Edited version of private advice

Authorisation Number: 1051646108477

Date of advice: 25 March 2020

Ruling

Subject: Derivation of income

Question 1

Are tuition fees received by the entity directly from students in advance of completion of each tuition period derived under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year in which the entity completes the work and the contingency of refund lapses relating to that tuition period?

Answer 1

Yes

Question 2

Are the service fees received by the entity under the subcontractor arrangements with a university in advance of completion of each tuition period derived under subsection 6-5(2) of the ITAA 1997 in the income year in which the entity completes the work relating to that tuition period?

Answer

Yes

This ruling applies for the following period:

A specified period

The scheme commences on:

A specified date

Relevant facts and circumstances

·   The entity is a private education provider that delivers education courses from various campuses.

·   The entity has elected to form a tax-consolidated group in Australia.

·   The entity delivers education programs for international students through/on behalf of, or in affiliation with universities.

·   Under the agreements between the entity and the university (further summarized below), the university appoints the entity to operate the education programs on an exclusive basis.

·   In consideration for its services in operating the program for the university, the entity is entitled to a fee equal to a specified percentage of the tuition fees received from students. The legal manner in which this is achieved is as follows:

-   The entity contracts directly with students but under the terms of a licence agreement with the university ("licence arrangement") where 'tuition fees' are payable directly by the student to the entity; or

-   The university contracts with the student and receives tuition fees, and contracts the operation and delivery of courses to the entity (subcontractor arrangement) with 'service fees' payable by the university to the entity.

Fees received under a licence arrangement (tuition fees payable by students directly to the entity)

·   Under a licence arrangement with universities, the entity contracts directly with students and receives tuition fees directly from students.

·   In addition, the entity delivers courses directly to students through its own brands and receives tuition fees directly from students.

·   'Tuition Fees' are defined in the entity's Cancellation and Refund Policy and Procedure document as 'fees paid for tuition in an enrolled unit of study'.

·   Payment and refund terms of tuition fees for students - licence arrangements

·   Where the entity contracts with the students and derives tuition fees directly from those students, the payment and refund terms are set out in the offer letter terms and conditions. The refund terms must be at least as beneficial to students as the requirements in the Education Services for Overseas Students Act 2000 (ESOS Act).

·   Broadly, where the university or the entity is unable to deliver a course in full, the student will be offered a refund of the unused portion of prepaid tuition fees; or at the student's choice, enrolment in an alternative course at no additional cost to the student.

·   Where a student withdraws from a course, tuitions fees may be refunded in whole or in part depending on the timing of the withdrawal and circumstances. As a result, course fees may still be refundable to a student at the entity's year end (ie 31 December). This is on the basis that the majority of courses run from February to June (Semester 1) and from July to -October (Semester 2) and most students make payments for the course (either Semester 1 or 2, or both) 3 to 4 months before course commencement. Thus, as at December year end a student is usually still able to obtain a refund for the amount prepaid for next year's course (as this is more than 4 weeks prior to course commencement).

·   Copies of the entity's Group Cancellation and Refund Policy and Procedure documents and the Agreements between the entity and each university were provided with the private ruling application.

·   The terms and conditions in the entity's Cancellation and Refund Policy and Procedure documents which apply broadly to each of the universities below provide that for tuition fee refunds the following conditions apply:

·   Where written notice of cancellation is received more than 4 weeks before commencement date of the course part of the tuition fee is retained

·   Where written notice of cancellation is received within the 4 weeks before commencement date of the course - 50% of the full tuition fees is retained.

·   Where written notice of cancellation is received on or after the commencement date, no refund may be available to the student unless compassionate grounds exist.

Fees received under a subcontractor arrangement (service fees payable by university to the entity)

·   Under the subcontractor arrangements, the university contracts with the students and is entitled to the tuition fees as principal, and pays a service fee to the entity, as per each individual agreement between the entity and the university (as detailed further below).

Payments and refund terms in relation to service fees under a subcontractor arrangement

·   Where the entity provides the tuition as part of a subcontractor arrangement to the universities, the payment and refund terms of its service fees will be determined in accordance with the terms of the service agreements entered into between the university and the entity.

·   Key terms are as follows:

·   The entity is a service contractor to the university and delivers programs on its behalf. No contractual relationship exists between the entity and the students (clause x of the University Agreement).

·   Under the agreement University is solely responsible for determining and collecting tuition fees from students, and administrating the providing refunds (clauses x and x of the University Agreement).

·   Students must pay tuition fees to University at least 4 weeks before commencement of the study session.

·   The entity is required to provide University with an invoice on account of their service fee for a particular month within 14 business days after the end of that month and the service fee is payable within 21 days of University receiving the invoice (clauses x and x of the University Agreement).

·   The service fee means fee for service per Item x of Schedule x of the University Agreement which is calculated to be an amount equal to Y% of the tuition fees collected by University in accordance with Clause x of that agreement.

·   The applicant submits that as University collects tuition fees each month, the entity invoices for its Y% share in the form of the service fee the following month. This invoicing occurs every month of the year. As the University collects tuition fees in advance of the program being fully delivered (by the entity under the subcontractor arrangement), so too does the entity invoice its service fee in advance of the full delivery of its services.

