Private ruling: Foreign income - bonus - timing of derivation
Date of advice: 8 September 2016
Published: November 2016
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will your bonus income to be paid 'in kind' be assessable income in Australia in the year of receipt? | A1: Yes

Relevant facts and circumstances: You were a resident, for tax purposes, of the overseas country for a period of time. While residing in the overseas country you were employed by an overseas company (Company). During a meeting of the Board of the Company it was resolved that a bonus be approved and paid in kind to you by way of the Company's real estate stock. You were then sent a letter advising of the bonuses (Bonus Letter). In the Bonus Letter, the Company undertook to pay the bonus payment relating to a number of financial years towards a purchase you make in the Company's real estate stock. A later resolution of the Board was made resolving that bonuses also be paid to you in respect of a certain number of later financial years and such bonuses and other incentives shall be paid in-kind in the same way as the previous bonuses. The CEO was authorised to determine the individual bonus entitlements. In a document issued by the Company (Company Document) it was stated that no bonuses had been paid out to you since a certain point in time and that bonuses from that certain point in time onwards were to be paid in kind, specifically by way of the Company's real estate stock. The Company Document stated that the Company's cash flow was prioritised towards financing the projects. The Company Document specified the specific real estate addresses (final real estate addresses specified in your resignation letter and a letter from the Company confirming the real estate stock calculation) that were to be paid to you in lieu of your bonuses (Allocated Real Estate Stock). It was further provided that the recipient of the Real Estate Stock would take possession upon completion of the project; however, title to the property would only be transferred after the Company repaid the project loan. You resigned from the Company by way of a resignation letter. Following your resignation you received a letter from the Company confirming: • You were owed an amount for the bonuses that were due to you for a period of time and your end of service benefit (Total Amount) • The real estate stock allocated to you in lieu of the Total Amount owed; and • That as the market value of the real estate stock were valued below the Total Amount, the balance was to be transferred to your nominated bank account (Cash Component). A further document showed that of the Total Amount owed to you a component represented your end of services benefits. The date of you joining the Company was listed and your last working day listed. A document showed, among other things, the bonus particulars. It was noted in this document that the funds were earned before your last working day. You returned to Australia on a certain date and you have been an Australian resident since your return. To date, the ownership of the Allocated Real Estate Stock has not yet been transferred to you, nor have you received the Cash Component.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 6-5(2). | Income Tax Assessment Act 1997 subsection 6-5(4).

Reasons for decision: Summary: Subsection 6-5(2) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. A bonus payment is ordinary income for the purposes of subsection 6-5(2) and ordinary income is included in assessable income when it is derived. | Detailed Reasoning - Derived: In Federal Commissioner of Taxation v. Clarke (1927) 40 CLR 246 at 261; [1927] HCA 49, Isaacs J said that 'derived' simply means 'obtained' or 'got' or 'acquired' and that 'all income is derived from something and by someone'. Isaacs J also added in Federal Commissioner of Taxation v. Thorogood (1927) 40 CLR 454 at 458; [1927] HCA 36 that 'derived' does not necessarily mean actually received, although receipt is the ordinary mode of derivation. Essentially, income is derived when it 'comes in' or 'comes home', in whatever sense is most appropriate in the particular circumstances: Commissioner of Taxes (SA) v. Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108; [1938] HCA 69. The time at which an amount of ordinary income is 'derived' depends on the tax accounting method used by the taxpayer to report the amount as income, i.e. whether the amount should be reported as income on a cash basis (receipts) or an accruals (earnings) basis. | Detailed Reasoning - Cash v Accruals: 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': paragraph 17 of Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings (TR 98/1). However, the receipts method is likely to be appropriate to determine income derived by an employee whereas the earnings method is, in most cases, appropriate to determine business income derived from a trading or manufacturing business: paragraphs 18 and 20 of TR 98/1. The cash basis of accounting is the method used by most individuals. Under this method, income is returned in the year when it is actually or constructively received, either in the form of cash or its equivalent, or other property. Paragraph 42 of TR 98/1 states that income from employment would normally be assessable on a receipts basis. Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period. This is the case even if the service to which the salary relates was performed before the taxpayer became an Australian resident: Re Clement Kam Man Tong and Commissioner of Taxation [2007] AATA 1234; 2007 ATC 2139; (2007) 66 ATR 412. | Detailed Reasoning - Constructive Receipt: The definition of 'derive' in subsection 995-1(1) refers to the meaning affected by subsection 6-5(4). Accordingly, 'derive' has its ordinary meaning, but it may be extended by the constructive receipt rule in subsection 6-5(4) which means that income can be derived even if an item of income is not paid over to the taxpayer. The explanatory memorandum to the Bill introducing subsection 6-5(4) states that the rule applies to income accounted for on a receipts basis because this subsection does not actually deem an amount to be derived; rather it deems receipt. Unless the taxpayer is on the cash receipts basis of returning income, the rule of constructive receipt does not apply. If the cash method applies, ordinary income is taken to be received as soon as it is applied or dealt with in any way on the taxpayer's behalf or as the taxpayer directs: subsection 6-5(4). The income does not need to be received as money, it is sufficient if it is received in the form of money's worth. Paragraph 4 of Taxation Ruling IT 2534 Income Tax: Taxation treatment of directors fees, bonuses, etc. provides that a bonus is taken to have been derived for income tax purposes at the time it is paid or otherwise made available to the employee. This is so even where the bonus relates to duties that were performed in a previous income year. The principle of constructive receipt involves the notion of control of, or the capacity to control, an amount that is receivable or otherwise held in a manner satisfying the concept of derivation. If an amount is credited to an employee in the books of his employer and can be drawn by the employee at any time, then it is derived at the time it was so credited and made available to the employee: