Edited version of private advice

Authorisation Number: 1051980861944

Date of advice: 12 May 2022

Ruling

Subject: Profit emerging basis

Question 1

Is the purchase price paid under the agreement capital expenditure?

Answer

Yes.

Question 2

Is profit acquired under the agreement, calculated on a profit emerging basis, assessable income under subsection 6-5(2) of the Income Tax Assessment Act 1997? (ITAA 1997)

Answer

Yes

Question 3

Can you use amortisation on a reasonable basis on the relevant portion of the investment?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2022

Year ending 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

The scheme commences on:

9 October 2021

Relevant facts and circumstances

You carry on a financial planning business.

You entered into a contract (purchase agreement) to purchase assets.

The assets acquired include:

•                the Client List;

•                the Client Servicing Rights;

•                the Client Contracts;

•                the Records; and

•                the Fee Entitlement

The assets acquired pertain to funds under management.

The purchase price paid under the purchase agreement was determined by reference to the annual revenue derived in the prior financial year.

Under the purchase agreement, you acquired a right to an income stream.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Purchase price

Under the purchase agreement you have acquired the right to an income stream. This is a legal chose in action, providing you with the right to receive a sum of money. Purchasing the right to future sums will therefore constitute a purchase of an asset and the amount paid under the purchase agreement is regarded as capital.

Assessable income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides, in brief, that an Australian resident must include in assessable income the ordinary income it derives from all sources. Ordinary income is income according to ordinary concepts.

The transaction was entered into with the expectation of making a profit where the proceeds of collection exceed the cost of the acquired right to receive trailing commissions associated with financial planning clients. Any receipts from collections therefore comprise a return in the form of a partial recovery of its investment (a return of capital) and a profit component.

Your receipts from collection activities do not represent ordinary income. They are receipts of money, rather than ordinary income, which incorporate a mix of returned capital and profit.

The bringing to account for tax purposes of the difference between receipts and disbursements in any one particular income year will not give a true reflection of the profit or loss sustained for that year. The assessment of profit under section 6-5 of the ITAA 1997 on an emerging profit basis is therefore considered to be the most appropriate in determining the income for taxation purposes.

Amortisation

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings provides guidance on the accounting method likely to provide a substantially correct reflex of income in a relevant year. While this ruling is mainly concerned with distinguishing between a cash receipts basis and an earnings basis, it states the following at paragraph 17:

When accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. A method of accounting is appropriate if it gives a substantially correct reflex of income. Whether a particular method is appropriate to account for the income derived is a conclusion to be made from all the circumstances relevant to the taxpayer and the income.

The Commissioner does not have a preferred method that should be adopted when using the profit emerging basis of assessment of income. Any method will suffice so long as it produces a substantially correct reflex of the taxpayer's true assessable income.

Whether a method gives a substantially correct reflex and therefore is appropriate is a conclusion to be made from all the circumstances relevant to the taxpayer and the income.

Possible methods that could be adopted include the straight line and the first in/first out (FIFO) methodologies.

In the absence of any direct guidance as to the method to be adopted when using the emerging profits basis of assessment of income, we therefore conclude that any method will suffice so long as it produces a substantially correct reflex of the taxpayer's true assessable income.