·   'Tuition Fee' means initially the fee set out in Item x of Schedule x payable by students for enrolment in a subject, as varied by University from time to time in accordance with clause x of the University Agreement.

·   Clause x of the University Agreement provides that within x business days after the end of each month during the term, the University must provide the entity with a report on tuition fees received from students during the preceding month, specifying the name of the student, type of fee and the amount paid.

·   If the University makes a refund of tuition fees to a student, the entity is required to reimburse the University for the service fees that have been pre-paid to the entity in relation to such tuition fees refunded to students in accordance with clause x of the University Agreement.

Payment and refund terms of fees for students - subcontractor arrangements

·   Subcontractor arrangement, relationship is between University and student. The University would be liable for any direct refunds to students.

·   A full refund of course fees will be given where the student withdraws prior to commencing study for the first time for the following reasons:

·   the University withdraws the offer of a place, the course which is applied for is no longer offered, or the University refused to enrol the student; political or civil unrest or natural disasters prevent the student leaving their home country; or the student is unable to commence their course because of a serious and prolonged illness, disability or death of a parent, sibling, spouse or child.

·   Where a student withdraws after commencement of study tuitions fees may be refunded in whole or part depending on the timing of the withdrawal and circumstances.

·   Generally, where withdrawal occurs more than 4 weeks after the start of a session, no refund is paid.

·   If a student withdraws from a subject within 4 weeks of commencement of a session, the student may request that the entire tuition fees be credited or rolled over to their University account for future subjects.

Refund process for students

·   In order to initiate the refund, the student submits an application for the refund which provides the entity or the university with the required information to administer the refund.

·   Section 47D (4) of the ESOS Act states that "the provider must pay the refund within the period (the provider obligation period) of 4 weeks after receiving a written claim from the student".

·   In instances where the entity has been unable to provide the course after the student has paid, each student is contacted as soon as practicable, notified of the situation and provided with a refund form. The process to refund is the same as the pre-commencement refund process.

·   In the case of default by the entity, the student is entitled to a refund of the unused/unspent portion of the prepaid tuition fees. Such unused portion would be calculated on a teaching days pro-rata basis.

·   In instances where the entity has been unable to provide the course in full after the student has paid and offers the student a place in an alternative course at the entity's expense, the student is notified of the situation and issued an offer letter to the alternate provider's course. On acceptance by the student, the entity will then reimburse the alternate provider with the unused tuition fee over the period of study.

ESOS Act and statutory requirement to provide refunds:

Notwithstanding the stated terms and conditions regarding refunds provided by the university, under statute all universities and education providers must provide refunds at least in accordance with the requirements set by the ESOS Act. Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 25(1)

Income Tax Assessment Act 1997 subsection 6-5(2)

Reasons for decision

Question 1

Summary

The tuition fees received by the entity directly from students under a university licence arrangement are derived under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) by the entity in the income year in which the entity completes the work to which the tuition fee relates and there is no contingency to refund an amount in accordance with their refund policy.

Detailed reasoning

As outlined in Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings, for the purposes of subsections 6-5(2) and (3) of the ITAA 1997, the two most commonly used methods of tax accounting for items of income are the receipts and earnings (accruals) methods. When accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances, gives a 'substantially correct reflex' of that income. The earnings method is, in most cases, an appropriate basis for determining income derived from a trading or manufacturing business. It may also be appropriate for business income derived from the provision of knowledge or exercise of skills possessed by a taxpayer where the business has sufficient scale (ie the taxpayer relies on staff to produce such income). The entity is accounting for service fees received under its licence arrangements on an accruals basis.

Taxation Ruling TR 93/11 Income tax: assessability of income on an accruals basis: when professional fees are derived considers when fees are 'derived' under subsection 25(1) of the ITAA 1936 (replaced by subsection 6-5(2) of the ITAA 1997) where income is assessable on an accruals basis. As per paragraph 12 of TR 93/11, the Australian courts have held that income assessable on an accruals basis is 'derived' when a recoverable debt is created such that the taxpayer is not obliged to take any further steps before becoming entitled to payment. The question of when professional fee income is derived needs to be determined by reference to the facts of each case, and especially by reference to the terms of the contract entered into between the professional person and the client (in this case, the entity and the student). It is necessary to determine when a recoverable debt is created such that the professional person is not obliged to take any further steps before becoming entitled to payment.

Where the entity provides tuition directly to students under a licence arrangement with a university or through its own brand institutions, the payment (receipt) of the tuition fees and the conditions of any refunds are determined in accordance with the terms of the offer letters from the entity to the student. These offer letters issued by the entity to the student; and the acceptance of that offer by the student, form the basis for a contractual relationship between the entity and the student and set the terms of the relationship between the entity and the student. Accordingly, in these arrangements there is a direct contractual relationship between the entity and the student.

The tuition fee payment terms and conditions for each institution were summarised as part of the reasoning for the private ruling bur have been removed for the purposes of this edited version.