paragraph 4 of Taxation determination TD 93/242 Income tax: what is the income tax treatment of a deferred salary payment agreement? However, merely crediting an amount in an account or record does not necessarily mean that the amount has been received. If the taxpayer cannot, in effect, call for the amounts to be paid to them until a certain time in the future, then those amounts will be derived when received in the future: see Blank v. FCT [2015] FCAFC 154. | Detailed Reasoning - Your Contentions: You contend that because you and the Company 'agreed' upon the Total Amount being replaced by the value of the Allocated Real Estate Stock and retained by the Company until a later date, being the date when the projects had been completed and the loan completely repaid (Later Date), the Total Amount had been 'dealt with' as you 'directed' and therefore derived at that time. On the contrary, there is no evidence that an 'agreement' was required as to the terms of the bonus payments. On the facts, it appears that the Board set the parameters for bonuses at its sole discretion and the CEO was authorised to determine the actual entitlements of individuals before notifying them. Despite your assertion that an agreement had been made as at the date of the Company Document, whether or not you sought to have the Total Amount retained by the Company until the Later Date was irrelevant and would not have affected the payment of the bonus. The crucial fact is that you could not have called for the payment as it seems the bonus was locked into the delivery of the real estate stock to you by a decision of the Board. The resolutions and Company Document recorded a real entitlement but not one from which you could immediately benefit. Whilst the Company may have recorded the employee bonus, it cannot be said that you were able to draw on the Allocated Real Estate Stock and Cash Component at any time. Furthermore, an amount is not considered to have been derived if the taxpayer's right to receive is contingent: Ballarat Brewing Co Ltd v. Federal Commissioner of Taxation (1951) 82 CLR 364; 9 ATD 254 and Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 314; [1965] HCA 58; 14 ATD 98; (1965) 9 AITR 673. In your case, the transfer of property titles and Cash Component were contingent on the Company repaying the project loan, per the Company Document. In your Private Ruling Application, you referred to Temples Wholesale Flower Supplies Pty Ltd v. Federal Commissioner of Taxation (1991) 21 ATR 1606 ( Temples Wholesale ) in support of your argument that recording a journal entry with the employee's agreement constitutes derivation of income. In Temples Wholesale : • The Commissioner imposed 'failure to deduct' penalties on the employer for amounts credited by journal entry to the employees of a family company. • Each of the amounts credited, being the said directors' fees or bonuses, were available on call, for use by each respective director. No monies were actually paid by cash, cheque or otherwise to the directors/employees and the only evidence of liability, or of 'payment', were the journal entries in question. There was no evidence elsewhere in company Minutes or actual or implied agreement that salary and wages were to be paid by journal entry. • The Commissioner's case was that a journal entry amounted to a 'payment' for the purposes of the PAYE withholding provisions and it was an agreed fact between the parties that the only evidence of a payment 'is the journal entries in question'. The case was therefore not directly about derivation of income by the employees. • The AAT held that there had been a payment when an amount was recorded for the employee by journal entry. Davies J, on appeal, found it was open to the AAT to make this finding and there was no error of law. • The Full Court allowed the appeal by the taxpayer on the basis that the authorities made it plain that a journal entry, in the absence of an agreement effecting constructive receipt by the employee, was insufficient to constitute a payment. • Essentially, for the Commissioner to impose penalties for non-withholding, there had to be a tax liability, which meant there had to be derivation of income. For that to happen, there had to be an agreement between the employer and employee and not just a journal entry. As this was inconsistent with the agreed basis on which the case was run, there was an error of law. • The Court held that the appeal was not the occasion for any discussion of the inferences that might be drawn in a case in which it was open to infer some form of agreement concerning the effect to be given to journal entries. Temples Wholesale therefore does not support your assertion that a journal entry is sufficient in itself for an amount to be derived. In Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418; [1971] HCA 48; 71 ATC 4195, Gibbs J considered whether an amount had been 'dealt with' on the taxpayer's behalf. The Commissioner sought to assess the taxpayer on certain sums of money due to her under an agreement for personal services rendered but which were not in fact paid during the period to which the assessment related. The evidence was that the taxpayer did not ask for payment and the company refrained from making payment. His Honour said: On the evidence I decline to hold that the company held the balance of the money pursuant to a request by the appellant not to pay it…even if the company had deferred payment at the request of the appellant…Income is not 'dealt with'… when all that happens is that a debtor refrains from paying his debt at the request of the creditor. The Court held that even if the money had been retained at the taxpayer's request, her position would have remained exactly as it was. The income would not have been used on her behalf and the company would have remained under an obligation to pay it to her. Similarly, income is not 'dealt with' when a person simply fails to pay a debt, whether for particular reasons or because of inadvertent delay: Case U152 87 ATC 894. In the absence of any 'agreement' there would not appear to be any derivation of income at that stage (if following your argument). Nonetheless, it is clear from Temples Wholesale that mere journal entries or recording by the employer do not constitute a payment for the purposes of determining derivation of income. Whilst Temples Wholesale discusses other cases that consider a journal entry made with the agreement of the employee, the 'agreement' referred to by you falls short. | Detailed Reasoning - Conclusion: Therefore in your case the bonus income in the form of the Allocated Real Estate Stock and Cash Component will be derived when received. Temples Wholesale does not support your assertion that a journal entry is sufficient in itself for an amount to be derived. An agreement would only support your argument if it meant you had access to the bonus at call from the time you were purportedly entitled to it under the Company Document. We acknowledge that the bonuses were earned when you were a resident of the overseas country however, there is no provision in the legislation that allows this income to be exempt. If you are an Australian resident for tax purposes when you receive the bonus from your employment in the overseas country, you will be assessed on those amounts under section 6-5 in the year you receive them.