Private ruling: Profit emerging basis
Date of advice: 23 April 2021
Published: June 2021
Ruling period: Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Can the Taxpayer calculate its taxable income, consisting of trailing commissions from a purchased loan book (the Loan Book), on a profit emerging basis? | A1: Yes. The profit emerging basis is an appropriate method in determining the Taxpayer's profit and assessable income from the right to receive trailing commissions from the Loan Book for the purposes of section 6-5 of the ITAA 1997. | Q2: Does the Commissioner accept the profit emerging calculations provided in the Taxpayer's application for private ruling produce a substantially correct reflex of the Taxpayer's assessable income? | A2: Yes. The Taxpayer's emerging profit method of calculating the profit from its receipts of trailing commissions is appropriate because this method produces a substantially correct reflex of the Taxpayer's income from trailing commissions received from the Loan Book. The Taxpayer can use this method to calculate the emerging profits from the trailing commissions for income tax purposes.

Relevant facts and circumstances: The Taxpayer is an incorporated company. The Taxpayer's business consists of acting as a loan/mortgage broker and it receives commissions in respect of business activities where it was the original broker. The income derived from the taxpayer's business structure is generally derived from two sources, upfront commissions - commissions paid upon application approval, and trailing commissions - commissions paid based on the life of a loan where the broker holds the loan, actively managing it. This income structure is typical across the mortgage brokering industry where the agreement is between the broker and an institutional financial entity. Specifically, trailing commissions are calculated, collated and paid out each month by an independent SP who assists the brokers, ensuring they received the appropriate level of trail commission. The source and rate of the trailing commission is derived from a document called a loan book. This book is a ledger of loans that a broker has accumulated over their lifetime and manages. Loans can range up to 30 years however, where a loan is refinanced, it is adopted as a new loan. The average time between a refinanced loan is roughly 4.5 years based on industry averages. Loan books carry a significant amount of goodwill and value, being freely sold and purchased with no regulatory limitations on acquisition or sale of these books, making them common transactions within the industry. The Taxpayer purchased the Loan Book from a third independent party. The Taxpayer has reviewed two methods to calculate emerging profit of the Loan Book, the straight-line method and the emerging profit formula. The Taxpayer considers the emerging profit approach is the most accurate method for income tax purposes because it incorporates actual and expected trailing commissions into its formula as opposed to a straight-line method. On the emerging profit basis and a 4.5 year average life loan, the Taxpayer proposes that in the 20XX financial year its assessable income from the trailing commissions on the Loan Book is X. The Taxpayer proposes to continually calculate the emerging profit of the Loan Book in the same manner until the cost base has been exhausted over the 4.5 years and it is confident that 100% of trailing commissions will be taxable. The Taxpayer's calculations provided with the application for private ruling form part of the facts.

Relevant legislative provisions: Income Tax Assessment Act 1997 s ubsection 4-15(1) | Income Tax Assessment Act 1997 section 6-5