Edited version of private advice

Authorisation Number: 1051796937819

Date of advice: 9 February 2021

Ruling

Subject: Assessability of a lump sum payment received in lieu of potential future rebates

Question

Does the receipt of the lump sum payment in lieu of future rebates give rise to a capital gains tax (CGT) event under the CGT provisions?

Answer

No, the lump sum is not considered a capital receipt but income in nature.

Question

Is the lump sum payment assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. See Reasons for Decision below for further discussion.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

A October 20YY

Relevant facts and circumstances

You are a private company.

You conduct a business. You hold a license for other entities to trade under. For that you receive a fee and a percentage of their commission

For a number of years you have had a Licence and Services agreement (LSA) with company B. As part of this agreement, company B provided services to you.

Company B receives fees from C companies when businesses such as yourself arrange one of their products.

As part of the LSA, subject to your compliance (and that of your authorised representatives), company B rebated a percentage of the fee received from C companies to you.

The amount of the rebate was determined by company B in its sole discretion.

While discretionary, company B historically paid you such rebates each year the LSA was in place.

You accepted an offer from company B to exchange future rebates for a cash settlement.

You received an amount of $XXX,XXX being Y times the rebates you received from SGL in the previous income year.

You entered a new amended LSA with company B whereby no rebates were payable.

You have net assets of less than $XXX as recorded in your audited balance sheets.

You consider the amount a capital receipt in relation to the ending of the contractual right to earn the rebates.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Summary

The amount received in lieu of future rebates is considered to be assessable as ordinary income and not a capital amount subject to the CGT provisions.

Detailed reasoning

Section 6-5 of the ITAA 97 provides that the receipt of ordinary income is included in the assessable income of the taxpayer. Ordinary income is defined to mean income according to ordinary concepts. It does not operate to include in a taxpayer's assessable income amounts of a capital nature.

Whether a lump sum or other compensation payment constitutes assessable income in the hands of the recipient depends on whether it is a receipt of a capital or income nature which in turn depends upon a consideration of all the circumstances surrounding the payment. It is the character of the receipt in the hands of the recipient that must be determined. For income tax purposes, a lump sum amount generally bears the character of that which it intends to replace.

The starting point in determining the nature of the receipt is to characterise it as either income or capital. Characterising amounts as income or capital is important in determining the correct tax treatment. In Scott v. FCT (1966) 117 CLR 514, Windeyer J stated:

Whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

Therefore, whether amounts are income or capital will depend upon what it is that the amount is replacing in your hands.

You view the payment as capital in nature as you consider it effectively represents compensation for ending the right to earn future rebate income. It is necessary to undertake a full consideration of all the circumstances surrounding the receipt.

As the High Court stated in G P International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 at CLR 138; ATR 7; ATC 4420:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character if a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging the transaction, venture or business.

Generally, the material factor in determining whether such payments are of an income or capital nature is not the measure of the payment, but what it is truly paid for: Glenboig Union Fireclay Co Ltd v. IR Commrs (1921) 12 TC 427.

The question of whether the payment in question in this case is capital or income will depend upon whether it can be said to be characterised as payment for deprivation of earning capacity or in whole or partial substitution of earnings which would have been earned but for the event which gave rise to the payment.

Application to your circumstances

We consider that the lump sum payment you received is income rather than capital in nature for the following reasons:

•         The payment is directly connected to income you have received previously and was paid in substitution of what was potential future income as whether you received that future income was entirely up to the discretion of company B.

•         Since the payment of the rebates was always at the discretion of company B, you did not have a right to receive it. Since you never had the right to receive the rebates, there is no CGT asset that has been disposed of. This is the case despite company B paying the rebates in every prior year.