Private ruling: Assessable income, correcting an accounting error
Date of advice: 18 September 2018
Published: October 2018
Ruling period: Year of income ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will the writing off in the accounts of entity A of amounts recorded as owing to it by entity B result in the derivation of assessable income by entity B under: ● section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), ● section 44 of the Income Tax Assessment Act 1936 (ITAA 1936), or ● section 109F of the ITAA 1936? | A1: No | Q2: Will the writing off in the accounts of entity A of amounts recorded as owing to it by entity B result in the application of Division 245 of the ITAA 1997? | A2: No

Relevant facts and circumstances: The Commissioner has ruled previously (‘the prior ruling’) that payments from entity A to entity B (collectively ‘the payments’) were assessable dividends in the relevant year. Entity B lodged and declared these amounts as fully franked dividends in the relevant year, in accordance with the private ruling received. The prior ruling request arose as the nature of the transactions between the entity A and entity B was unclear, particularly whether entity A had made loans to, or paid distributions to or for the benefit of entity B. At the time of the prior ruling request, entity A and entity B had been involved in a legal dispute and the payments, the subject of the prior ruling request, were made in accordance with a court order. A decision was made by entity A that, for accounting purposes, the payments would be treated as loans to entity B, rather than as dividends declared. Additionally, notwithstanding the fact that entity B lodged its income tax returns declaring the payments as dividends, its financial statements were prepared on the basis that the amounts were loans (from entity A). This was done because the accountants of entity B considered it prudent to adopt an accounting treatment that was consistent with that adopted by entity A. It has now been agreed between the parties (entity A and entity B) that the payments are not a ‘loan’ between the parties and will not be repaid to entity A by entity B. Accordingly, the loan will be written off by entity A to remove it from the accounts of both parties.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1) | Income Tax Assessment Act 1936 subsection 44(1) | Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1936 section 109D | Income Tax Assessment Act 1936 section 109F | Income Tax Assessment Act 1936 section 109G | Income Tax Assessment Act 1936 section 109N | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 Division 245

Reasons for decision: Summary: An amount will be included in assessable income if it is income according to ordinary concepts (section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)) or statutory income that is specifically included in assessable income under another provision of the taxation legislation. Relevant to this ruling request, the other provisions are section 44 of the ITAA 1936 (dividends), Division 7A (private company distributions), or Division 245 of the ITAA 1997 (commercial debt forgiveness). Excising the amounts that had been incorrectly recorded in both entity A’s and entity B’s books does not represent the payment of an amount of income according to ordinary concepts and therefore will not be assessable under section 6-5 of the ITAA 1997. The Commissioner has previously ruled that the nature of the amounts paid by entity A were dividends, as defined in subsection 6(1) of the ITAA 1936. In accordance with the prior ruling, these amounts were included in entity B’s assessable income as a dividend under subsection 44(1) of the ITAA 1936 in the relevant year. Therefore there is no additional amount to be included in relation to these amounts. If these amounts had in fact been loans, then they would not come within the definition of ‘dividends’ under subsection 6(1) of the ITAA 1936. If these amounts were loans at the time that they were made, it is likely that the provisions of Division 7A of the ITAA 1936 would have applied to deem the amounts to be dividends and assessable to entity B under section 109D (because complying 109N loan agreements were not entered into between the parties). If so, entity B would still have been assessable on the amounts in the prior years (as a deemed dividend). The subsequent writing-off of the amounts would not represent assessable income to entity B as a result of the operation of section 109G of the ITAA 1936. Additionally, because the payments were not loans there has been no forgiveness of a debt and section 109F of the ITAA 1936 will have no application. Division 245 of the ITAA 1997 provides for special rules in circumstances where a commercial debt owing by a debtor is forgiven. The terms of the Court Order imposed an obligation entity A to make the payments to entity B as an income entitlement, and not as a debt that was to be repaid at some point in the future. The payments do not represent a debt between the parties, and there is no debt to be forgiven. As a result, excising the amounts from the accounts of entity A and entity B is not a writing-off or forgiveness of an existing debt, but merely a correction of an accounting error. Therefore the provisions of Division 245 of the ITAA 1997 will not apply. The terms of the Court Order imposed an obligation on entity A to make the payments to entity B as an income entitlement, and not as a debt that is to be repaid at some point in the future. Entity B has treated the amounts as assessable income in the relevant income years, in accordance with the prior ruling issued by the Commissioner. Even though the amounts have been treated as loans in the books of accounts, there is no evidence that the amounts ever were loans. Therefore, writing off the amounts in the accounts is merely rectifying an accounting error, and there will be no additional amounts required to be included in entity B’s income tax return as a result.