936?

Answer

No.

Question 3

Are refunds of Agent’s Fees included in the assessable income of the taxpayer under Section 6-5 of the Income Tax Assessment Act 1997 in the year they become receivable?

Answer

Yes.

This ruling applies for the following period(s)

1 January 20XX to 31 December 20XX

The scheme commences on

1 January 20XX

Relevant facts and circumstances

1. The taxpayer is an Australian resident company that derives income from providing programs for foreign resident Participants in Australia.

2. The taxpayer engages independent third parties (referred to as Agents) to provide services related to recruiting Participants in their programs. The engagement takes place under the terms of an agreement (the Agreement) entered into between the taxpayer and the Agent.

3. Agents are entitled to a fee for the provision of its services in relation to each Participant (referred to as Agent’s Fees) once they satisfy the obligations of the Agreement and the Participant has started the program. Although the Agent may perform some of the services on an ongoing basis, no Agent’s Fee is payable unless and until all the obligations under the Agreement are fully satisfied. No payment is available for partial performance.

4. A pecuniary (monetary) obligation to pay the Agent’s Fees arises when the Participant commences the program after which the Agent has no further obligations to provide any further services.

5. Participants may receive a part or full refund of their program costs in special circumstances. In these instances, the Agent’s Fees paid to the Agent will be reduced by a pro-rata amount if they have already been paid in full. Per the Agreement, the refund is recoverable from the Agent immediately upon receiving notice from the taxpayer.

6. For financial accounting purposes, the taxpayer accounts for Agent’s Fees as a prepayment and amortises this amount over the life of the program to which the fees relate

7. For financial accounting purposes, the taxpayer accounts for refunds of Agent’s Fees as a reversal against Prepaid Commissions

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1936 subsection 82KZL(1)

Income Tax Assessment Act 1936 subsection 82KZL(2)

Income Tax Assessment Act 1936 paragraph 82KZL(2)(b)

Income Tax Assessment Act 1936 section 82KZMA

Income Tax Assessment Act 1936 paragraph 82KZMA(1)(a)

Income Tax Assessment Act 1936 paragraph 82KZMA(1)(b)

Income Tax Assessment Act 1936 subsection 82KZMA(2)

Income Tax Assessment Act 1936 subparagraph 82KZMA(2)(a)(i)

Income Tax Assessment Act 1936 subsection 82KZMA(3)

Income Tax Assessment Act 1936 subparagraph 82KZMA(3)(a)(i)

Income Tax Assessment Act 1936 subparagraph 82KZMA(3)(b)

Income Tax Assessment Act 1936 subparagraph 82KZMA(3)(c)

Income Tax Assessment Act 1936 subsection 82KZMA(4)

Income Tax Assessment Act 1936 subsection 82KZMA(5)

Income Tax Assessment Act 1936 section 82KZMD

Reasons for decision

Question 1 (a)

Summary

Agent’s Fees that are payable under the Agreement will be an allowable deduction under section 8-1 of Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Agent’s Fees will be deductible under section 8-1 of the ITAA 1997 if either of the positive limbs in subsection 8-1(1) are satisfied and it does not fall within any of the negative limbs in subsection 8-1(2). The relevant negative limb is paragraph 8-1(2)(a), which denies a deduction to the extent that expenditure is capital in nature.

Business expenditure is deductible as a general (revenue nature) deduction if it has the necessary and relevant connection with the operation or activities which directly gain or produce assessable income (Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; Federal Commissioner of Taxation v. Smith (1981) 147 CLR 578; Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47).

Provided that a loss or outgoing can be objectively viewed as a necessary or natural consequence of the taxpayer's income earning activities, it will be 'incidental and relevant' to the income earning activities of the taxpayer and deductible as a revenue deduction under section 8-1 of the ITAA 1997, except to the extent that it is a loss or outgoing of capital or of a capital nature (High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459).