An exception to the position that income is derived when a recoverable debt arises can apply if amounts are received or receivable in advance of services being provided, as outlined in paragraph 8 of TR 93/11 (Arthur Murray (NSW) Pty Ltd v. FC of T (1965) 114 CLR 314; (1965) 14 ATD 98). Paragraph 8 provides that if the contract or arrangement requires that the fee be paid in advance, the fee income is derived in the income year in which the professional person (the entity) completes the work (or the part of the work) to which the tuition fee relates. Under all of the direct tuition fee agreements, payment of tuition fees in advance to the entity prior to commencement of the corresponding semester/tuition period is a condition of the offer of a place (and therefore a condition of the contract between the entity and the student). The work to which that tuition fee relates is the delivery of the program by the entity to the student for that corresponding semester/tuition period. In applying paragraph 8 of TR 93/11 to the facts, the tuition fee income is derived in the income year in which the entity completes the part of the work (delivery of the course tuition) to which that tuition fee relates.

Furthermore, each of the direct tuition fee agreements sets out the terms upon which a student may be eligible to receive a refund of tuition fees in whole or in part. Under each agreement and under the relevant terms of the ESOS Act, there exists the requirement to provide a refund of tuition fees in whole or in part to the student during the semester/tuition period to which that tuition fee relates. The circumstances and processes around refunds are set out in the facts of this private ruling.

In Arthur Murray (NSW) Pty Ltd v. FC of T (1965) 114 CLR 314; (1965) 14 ATD 98, it was considered when an amount received will represent unearned income. In Arthur Murray, their Honours relevantly held that where a taxpayer had received amounts in advance for a specified number of lessons and a general practice existed of giving refunds where not all lessons were taken, that:

"...the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back...the possibility of having to make such a payment back...is an inherent characteristic of the receipt itself. In our opinion it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company."

The import of Arthur Murray is that once the contemplated contingencies to provide a refund lapse, the amount may be retained by the service provider. At this point the amount converts from unearned income to earned income for income tax purposes. As there exists the requirement in accordance with their refund policy and the ESOS Act to provide a refund of the tuition fees in whole or in part to the student during the semester/tuition period to which that tuition fee relates (as stated in documents supplied with this private ruling application); as well as a comprehensive and established process for when and how refunds are provided, a relevant contingency exists in relation to the unqualified retention of the tuition fee in whole or in part. As students are required to pay their tuition fees in advance of each semester/tuition period, the contingency of repayment would lapse where there is no longer a requirement to refund an amount for the corresponding semester/tuition period.

Accordingly, in applying TR 93/11 and the contingency principle established in Arthur Murray to the facts, for the purposes of subsection 6-5(2) the tuition fee income is derived in the income year in which the entity completes delivery of the course tuition for the corresponding semester/tuition period to which that portion of the tuition fee relates or at the earliest where there is no requirement to refund such tuition fees under their refund policy based on the documentation provided with the ruling application.

Question 2

Summary

The service fees received by the entity under the subcontractor arrangements with the University is derived under subsection 6-5(2) of the ITAA 1997 by the entity in the income year in which the entity completes the part of the work to which the service fee relates.

Detailed reasoning

As outlined in TR 98/1 and above, for the purposes of subsections 6-5(2) and 6-5(3) when accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances, gives a 'substantially correct reflex' of that income. The earnings method may be appropriate for business income derived from the provision of knowledge or exercise of skills possessed by a taxpayer where the business has sufficient scale. The entity is accounting for service fees received under its subcontractor arrangements on an accruals basis. As per TR 93/11 paragraph 12, the Australian courts have held that income assessable on an accruals basis is 'derived' when a recoverable debt is created such that the taxpayer is not obliged to take any further steps before becoming entitled to payment.

An exception to the position that income is derived when a recoverable debt arises can apply if amounts are received or receivable in advance of services being provided, as outlined in paragraph 8 of TR 93/11 (Arthur Murray (NSW) Pty Ltd v. FC of T (1965) 114 CLR 314; (1965) 14 ATD 98). Paragraph 8 of TR 93/11 provides that if the contract or arrangement requires that the fee be paid in advance, the fee income is derived in the income year in which the professional person (the entity) completes the work (or the part of the work) to which the fee relates.

Under the arrangement between the entity and the University, In summary, the agreement requires that at least a part of the service fee payable by the university to the entity is payable in advance of the full delivery of the program for the tuition period to which that service fee relates. Accordingly the exception at paragraph 8 of TR 93/11 will apply such that the service fee income is derived by the entity in the income year in the entity completes the work to which that service fee relates. The work to which it relates is the delivery of the program for that particular tuition period.

Therefore, the recoverable debt for the service fee charged by the entity is created when the entity completes the delivery of the program for that particular semester/term relating to the service fee or at the earliest where there is no requirement to reimburse the entity for an amount under clause x of the University Agreement where University refunds an amount to a student under their refund policy (as per the Arthur Murray). It is considered this is when the service fee received by the entity is derived for purposes of subsection 6-5(2) of the ITAA 1997 under the University Agreement.