Private ruling: Assessable income and allowable deductions
Date of advice: 4 August 2016
Published: September 2016
Ruling period: 1 July 2015 - 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: For the purpose of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), were Payments assessable income derived by Company A in the income years when they are made? | A1: Yes. | Q2: For the purpose of section 6-5 of the ITAA 1997, are Gross Proceeds for the sale of each unit assessable income derived in the income year in which settlement of a sale contract occurs? | A2: Yes. | Q3: Is an allowable deduction available under section 8-1 of the ITAA 1997 for that part of Gross Proceeds that are paid to Company B in the income year in which distribution of Gross Proceeds occurs? | A3: Yes. | Q4: Will the Services Fee paid to Company B be a deduction under section 8-1 of the ITAA 1997 incurred in the income year in which distribution of Gross Proceeds occurs? | A4: Yes. | Q5: Can Company A deduct an aliquot portion of the cost of the Property referrable to a sale contract pursuant to subsection 70-35(3) of ITAA 1997 in the income year in which settlement of a sale contract occurs? | A5: Yes.

Relevant facts and circumstances: Company A, (A) is the owner of a property (Property). The property was held by A on capital account for rental purpose. A entered into an agreement with Company B (B) in which A, appointed B to provide services in relation to the Property (Agreement). A has obtained approval from the relevant council for the development of units on the Property. In the income year when the Agreement was entered into A recorded the Property in its accounts as trading stock for the purpose of Division 70 of the Income Tax Assessment Act 1997 (ITAA 1997). It adopted the election under section 70-30 of the ITAA 1997 to treat the Property as having been sold at arm's length for its cost and reacquired at the same amount. The value of the Property for the purpose of Division 70 of the ITAA 1997 is the net cost of the Property. Under the terms of the Agreement B provides services to A in return for a Services Fee. The Agreement requires B to make payments to A, on specified dates at specified amounts (Payments). The Payments are non-refundable. When a unit is sold the gross proceeds arising from the sale (Gross Proceeds) are held by B as agent for A and distributed to A following settlement of the sale contract. B is required to take into account the Payments and Services Fee in accordance with the terms of the Agreement. A proposes to allocate an equal portion of the cost of the Property to each individual unit at the time of settlement of a sale contract for the purpose of Division 70 of the ITAA 1997. A adopts the earnings method of tax accounting to determine its assessable income.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 70-10 | Income Tax Assessment Act 1997 subsection 70-35(3) | Income Tax Assessment Act 1997 subsection 70-80(1)

Reasons for decision: Summary: The Payments are assessable income derived by A in the income years they are made. | Detailed Reasoning - Detailed reasoning: Subsections 6-5(2) of the ITAA 1997 states that: If you are an Australian resident, your assessable income include the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings (TR 98/1) states at paragraphs 8 and 9 that: 9. ….Under the earnings method, income is derived when it is earned. The point of derivation occurs when a 'recoverable debt' is created. Income has 'come home' when a recoverable debt has been created and the taxpayer is not obligated to take any further steps to be entitled to payment ( Henderson v. Federal Commissioner of Taxation (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596; J Rowe & Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421; 71 ATC 4157; (1971) 2 ATR 497). In the present case, A uses the earnings method to determine its assessable income. Under the Agreement, A receives Payments in specified amounts at specified dates. The Payments are non-refundable. Therefore, for the purpose of section 6-5 of the ITAA 1997 Payments are assessable income derived by A in the income years in which they are made. | Summary: For the purpose of section 6-5 of the ITAA 1997 Gross Proceeds arising from the sale a unit are derived in the income year in which settlement of a sale contract occurs. | Detailed Reasoning - Detailed reasoning: Under subsection 6-5(2) of the ITAA 1997, a taxpayer is required to include in assessable income the ordinary income it derives during the income year. Subsection 70-80(1) of the ITAA 1997 provides that the proceeds from the disposal of trading stock are to be included in assessable income as ordinary income. The units being constructed and held by A are considered 'trading stock' for the purpose of section 70-10 of the ITAA 1997. The units remain 'trading stock on hand' of A provided A has dispositive power over them (Taxation Ruling TR 97/9 Income tax: sale of wool , which examines trading stock and income derivation in the context of sales of wool). The test of dispositive power was applied in the decision of the High Court of Australia in Farnsworth v. Federal Commissioner of Taxation (1949) 78 CLR 504; (1949) 9 ATD 33; (1949) 4 AITR 258. In that case a fruit grower had delivered dried fruit to a packing house where it had been mixed with other growers' fruit. The High Court held that the fruit was not stock on hand of the taxpayer. In the leading judgment Dixon J (with whom McTiernan J agreed) at page 518 relied