The taxpayer carries on a business and derives assessable income from the provision of programs. The taxpayer engages independent Agents to provide a range of services related to the sourcing of Participants in their programs. The taxpayer pays Agents fees for performing that service. The engagement takes place under the Agreement. The Agent’s Fee will be incurred in relation to each Participant an Agent has successfully recruited at the time that Participant commences their program.

Therefore, there is sufficient nexus between the incurring of Agent’s Fees and the derivation of assessable income by the taxpayer’s business.

To consider whether the outgoing is of a capital nature, Dixon J observed in Sun Newspapers Ltd v FC of T (1938) 61 CLR 337 (Sun Newspapers) at 359 in explaining the capital versus revenue distinction as the difference:

‘between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and the returns representing profit or loss

The identification of what expenditure is calculated to effect involves both a consideration of the character of the expenditure and, in many cases, an examination of the business structure and the operations of the business in the course of which the expenditure has been incurred.’

The Agent’s Fees are not incurred to acquire an enduring asset or benefit but are regular outlays incurred as an ordinary consequence of the taxpayer’s business. The amounts are not a loss or outgoing of a capital nature.

Therefore, Agent’s Fees that are payable by taxpayer under the Agreement will be an allowable deduction under section 8-1 of the ITAA 1997.

Question 1 (b)

Summary

The Agent’s Fees will be incurred under section 8-1 of the ITAA 1997 at the time when the taxpayer has a pecuniary (monetary) obligation under the Partner Agreement to pay the Agent’s Fees.

Detailed reasoning

For an expense to be an allowable deduction, the expense must be incurred.

Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's views on the meaning of incurred. The ruling outlines rules, settled by case law, which assist in defining when an outgoing is incurred.

Generally, an entity incurs an expense at the time they owe a present money debt that they cannot escape. That is for an expense to be incurred, there must be a presently existing liability to pay a pecuniary sum. The entity must be definitively committed to the expense in the year of income for the expense to be incurred. Presently existing liability is determined on the circumstances of the case, and especially by reference to the terms of the contract or agreement entered into.

The High Court in Federal Commissioner of Taxation v. James Flood Pty Ltd (1953) 27 ALJ 481; [1953] ALR 903; (1953) 10 ATD 240; (1953) 88 CLR 492 (James Flood) at (CLR 506) provided that a loss or outgoing will be incurred where the taxpayer is definitely committed or has completely subjected themselves to the loss or outgoing.

Dixon J in New Zealand Flax Investments Ltd v. Federal Commissioner of Taxation (1938) 12 ALJ 313; [1939] ALR 1; (1938) 5 ATD 36; (1938) 61 CLR 179 (New Zealand Flax) stated the term incurred, does not include a loss or expenditure which is no more than impending, threatened, or expected.

Barwick CJ in Nilsen Development Laboratories Pty Ltd v. Federal Commissioner of Taxation (1981) 144 CLR 616; (1981) 55 ALJR 97; (1981) 33 ALR 161; (1981) 81 ATC 4031; (1981) 11 ATR 505 (Nilsen Development) cited with approval the decision of Dixon J in New Zealand Flax. Barwick CJ in Nilsen Development provided that an impending, threatened, or expected loss or outgoing is not deductible, no matter how certain it is in the year of income that that loss or expenditure will occur in the future.

Applying the decision in Nilsen Development to the taxpayer’s arrangement, the liability to pay the Agent’s Fee arises at the time the Agent has satisfied the conditions of the Agreement and only once the Participant commences their program. It is at that time that the taxpayer has a pecuniary (monetary) obligation under the Agreement to pay the Agent’s Fee.

Prior to that date, the Agent’s Fee is no more than 'impending', 'threatened', or 'expected' because the Agent may fail to satisfy the conditions under the Agreement and/or the Participant does not actually commence the program. As a result, it will be on the program commencement date that a liability will 'come home' to the taxpayer and the Agent’s Fee is incurred and payable.

