Private ruling: Timing of Deductions
Date of advice: 24 November 2015
Published: February 2016
Ruling period: Year ended 30 June 2016 to Year ended 30 June 2026
Date scheme commenced: 1 July 2015

Ruling: Q1: Where fees invoiced by the Applicant in a particular financial year (Fee Year) are not received by the Applicant until the following year, is the accrued Bonus that will be payable in respect of those fees in the following year an allowable deduction in the Fee Year? | A1: Yes

Relevant facts and circumstances: The annual remuneration of the employee (inclusive of superannuation) is the higher of: • A base salary of $50,000; or • 40% of the fees received by the taxpayer which relate to the fees written by the employees. The employees are remunerated each month as follows: • each employee receives the monthly proportion of their base salary (Base Amount); plus • an additional amount calculated as 40% of the client fees written by that employee that have been received by the taxpayer in the prior month less the Base Amount (Bonus). The Applicant uses accrual accounting.

Relevant legislative provisions: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)

Reasons for decision: Detailed Reasoning - Deductibility of Losses or Outgoings:: The general deduction provision, section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) relevantly provides: 8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) … (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. There is no statutory definition of the term 'incurred'. Generally, a deduction is allowable because a liability arises necessitating the payment of an expense. Taxation Ruling IT 2534 Income tax: taxation treatment of directors fees, bonuses etc sets out the Commissioners view as to when an amount is incurred for the purposes of section 8-1 of the ITAA 1997, in relation to directors fees, employee bonuses etc. It states that to qualify for a deduction a company must, before the end of the year of income, become definitively committed to the payment of quantified amount of directors fees, bonuses or other such payments. The Ruling provides the example of a properly authorised resolution as evidence that a company is definitively committed. However, even in the case of a properly authorised resolution, the general meaning of incurred under section 8-1 must be considered to determine whether the loss or outgoing satisfies the requirements of that provision. Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioners view on the meaning of incurred under section 8-1. The meaning of incurred in this ruling is derived from case law on the predecessor to section 8-1 of the ITAA 1997, section 51(1) of the Income Tax Assessment Act 1936 . The Ruling provides a summary of the principles that can be derived from case law on the meaning of incurred for the purposes of section 8-1 of the ITAA 1997. Paragraph 6 of Taxation Ruling TR 97/7 outlines the general rules, based on case law, which help to define whether and when a loss or outgoing has been incurred: (a) a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitely committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum; (b) a taxpayer may have a presently existing liability, even though the liability may be defeasible by others; (c) a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it can be reasonably estimated; (d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise; (e) in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid. The relevant principles are as follows: | Detailed Reasoning - A taxpayer must be completely subjected or definitively committed to the liability: Paragraph 16 of TR 97/7 provides: 16. A loss or outgoing may be incurred for the purposes of section 8-1 even though no money has actually been paid out. In W Nevill & Company Ltd v. FC of T (1937) 56 CLR 290 at 302 it was said: 'the word used is 'incurred' and not 'made' or 'paid'. The language lends colour to the suggestion that, if a liability to pay money as an outgoing comes into existence, [the section is satisfied] even though the liability has not been actually discharged at the relevant time … it is only the incurring of the outgoing that must be actual; the section does not say in terms that there must be an actual outgoing - a payment out.' (See also New Zealand Flax Investments Ltd v. FC of T (1938) 61 CLR 179 at 207 (New Zealand Flax); FC of T v. James Flood Pty Ltd (1953) 88 CLR 492 at 506 (James Flood); Nilsen Development Laboratories Pty Ltd & Ors v. FC of T (1981) 144 CLR 616 at 624 (Nilsen Development Laboratories); FC of T v. Firstenberg 76 ATC 4141 at 4148; (1976) 6 ATR 297 at 305.) FC of T v James Flood Pty Ltd (1953) 88 CLR 492 ( James Flood ) provides that in order for a loss or outgoing to be incurred under section 8-1 of the ITAA 1997, the taxpayer must have completely subjected or definitively committed itself to the liability and not be dependent on the occurrence of a future event. According to the case of Nilsen Development Laboratories Pty Ltd & Ors v FC of T (1981) 33 ALR 161, a taxpayer is definitively committed to a loss or outgoing where they have a presently existing liability. Subparagraph 6(d) of TR 97/7 provides that determining whether the taxpayer has a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed or arises. For a loss or outgoing to be incurred for the purposes of section 8-1, it must therefore be a liability in the sense of an existing obligation to pay an amount, rather than a probable future payment. In the circumstances of this case, the taxpayer is completely subjected to paying the Bonus liability when the fees are invoiced to the client. This is supported by the following evidence: • There is an obligation to pay the Bonus in accordance with an employment agreement. • The applicant does not have any discretion as to whether the Bonuses are paid. • If an employee resigns, they are still entitled to the Bonus as calculated on the fees, even if the fees have not been collected at the time they cease employment with the applicant. As such the taxpayer is considered to be completely subjected or definitely committed to the liability at the end of the fee year. | Detailed Reasoning - A liability whose quantum is not known may be incurred if it is capable of reasonable estimation.: According to the case of Commonwealth Aluminium Corp Ltd v FC of T (1977) 77 ATC 4151; 7 ATR 376, a liability is capable of reasonable estimation where it can be approximately calculated based on probabilities. The case of Merrill Lynch International (Australia) Ltd v Ors v FC of T (2001) 47 ATR 611 (Merrill Lynch International) furthers the Commissioners view in TR 97/7 that there must be a presently existing legal liability rather than a mere commercial certainty that an amount will be paid. This case involved a company who paid bonuses to employees after the end of the income year while it claimed a deduction for the bonuses in the income year. The taxpayer had discretion whether to pay the bonuses but commercial circumstances made it likely that they would be paid and management regarded it as a certainty and made accounting provision for them through the income year. The amount of the bonuses was determined after the end of the income year. It was determined that the taxpayer must have a legal liability to pay the bonuses in order for the bonuses to be incurred in the income year. That is, a taxpayer has only completely subjected or definitively committed itself when a legal liability exists. A legal liability was held not to exist in this case because the company could still exercise its discretion not to pay the bonuses. The case of Merrill Lynch International can be distinguished on the facts as the applicant does not have any discretion. As submitted by the taxpayer, more than 99% of debtors have been recovered in the previous five years. Therefore, it is considered that the amounts of the bonuses are capable of reasonable estimation.