on the fact that the taxpayer had no dispositive power over the fruit and no power to direct or control the disposal of it by the packing house. The loss of dispositive power received support of von Doussa J in Gasparin v. Federal Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1949) 28 ATR 130. The issue of whether real property was 'trading stock on hand' was considered in that case and it was found that the allotments of land remained trading stock on hand until settlement. In this case, when a purchaser enters into a sale contract A continues to remain the registered owner of the unit. It is not until settlement of a sale contract that A will transfer the title to the purchaser and ceases to have any propriety interest in the unit. It is only at settlement that a debt accrues to A and income is derived for taxation purposes. Until that point in time, the unit remains part of the trading stock of A, and no income from the sales has been derived for the purpose of subsection 6-5(2) of the ITAA 1997. Accordingly, Gross Proceeds for the sale of a unit are derived and included as assessable income under section 6-5 of the ITAA 1997 in the income year in which settlement of a sale contract occurs. | Summary: A is entitled to an allowable deduction under section 8-1 of the ITAA 1997 for that part of Gross Proceeds that are paid to B in the income year in which distribution of Gross Proceeds is made. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent that they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for that purpose. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible. In addition, losses or outgoings will not be deductible under section 8-1 of the ITAA 1997 where another provision prevents it. It is, therefore, necessary to determine the connection between the particular loss or outgoing and the activities by which the taxpayer more directly gains or produces his or her assessable income ( Charles Moore & Co (WA) Pty Ltd v. Federal Commissioner of Taxation (1956) 95 CLR 344; (1956) 11 ATD 147; (1956) 6 AITR 379. For a loss or outgoing to be deductible under section 8-1 of the ITAA 1997, it must have the essential character of a loss or outgoing incurred in gaining assessable income or of an income producing expense ( Lunney & Hayley v. Federal Commissioner of Taxation (1958) 100 CLR 478; (1958) 11 ATD 404; (1958) 7 AITR 166). There must be a nexus between the loss or outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 7 AITR 236. Under the terms of the Agreement, Payments are to be made to A on specified dates. Any amount of Payments that has been made is to be applied and paid to B as a condition of the Agreement. This amount, therefore, has the character of an outgoing incurred to enable A to gain assessable income as it is an amount required to be paid under the terms of the Agreement. Accordingly, A is entitled to a deduction under section 8-1 of the ITAA | Summary: The amount of Services Fee paid to B is a deduction under section 8-1 of the ITAA 1997 incurred in the income year in which distribution of Gross Proceeds occurs. Detailed reasoning : Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for that purpose, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. The essential character of the loss or outgoing, therefore, determines its deductible status. Essentially, the expenditure must be incurred in the producing of assessable income or as a business expense. In this case, A entered into an agreement with B whereby B agreed to provide services in relation to the Property. Under the Agreement, A appoints and authorises B to provide such services. B accepts the appointment in consideration for payment by A of a Services Fee. The Services Fee is, therefore, an outgoing incurred in producing assessable income by A. Accordingly, the Services Fee is deductible under section 8-1 of the ITAA 1997 in the income year in which distribution of Gross Proceeds is made. | Summary: A is entitled to deduct an aliquot portion of the cost of the Property referrable to a sale contract pursuant to subsection 70-35(3) of ITAA 1997 in the income year in which settlement of a sale contract occurs. | Detailed Reasoning - Detailed reasoning: Division 70 of the ITAA 1997 deals with tax accounting for trading stock. Section 70-10 of the ITAA 1997 defines 'trading stock' to mean 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and livestock'. Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as 'trading stock'? clarifies that land will be treated as trading stock for income tax purposes if it is held for the purpose of resale and a business activity which involves dealing in land has commenced. The land in this case is considered trading stock by A as it is held for the purpose of resale and A has commenced a business dealing in land. For the purpose of determining the value of trading stock in working out assessable income and deductions for the purpose of Division 70 of the ITAA 1997 A proposes to value each individual unit at cost and to allocate an equal portion of the cost to each individual unit. An aliquot part of the cost of the land is properly characterised as part of the cost price of the individual units. It is the cost price which forms part of or creates the individual units. Accordingly, an aliquot part of the cost of the Property is to be regarded the cost price of each unit and is taken into consideration in determining the amount under subsection 70-35(3) of the ITAA 1997 in the year in which settlement of a sale contract occurs.