Edited version of private advice

Authorisation Number: 1052378316291

Date of advice: 27 March 2025

Ruling

Subject: Assessable income

Question 1

Can you calculate your taxable income, consisting of trailing commissions from purchased loan books, on an emerging profits basis?

Answer 1

Yes.

Question 2

Does the Commissioner accept your profit emerging calculation method of calculating your assessable income?

Answer 2

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are a trading trust whose business involves acting as a XX broker.

You receive commissions for originating finance products, specifically for brokering loans. The nature of the agreements between the XX brokers and financial institutions is substantially uniform across the XX broking industry.

XX brokers typically receive upfront commissions and trailing commissions from institutional lenders as compensation for brokering loans. Trailing commissions are calculated monthly as a percentage of the average loan balance, commencing from the month the loan was settled. These commissions are aggregated and distributed to brokers by an independent service provider.

Loan books represent a XX broker's client list and associated data, including client data and entitlements to trailing commissions. These loan books are valuable assets within the industry and are often bought and sold between entities without regulatory restrictions, provided that the purchaser meets professional requirements such as being an authorised Credit Representative of a company holding an Australian Credit Licence in relation to specific products, being a member of a specified professional organisations, and holding appropriate professional indemnity insurance.

You purchased a loan book from an unrelated party. Trailing commissions likely to be received and the time value of money were considered on the purchase price.

You intend to collect and report any accrued or ongoing commissions and other entitlements from the loan book. The loan book is no longer growing, just reducing in value as the loans get repaid.

You reviewed and considered that any money received from collections will be used to partially recover your capital, and in part, as an assessable profit.

Based on industry comparatives, the average loan term is XX years (XX months).

You have no intention in the future of being in the business of trading in commission trails and client lists.

You proposed calculating the taxable income on the profit emerging basis of the loan book until the cost base has been exhausted over the XX years.

Your proposed method of calculating the net profit arising from the acquisition of the loan book is:

A − (A × B÷C)

Where:

•                    A is the collections from the ledger

•                    B is the cost of the ledger

•                    C is the total anticipated collections from the ledger

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 4-15(1)

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Question 1

Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).

In Federal Commissioner of Taxation v. Stone [2005] HCA 21 (2005) 222 CLR 289 (2005) 2005 ATC 4234; (2005) 59 ATR 50, the majority judgment of the High Court considered the meaning of the phrase 'income according to ordinary concepts'. The court referred to the judgment in Scott v. Commissioner of Taxation (NSW) (1935) 3 ATD 142 at 144-145, where it was considered that in determining how much of a receipt should be treated as income, regard must be had to the ordinary concepts and usages of mankind.

When you entered into the agreement to acquire a loan book, you acquired a legal chose in action giving you the right to receive trailing commissions. You entered into the transaction with the expectation of making a profit where the proceeds from the trailing commissions would exceed the cost of the acquired right to receive them. The consideration paid on acquisition of the right is funded by capital being either debt, equity or a mixture of both. Any receipts from collections therefore comprise a return in the form of a partial recovery of your investment (a return of capital) and a profit component.

As such, the receipt of trailing commissions from the loan book purchased by you, do not represent ordinary income. They are receipts of money, rather than ordinary income, which incorporate a mix of returned capital and profit.

Paragraph 17 of Taxation Ruling TR 98/1 (Income tax: determination of income; receipts versus earnings) states:

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.

In Federal Commissioner of Taxation v. Citibank Limited & Ors (1993) 44 FCR 434; (1993) 93 ATC 4691; (1993) 26 ATR 423 Hill J, in considering the relevance of accounting evidence in determining income tax issues, said:

Where there is no impediment in the Act to bringing to account a net profit as gross income, then that profit will need to be calculated in accordance with the accounting standards.

In XCO Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 343; (1971) 71 ATC 4152; (1971) 2 ATR 353, the High Court considered the application of a profit emerging basis, where a taxpayer was assigned debts at a deep discount to their face value for consideration Gibbs J said:

Where the carrying out of a profit-making scheme extends over more than one year, the difference between receipts and disbursements in any one year may not give a true reflection of the profit arising or loss sustained in that year, and the assessment of profit on an emerging basis may be appropriate.

In determining its profit for accounting purposes, it is appropriate that the taxpayer amortises the cost of the debt ledgers. It does not calculate its profit or loss by deducting from the year's collections the total cost it outlays in acquiring trailing commissions for that year for that would distort its true position for that year. Instead, its profits are effectively determined on an emerging basis taking into account that portion of the cost relevant to the acquisition of the trailing commissions that result in collected income over the period.

In your case, your profit-making scheme extends over more than one income year. 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 a profit emerging basis is therefore considered to be the most appropriate method in determining your income (from the acquired loan book) for taxation purposes.

Question 2

In The Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Limited (1938) 63 CLR 108 Dixon J pointed out as a general proposition that:

....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 realized or realizable form.

Dixon J also expressed the view that the admissibility of the chosen method of accounting for income depended on 'whether in the circumstances of the case it is calculated to give a substantially correct reflex of the taxpayer's true income'. His Honour also pointed out 'to a great degree the question whether income can be properly calculated on one basis alone or upon either, must depend upon the nature of the source of the income'.

In light of this judicial decision, and in the apparent absence of any ruling or other determination or direction by the Commissioner specifying how assessable income is to be calculated when an emerging profit basis is the appropriate form of assessment of income, it is considered that more than one basis of calculating the assessable income may be contemplated as being correct.

Consequently, 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.

Your proposed method of calculating assessable income arising from the trailing commissions has been accepted by the Commissioner as being applicable where the method provides a substantially correct reflex of the taxpayer's true assessable income.

Your emerging profit method of calculating the profit from your receipts of trailing commissions is appropriate because this method produces a substantially correct reflex of your income from trailing commissions received from the loan book. You can use this method to calculate the emerging profits from the trailing commissions for income tax purposes.