Edited version of private advice

Authorisation Number: 1051620936140

Date of advice: 17 December 2019

Ruling

Subject: R&D tax offset / aggregated turnover

Question

Does the aggregated turnover of Company A include the Milestone Amounts paid pursuant to the Purchase and Sale Agreement between Company B and Limited Partnership A effective as of XX November 20XX as per section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

XX/YYY/ZZZZ

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1. The Company A is 100% owned by Company B.
2. Refundable R&D tax offsets have been claimed for the income tax years ended 30 June 20XX and 20XX.
3. In the year ended 30 June 20XX, Company B (the Seller) entered into an Amended and Restated Purchase and Sale Agreement with the Limited Partnership A (the Purchaser) effective XX/YYY/ZZZZ (The Agreement).
4. The Agreement provides:

a)    Limited Partnership A pays Milestone Payments in tranches and will receive income on future sales of Company B products

b)    Further clauses in The Agreement state that Seller will sell, convey, transfer and assign to Purchaser, and Purchaser agrees to purchase and accept from Seller, all of Seller's right, title and interest in, to certain Receivables.

5. Under the agreement Company B received two payments in the current period.
6. Company C and Limited Partnership B invest in Limited Partnership A. Limited Partnership C, Limited Partnership D and Limited Partnership E invest in Company C. Limited Partnership B, Limited Partnership C, Limited Partnership D and Limited Partnership E are investment funds that are managed by Company D.
7. The total voting power of Limited Partnership B, Limited Partnership C, Limited Partnership D and Limited Partnership E in Company B is less than 10%.
8. Limited Partnership F acquired Company D.
9. Limited Partnership F and subsidiaries do not have any voting rights in Company B beyond that held by Company D and subsidiaries.
10. There is no affiliation relationship between Limited Partnership F and subsidiaries and Company B or Company A i.e. they do not act in accordance with directions/wishes or in concert in relation to these entities business affairs.
11. Company D and subsidiaries received one seat on Company B's Board of Directors.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 328-115

Income Tax Assessment Act 1997 Section 328-130

Income Tax Assessment Act 1997 Section328-125

Income Tax Assessment Act 1997 Section 328-120

Reasons for decision

1.    Section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997) defines aggregated turnover. Relevantly:

325-115(1)

Your aggregated turnover for an income year is the sum of the relevant annual turnovers (see subsection (2)) excluding any amounts covered by subsection (3).

328-115(2)

The relevant annual turnovers are:

(a) your *annual turnover for the income year; and

(b) the annual turnover for the income year of any entity (a relevant entity ) that is *connected with you at any time during the income year; and

(c) the annual turnover for the income year of any entity (a relevant entity ) that is an *affiliate of yours at any time during the income year.

2.    As explained below Company B is connected with Company A and therefore its annual turnover is included in Company A.

3.    Section 328-125 provides the meaning of "connected with" an entity, relevantly:

328-125(1)

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

328-125(2)

An entity (the first entity ) controls another entity if the first entity, its *affiliates, or the first entity together with its affiliates:

...

(b) if the other entity is a company - own, or have the right to acquire the ownership of, *equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage ) that is at least 40% of the voting power in the company.

4.    As per the facts Company B owns 100% of Company A therefore the entities are connected.

5.    Annual Turnover is defined in section 328-120, specifically subsection 328-120(1) of the ITAA 1997 states:

An entity's annual turnover for an income year is the total *ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business.

6.    Ordinary income is defined in section 995-1 and section 6-5 of the ITAA 1997 as "income according to ordinary concepts". A significant body of case law has considered the meaning of this phrase.

7.    In determining whether this was ordinary income the character of the transaction was analysed.

8.    As outlined in the facts above The Agreement is a sale and purchase agreement with multiple termination points i.e. the Purchaser does not own the right to the Receivables in perpetuity.

9.    The following cases make relevant comments regarding the legal substance of contracts:

10.  Lord Devlin in Chow Yoong Hong v Choong Fah Rubber Manufactory [1962] AC 209 stated (at 216-217):

There are many ways of raising cash besides borrowing.... The task of the court in such cases is clear. It must first look at the nature of the transaction which the parties have agreed. If in form it is not a loan, it is not to the point to say that its object was to raise money for one of them or that the parties could have produced the same result more conveniently by borrowing and lending money.

11.  In the IRC v. Church Commissioners for England [1974] 3 All ER 529 at p. 551-552; [1975] 1 WLR 251; Megarry J stated that:

First, the starting point is the ascertainment of the true character in law of the actual transaction, and not of some other transaction that might have been effected but was not. Second, to do that involves construing the documents; but the true construction of the documents, though important, is not always conclusive. ...