Question 2

Summary

The Agent’s Fees incurred by the taxpayer would not be pro-rated over a specified period under the combined application of sections 82KZMA and 82KZMD of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

Subdivision H of Part III of the ITAA 1936 provides rules for the period of deductibility of certain advance expenditure and applies in certain circumstances to change the timing of a deduction for expenses incurred under section 8-1 of the ITAA 1997. Under section 82KZMA and section 82KZMD of the ITAA 1936 certain expenditure that would otherwise be fully deductible under section 8-1 of the ITAA 1997 is instead deducted over a specified period. These provisions apply where the expenditure is seen to be in the nature of a prepayment and where the period of the agreement will not be completed wholly within the year of the expenditure.

Subsection 82KZMA(3) of the ITAA 1936 provides that the expenditure must be incurred:

a) in carrying on a business or incurred otherwise than in carrying on a business by a taxpayer that is not an individual

b) under an agreement (as defined in subsection 82KZL(1) of the ITAA 1936), and

c) in return for the doing of a thing under the agreement that is not to be wholly done within the expenditure year.

Where all the elements of subsection 82KZMA(3) are satisfied, subsection 82KZMD(2) of the ITAA 1936 provides for the expenditure to be deductible pro-rata across the eligible service period, which is defined by subsection 82KZL(1) of the ITAA 1936 as:

eligible service period, in relation to an amount of expenditure incurred under an agreement, means the period from the beginning of:

(a) the day, or the first day, on which the thing to be done under the agreement in return for the amount of expenditure is required, or permitted, as the case may be, to commence being done; or

(b) if the expenditure is incurred on a later day - the day on which the expenditure is incurred;

until the end of:

(c) the day, or the last day, on which the thing to be done under the agreement in return for the amount of expenditure is required, or permitted, as the case may be, to cease being done; or

(d) if that day or last day ends more than 10 years after the beginning of the period - 10 years after the beginning of the period.

In this case, the relevant agreement, as that term is defined in subsection 82KZL(1), is the Agreement, under which the taxpayer pays Agent’s Fees. The issue is therefore whether the Agent’s Fees the taxpayer incurs is in return for the ‘doing of a thing’ under the Agreement that is not to be wholly done within the expenditure year.

In Taxation Ruling IT 2646 (IT 2646), the deductibility of costs incurred by television stations under the Television Program Licence Agreements (TPLA) is considered in paragraph 14 as follows:

Expenditure incurred to acquire program licences is not expenditure "incurred in return for the doing of a thing...that is not to be wholly done within 13 months" in terms of subparagraph 82KZM(b)(i)). Because the "thing" to be done is the granting of the right to use the program and this "thing" is done only once (usually at the commencement of the agreement), expenditure incurred to acquire program licences would not, of itself, fall within section 82KZM. If, however, the expenditure fell within the expression "payments of a similar kind" in paragraph 82KZL(2)(b), the "thing" to be done would be taken to be done over the period of the agreement. Where that agreement was for a period in excess of 13 months, section 82KZM would apply. The expression "payments of a similar kind" in paragraph 82KZL(2)(b) is considered to refer to payments:

a. the nature of which is similar to the nature of rent and lease payments; and

b. the object or benefit sought by the payments is similar to the object or benefit sought by a payment of rent or a lease payment.

The intention of the legislation is to create a symmetry between advance expenditure and either the service to be provided or the income to flow. Bearing in mind this intention and the above construction of the expression "payments of a similar kind", expenditure to acquire program licences is considered to not be a payment of a similar kind to a payment of rent or a lease payment in terms of paragraph 82KZL(2)(b). Accordingly, the advance expenditure provisions (Subdivision H of Division 3 of Part III of the Act) do not apply to change the timing of deductions for expenditure on program licences.

The payment to acquire a program licence is not taken to be a payment of a similar kind under paragraph 82KZL(2)(b) of the ITAA 1936, as expenditure to acquire the program license is not seen to be in the nature of a rental or a lease payment.

