Private ruling: Payments for entering into a contract
Published: November 2014

Ruling: Q1: Will the lump sum payment be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will the lump sum payment be included in your assessable income as a capital gain from CGT event D1 under section 104-35 of the ITAA 1997? | A2: No, anti-overlap provisions will reduce any capital gain to nil | Q3: If the answer to question 2 is yes will you be able to access the small business concession under Division 152 of the ITAA 1997? | A3: No, as the payment is not assessable as a capital gain

Relevant facts and circumstances: You carry on a business of providing services. You have entered into a contract to provide services from the premise of a company. The company will provide you administrative services. In return for the services you will assign the company a percentage of the fees you charge out to customers for your services. The contract all includes a restrictive covenant.

Relevant legislative provisions: Income tax Assessment Act 1997 Section 6-5 | Income tax Assessment Act 1997 Section 104-35 | Income tax Assessment Act 1997 Section 118-20

Reasons for decision: Detailed Reasoning - Assessable as ordinary income: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. In your case, the one-off payment received was in consideration for entering into a contract where you would provide your services through the company's premise, whereby you will assign them a percentage of the fees you charge to patients for the administration services they provide. Although the payment was an isolated transaction not within the ordinary course of your business, there is sufficient connection between the payment and the business you carry on. Thus, the payment was received in the course of your business. Taxation Ruling provides the Commissioner's view on the income tax treatment of isolated transactions post the decision of FCT v The Myer Emporium Ltd (1987) 87 ATC 4363. Paragraph 15 of TR 92/3 states where a taxpayer carries on a business the profits of an isolated transaction will be assessable where the transaction: (a) is in the ordinary course of the taxpayer's business (see paragraph 32 for an explanation of the circumstances in which a transaction is in the ordinary course of business) - provided that any gross receipt from the transaction or operation is not income; or (b) is in the course of the taxpayer's business, although not within the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or (c) is not in the course of the taxpayer's business, but (i) the intention or purpose of the taxpayer in entering into the transaction or operation was to make a profit or gain; and (ii) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. In both Montgomery v FCT [1999] HCA 34; (1999) 164 ALR 435; 99 ATC 4749 and FCT of Cooling (1990) 21 ATR 13; (1990) 94 ALR 21; (1990) 22 FCR 42; 90 ATC 4472 it was held that incentive or inducements payments made to law firms to enter into a lease agreement were assessable income. In Montgomery at 435,463 The inducement amounts received by the firm did not augment the profit-yielding structure of the firm. The lease was acquired as part of that structure; the inducement amounts were not. There was, in the words of Pitney J in Eisner v Macomber " not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in , being ` derived ', that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal". Further at 435,463: The firm used or exploited its capital in the course of carrying on its business, albeit in a transaction properly regarded as singular or extraordinary. And the sums it received from the transaction were not as some growth or increment of value in its profit-yielding structure - the receipts came in or were derived for the separate use, benefit and disposal of the firm and its members as they saw fit. It is considered that the above principles apply to your factual circumstances even though you have not entered into a lease agreement. You have exploited your capital to enter into the arrangement on favourable terms; this is evidenced by the representations made to the company about your expected billings. Further, the company is providing you a place to practise and administrative services in return for you agreeing to assign X% of the fees you charge. Both the charging of fees and the payment of expenses such as lease payments and administrative fees are on revenue account, and not of a capital nature. We consider that your intention or purpose in entering into the transaction was to make a profit or gain and, the profit or gain was made in carrying out an operation of your business of providing services, albeit not in the ordinary course of your business. Accordingly, the lump sum payment would be considered ordinary income and therefore assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - CGT event D1 and Restrictive Covenant: It is clear under the contract you have created contractual rights with the company to receive a percentage of your fees. Further it is acknowledged that as part of the agreement, you are prohibited from carrying on your business or becoming involved directly or indirectly in any business or activity that is the same or substantially similar to, or in competition with the business being conducted by the company. Consequently the payment under the contract would be considered capital proceeds from CGT event D1 under section 104-35 of the ITAA 1997. However as the Commissioner has determined that the lump sum payment is assessable as ordinary income the anti-overlap provisions in section 118-20 of the ITAA 1997 would operate to reduce any capital gain to nil.