Putting the matter even more shortly, I would attempt to summarise the matter by saying 'Look at the contract and any evidence that is admissible to discover what the true bargain between the parties actually is. ... Ignore any other bargain that the parties might have made but did not'.

12.  On this basis and as The Agreement is clear that there is a sale of Receivables such that the Purchaser has a right to this income and Company B has given up this right to the Purchaser it is considered to be characterised as such.

13.  In Federal Coke Co Pty Ltd v. Federal Commissioner of Taxation (1977) 34 FLR 375; (1977) 15 ALR 449; (1977) 7 ATR 519; 77 ATC 4255; [1977] FCA 3 Brennan J said:

When a recipient of moneys provides consideration for the payment, the consideration will ordinarily supply the touchstone for ascertaining whether the receipt is on revenue account or not. The character of an asset which is sold for a price, or the character of a cause of action discharged by a payment will ordinarily determine, unless it be a sham transaction, the character of the receipt of the price or payment. The consideration establishes the matter in respect of which the moneys are received. The character of the receipt may then be determined by the character, in the recipient's hands, of the matter in respect of which the moneys are received. Thus, when moneys are received in consideration of surrendering a benefit to which the recipient is entitled under a contract, it is relevant to enquire whether or not that benefit was a capital asset in his hands. To adapt the words of Lord Macmillan in Van den Berghs Ltd. v. Clark (1935) A.C. at p. 443, and of Williams J. in Bennett v. F.C. of T. (1947) 75 C.L.R. 480 at p. 485, the enquiry is whether the congeries of the rights which the recipient enjoyed under the contract and which for a price he surrendered was a capital asset.

14.  The Agreement assigns rights to future receivables in exchange for payments at. These receivables would have been revenue in the hands of Company B.

15.  The High Court in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (Myer) found that an amount received for the transfer of a right to an income stream which has been severed from the property to which it relates is income according to ordinary concepts. It is future income converted into present income.

16.  Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income states (TR 92/3) sets out the Commissioner's view as to the application of the decision in Myer. Relevantly,:

3. In that case, the taxpayer company made an interest bearing loan to a subsidiary. Three days later, as had always been intended, the taxpayer assigned the right to receive interest income from the loan in return for a lump sum. The Court relied on 2 strands of reasoning in holding that the amount received by the taxpayer was income:

(a) The amount in issue was a profit from a transaction which, although not within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business.

(b) The taxpayer sold a mere right to interest for a lump sum, that lump sum being received in exchange for, and as the present value of, the future interest it would have received. The taxpayer simply converted future income into present income.

17.  Further in regards to the second strand in Myer TR 92/3 states:

B - Conversion of stream of income to a lump sum

17. An amount received for the transfer of a right to an income stream severed from the property to which it relates is income according to ordinary concepts. Future income is simply converted into present income. This is the case even if the income stream is produced by a contractual right rather than by the relevant property.

18. The above principle does not apply if:

(a) the right to income is not related to any underlying property e.g. a right to an annuity; or

(b) the right is related to underlying property which the transferor has not previously owned e.g. the transferor owns a right to income under a licence contract granting a right to use a trademark which the taxpayer has not owned.

19. An amount received in these circumstances could be income even if the second strand of reasoning in Myer does not apply. For example, if the transfer of the right to receive income is in the ordinary course of the taxpayer's business or if the first strand of reasoning in Myer applies.

20. If a taxpayer transfers a right to an income stream, having previously disposed of the underlying property to which that right relates and retained the right to income, an amount received for that transfer is income.

18.  In Henry Jones (IXL) Ltd v. Commissioner of Taxation (1991) 31 FCR 64; (1991) 102 ALR 1; (1991) 22 ATR 328; 91 ATC 4663 Hill J expanded upon the principle in Myer and discussed in TR 92/3 and held that:

Notwithstanding some doubt, I think Myer must be taken as establishing that, except in the case of the assignment of an annuity where the income arises from the very contract assigned, an assignment of income from property without an assignment of the underlying property right will, no matter what its form, bring about the result that the consideration for that assignment will be on revenue account, as being merely a substitution for the future income that is to be derived. Thus, the fact that the future income may be secured by an agreement, and that the assignment is of the right title and interest of the assignor in that agreement will not affect the result.

