Edited version of private advice

Authorisation Number: 1051931881418

Date of advice: 10 December 2021

Ruling

Subject: Lump sum payment

Question 1

Is the lump sum payment received by Dr. A from Company C, in respect of the restraint of trade, assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the disposal of the business name by Dr. A considered a CGT event A1 under Section 104-10(1) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Dr. A entered into a Service Agreement with the Company A as Trustee for Trust B (The Trust). The commencement date of the Service Agreement was XX/XX/XXXX.

The Service Agreement provides:

•         The Trust has a lease on premises which it has equipped for use as a medical practice

•         Dr. A is a registered medical practitioner. Dr. A will conduct the medical practice from the premises and The Trust has agreed to make the premises available for this purpose and to supply extensive services to Dr. A using the terms contained in the Service Agreement.

•         The Trust is to provide such administrative services, clerical staff, facilities, plant and equipment which are necessary for Dr. A to conduct the medical practice from the premises.

•         Dr. A must conduct the medical practice at the specified location within the premises specified by The Trust and during such hours that are mutually agreed upon by Dr. A and The Trust at any time.

•         The Trust will charge, and Dr. A agreed to pay The Trust service fees in accordance with the schedule set in the Service Agreement. The service fee is calculated by reference to a percentage of one or more categories of Practice Billings billed by Dr. A during a Billing Period for all Medical Services.

•         The Service Agreement has no fixed term and can be terminated voluntarily by either party giving written notice to the other party without cause.

The Trust derives its income by virtue of charging a number of medical professionals (which includes Dr. A) a fee based on the earnings of the medical practitioner

The Trust also derives income from the sale of medical inventory.

The Trust sold the business to the Company C on XX/XX/XXXX. As part of the sale, the Service Agreement was assigned to Company C by The Trust on the same day.

There are two other doctors and a Laser Technician that had their agreements transferred.

Dr. A personally owned the business name "XXX", which was registered by Dr. A around 20XX, and has been licenced to The Trust to utilise in the carrying on of its healthcare centre business.

Dr. A entered into an Asset Sale Agreement with Company C on XX/XX/XXXX.

Under the Asset Sale Agreement:

•         Dr. A must not during the restraint period (three years) render medical services at any place within a radius of 15 kilometres of the premises

•         Dr. A will stay with the healthcare facility after Company C purchases it and will continue to provide medical services

•         Dr. A agreed to transfer the following assets to Company C with agreed price

The business of Dr. A included the provision of cosmetic injections through engaging with registered nurses to facilitate the injections under supervision. As part of his business Dr. A held an amount of inventory which was used in the provision of services to his patients.

Following the transaction with Company C, Dr. A will continue to provide the cosmetic injections as part of his own business, however, he will now only receive a supervisory fee with the procedures performed by the Company C nurses.

Under the Business Sale Contract between the Trust the Company C:

•         All service agreements with all doctors assigned from the Trust are transferred to Company C

•         Sale price was $XXX (excluding GST)

Payment will be paid across four years

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 118-20

Further issues for you to consider

We have limited our private ruling to the questions raised in your application. There may be related issues that you should consider, including:

•         The valuation of the restraint of trade, business name and inventory in the Asset Sale Agreement.

You may apply for another private ruling on these or any other matters.

Reasons for decision

Question 1

Is the amount received by Dr. A in respect of the restraint of trade considered to be a lump sum payment in the nature of ordinary income?

Summary

Yes. The lump sum payment for the restraint of trade is income in nature and considered to be assessable income under section 6-5 of the ITAA 1997.

Detailed reasoning

The ATO is generally of the view that lump sum payments are not capital receipts but are income. Lump sum payments are common in the medical industry as a reward to doctors for either joining or staying at a medical centre or agreeing to a restrictive covenant that prevents them working elsewhere.

Courts have often held that incentive payments or inducements can be assessable income. In McLean and Anor v. Federal Commissioner of Taxation 96 ATC 4443 the Federal Court held that lump sum payments made to a taxpayer to remain in the employment of their employer were held to be assessable income.

The principle of this is similar in this case where Dr. A agreed to continue to provide his services to the healthcare facility even after Company C took over, albeit as a contractor rather than an employee.

A restraint of trade agreement would normally lead to CGT event D1 occurring under section 104-35 of the ITAA 1997, where an entity creates a contractual right or other legal or equitable right in another entity. The section includes an example of the entering into a contract with the purchaser of the entity's business not to operate a similar business in the same town. The ATO however has provided guidance in respect of medical practitioners which outlines that....[outline what our guidance says - as we've provided an outline of the application in the next paragraph].

In this case however, the ATO views the amount received in respect of restraint of trade to be ordinary income as:

•         the lump sum is fundamentally connected to the practitioner's provision of his medical services;

•         the mere fact the payment is a one-off lump sum, or expressed to be principally consideration for the restraint imposed, for the goodwill or for the other terms or conditions, does not define it as having the character of a capital receipt;

•         there is no transfer of goodwill as the third party operating the healthcare centre does not acquire the right to provide healthcare services from the practitioner;

•         the taxpayer must not during the restraint period (three years) render medical services at any place within a radius of 15 kilometres of the premises

•         the taxpayer will stay at the healthcare facility and will not cease to provide healthcare services.

The result is the taxpayer is required to include the full amount of the lump sum payment in his assessable income. This is in accordance with section 6-5 of the Income Tax Assessment Act 1997.

Where a transaction gives rise to both ordinary income and a capital gain for capital gains tax (CGT) purposes, the anti-overlap provisions in section 118-20 of the ITAA 1997 would operate to reduce any capital gain arising as a result of relevant CGT events by the amount of income assessed under section 6-5 of the ITAA 1997.

Question 2

Is the disposal of the business name by XXXX considered a CGT event A1 under Section 104-10(1) of the ITAA 1997?

Summary

Yes. The business name is a separated CGT asset and the disposal of the business name is considered as CGT event A1 under Section 104-10(1) of the ITAA 1997.

Detailed reasoning

Section 104-10(1) of the ITAA 97 provides that CGT event A1 happens if a taxpayer disposes of a CGT asset as defined by Section 108-5 of the ITAA97. A business name is considered a CGT asset for the purposes of Section 108-5.

Paragraph 99 of Taxation Ruling TR 1999/16 states that a business name is a source of goodwill. Paragraph 108-5 (2) (b) states that goodwill is a CGT asset.

The disposal of the business name was considered a separate transaction from the restraint of trade and sale of other assets by the taxpayer.

The business name was previously leased by the Trust that ran the medical centre. The Trust used the business name to attract patients and generate income. Company C will do the same, therefore the business name and its associated goodwill would be an asset.

CGT event A1 happened when the taxpayer transferred the ownership of the business name to Company C under subsection 104-10 (1) of the ITAA 1997.