The Agent’s Fees paid by the taxpayer under the Agreement are comparable to the payments made under the TPLA that are addressed in IT 2646. As for a TPLA, the thing to be done under the Agreement for an Agent’s Fee to be payable, is the facilitation services provided by the Agent leading to the successful commencement of the program by the Participant. There is no other ongoing thing to be done by the Agent subsequent to receiving the Agent’s Fee. The thing is also done only once, and is made for a single point in time obligation, rather than an ongoing obligation or as a prepayment for goods or services.

Also similar to a payment to acquire a Television Program licence in paragraph 14 of IT 2646, the payment of Agent’s Fees paid by the taxpayer for each Participant in a program is not a payment of a similar kind to a payment of rent or a lease payment within the meaning of section 82KZL(2)(b) of the ITAA 1936.

Therefore, the Agent’s Fees incurred by the taxpayer would not be pro-rated over a specified period under the combined application of sections 82KZMA and 82KZMD of the ITAA 1936.

Question 3

Summary

Refunds of Agent’s Fees will form part of the taxpayer’s assessable income under section 6-5 of the ITAA 1997 in the year of income they become receivable.

Detailed reasoning

Section 6-5 of the ITAA 1997 states that 'your income includes income according to ordinary concepts, which is called ordinary income'. The characterisation of the consideration received by the taxpayer will determine whether the amount is assessable under section 6-5 of the ITAA 1997.

In HR Sinclair & Son Pty Ltd v. Federal Commissioner of Taxation (1966) 114 CLR 537; (1966) 14 ATD 194; (1966) 10 AITR 3, the High Court considered whether a refund of royalties paid to the Forest Commission of Victoria should be taken into account in ascertaining the proceeds of the business in the year the refund of royalty was received. The Court held that the refund was assessable because it was directly related to the taxpayer's business operation or in the carrying on of that business operation. Owen J stated:

The company's business was that of a saw-mill. It was in that capacity that it paid royalties for timber cut by it for the purpose of its business and it was in that capacity that it received the amount refunded. It was part of the proceeds of the business carried on by it and, in my opinion, properly found its place, as it did, in the company's profit and loss account for the year of its receipt and was taken into account in arriving at its net trading profit for that year...

Similarly in Warner Music Australia Pty Limited v. Federal Commissioner of Taxation (1996) 70 FCR 197; 96 ATC 5046; (1996) 34 ATR 171 (Warner Music) the taxpayer was refunded sales tax. The Federal Court held that for a reimbursement or refund to be assessable, two requirements must be satisfied:

The first involves the question of whether the amount released involved a gain to Warner so as to constitute a profit. The second is whether this profit or gain was on revenue account.

In relation to the first requirement, the refund of the unearned component of the premium is clearly a gain to the recipient.

In relation to the second requirement, the characterisation of a receipt is determined by examining the receipt in the hands of the recipient. In Warner Music, Hill J stated that for a reimbursement or refund to be assessable it must be in respect of an expenditure that is 'intimately connected' with the business.

Applying these principles to the present case, the refund of Agent’s Fees, whilst not necessarily a frequent aspect of the taxpayer’s business, is nevertheless integral and incidental to its general business activities and is therefore 'intimately connected' to the taxpayer's ordinary business and is of a revenue nature.

As stated in the Relevant facts and circumstances, where a Participant is refunded all or part of their program fee and the full Agent’s Fees have been paid, the Agent is obliged to repay the excess portion of the Agent’s Fee on a pro-rata basis. This will be immediately upon receiving notice from the taxpayer.

Taxation Ruling TR 98/1 Income Tax: determination of income; receipts versus earnings considers the point of derivation of income and relevantly paragraphs 9 and 11 state

….that the point of derivation occurs when a recoverable debt is created….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.’

The refund of Agent’s Fees will be derived when they are recoverable in law and become receivable. On the facts this will be the point in time that the Agent receives notice from the taxpayer and it is at this point that the Agent is obliged to repay the excess portion. Therefore, the refund of the Agent’s Fees will be assessable to the taxpayer under section 6-5 of the ITAA 1997 in the year of income the amount becomes receivable.