So stated the principle is consistent with the development of the law in cases involving compensation for rights of income. Amounts received as compensation for an income right, amounts which thus fill the hole of income, have the character of income. The giving up of an opportunity to earn remuneration in consideration of the payment of an agreed sum payable in instalments was held to be income in

Commissioner of Taxes (Vic) v Phillips (1936) 3 ATD 330; (1936) 55 CLR 144.

19.  Hill J in SP Investments Pty Ltd v. Federal Commissioner of Taxation (1993) 41 FCR 282; (1993) 25 ATR 165; (1993) 112 ALR 443; 93 ATC 4170 further expanded on this:

In the present case, and to the extent that it is appropriate to refer to the royalty income as deriving from property at all, the property from which the income is derived (ie, the chose in action) cannot, without qualification, be said to continue in the ownership of the assignor. A part only of the rights encompassed by the equitable chose in action, which the appellant had, has been assigned. The assignments are limited both as to quantum and as to period. Subject to the terms of the assignments, the underlying right to take action against the payer of the royalty remains with the assignor. In that sense it can be said that there was an assignment of a right to receive periodical sums which when received would be income, in circumstances where the underlying chose in action is retained subject to the assignment and the right is assigned in consideration of an amount calculated as the present value of the income stream. In my view, in those circumstances, the consideration should be as much seen as being income replacing the income stream assigned as was the consideration for the assignment in Henry Jones (IXL)

In so far as analogies are useful, the present case can be seen not so much as an assignment of the tree itself (the underlying agreement which gave rise to the obligation to pay the annuity to the appellant) but as the sale, in advance of the fruit forming, of that fruit for a sum calculated as the present value of the harvest. So seen, the consideration is received as compensation for the future fruit or in substitution for that fruit.

20.  Company B has not assigned all of its receivables under The Agreement, it has not assigned the intellectual property which it is exploiting to obtain sales, it has sold a right to fruit which is yet to form.

21.  The above authorities indicate that this income is income according to ordinary concepts.

22.  This ordinary income has been received by Company B during the income year (see Relevant Facts and Circumstances). Limited Partnership A has paid the amounts due to be paid to Company B under The Agreement. There is no further action that Company B has to perform and no refunds for this amount are considered under The Agreement.

23.  Regarding when income is derived Dixon J in The Commissioner of Taxes (South Australia) v. The Executor, Trustee and Agency Company of South Australia Limited (Carden's case) (1938) 63 CLR 108 stated:

Speaking generally in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realised or immediately realisable form.

24.  This income has therefore been derived by Company B.

25.  Company B received this in the ordinary course of carrying on a business for reasoning as follows.

26.  This phrase "in the ordinary course of carrying on a business" is not defined in ITAA 1997 so it takes its ordinary meaning. As stated in Re PFGG and Federal Commissioner of Taxation 2015 ATC 1-078; [2015] AATA 972; (2015) 102 ATR 677 (and affirmed by Doutch v Federal Commissioner of Taxation and Another [2016] FCAFC 166; 2016 ATC 20-592; (2016) 104 ATR 394; [2017] ALMD 4625; [2017] ALMD 4626; (2016) 248 FCR 211)

In the Tribunal's view, the EM provides assistance in the construction of s 328-120(1) because it does not displace, but rather confirms the ordinary meaning of the words "income....derived....in the ordinary course of carrying on a business" as to refer to income which is an incident of, or directly related to, the carrying on of the normal day to day activities of the business in question, even if that income is not regularly derived in that way.

27.  Given the analysis above the money the Company B has received was in replacement of a portion of these future sales. Although Company B may not regularly derive income in this method (i.e. it may not have further similar Agreements on foot), it is part of its ordinary business. On this basis it is received in the ordinary course of carrying on a business.

28.  Additionally, it should be noted that Limited Partnership A is not affiliated or connected to Company A so this income is not excluded from aggregated turnover by section 328-115(3).

328-115(3)

Your aggregated turnover for an income year does not include the following amounts:

(a) amounts *derived in the income year by you or a relevant entity from dealings between you and the relevant entity while the relevant entity is *connected with you or is your *affiliate;

(b) amounts derived in the income year by a relevant entity from dealings between the relevant entity and another relevant entity while each relevant entity is connected with you or is your affiliate;

(c) amounts derived in the income year by a relevant entity while the relevant entity is not connected with you and is not your affiliate.

29.  It is not affiliated or connected because of facts outlined above i.e. the group has a voting power of less than 10% and the entities do not act in accordance with directions/wishes or in concert in relation to these entities business affairs.