Private ruling: Assessable income - prepayment amount
Date of advice: 18 November 2025
Published: 5 January 2026

Ruling: Q1: Is the Prepayment Amount paid by a customer to the Supplier under the Prepayment Program derived as ordinary income of the Supplier at the time of receipt? | A1: No This private ruling applies for the following periods: • Income year ended 30 June 20XX • Income year ending 30 June 20XX • Income year ending 30 June 20XX

Relevant facts and circumstances: The Supplier is a business owner that sells agricultural products and provides associated services to primary producers. Customers of the Supplier are invited to submit an application to participate in the Supplier's program for the prepayment of Supplies (the Prepayment Program). The Prepayment Program is subject to terms which constitute an agreement between the customer of the Supplier and the Supplier. The Program is, among other things, designed to assist customer cash-flow management by enabling them to pay for Supplies during major agricultural sale periods. Pursuant to the Prepayment Terms: • The Customer makes a payment to the Supplier referred to as the Prepayment Amount. The Prepayment Amount: ­ will be deemed to include a component of goods and services tax (GST); ­ may only be used by the customer to purchase Supplies from the Supplier within X months of being made; ­ will expire if not used by that time; and ­ is not refundable to the customer. • The customer receives a reward based on the unused Prepayment Amount at the time (Reward Amount). The Reward Amount: ­ is calculated by application of a specified rate on the unused Prepayment Amount, and is credited at the end of each calendar month; ­ may only be used by the customer to purchase Supplies from the Supplier; ­ will expire if not used within X months of the Prepayment Amount being made; and ­ is not refundable to the customer. • The Supplier may use any Prepayment Amount paid by the customer and any Reward Amount added by the Supplier as part of the Prepayment Program to set off and apply against any amount owing by the customer to the Supplier if the customer is: ­ in breach of the Prepayment Program terms or any other agreement the customer has entered into with the Supplier; or ­ insolvent within the definition of section 95A of the Corporations Act 2001 . The Supplier's standard terms and conditions of trade for the Supplies remain in full force and effect, other than as set out in the Prepayment Program terms. The Supplier intends to hold the Prepayment Amount in a special account under the name of the customer, described as a prepayment account. When the customer applies a portion of the Prepayment Amount to purchase Supplies from the Supplier that portion is treated as a sale. The receipt of the Prepayment Amount from a customer (of, for example, $11,000) will be reflected in the following journal entries: DR Bank account $11,000 CR Customer prepayment account $11,000 The GST will be a reconciliation item. The provision of Supplies to the customer will be reflected in the following journal entries: DR Customer prepayment account $11,000 CR GST payable $1,000 CR Sales $10,000 The GST adjustment will be offset here.

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 subsection 6-5(4) | Corporations Act 2001 section 95A

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 . The Prepayment Amount paid by a customer to the Supplier under the Prepayment Program is not derived as ordinary income of the Supplier at the time of receipt. It is derived by the Supplier when the Supplier provides the Supplies to the customer and/or when it is not used within X months and expires. | Detailed Reasoning - Detailed reasoning: Subsection 6-5(2) provides that the assessable income of a resident taxpayer includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Gross income from everyday business activities, including income from sales, is ordinary income for the purposes of section 6-5. Whether the Prepayment Amount paid to the Supplier pursuant to the Prepayment Program terms constitutes ordinary income derived by the Supplier at the time of receipt or when either the Supplies are provided or the Prepayment Amount is not used within X months and expires is relevant given the provision of Supplies and/or the expiration of the Prepayment Amount can occur in the income year following the one in which the Prepayment Amount is received. The point at which income is derived depends upon the method of accounting adopted, whether upon a receipts (or cash) method or the earnings (or accruals) method. The first method brings to account income when it is received, either actually or constructively under subsection 6-5(4), and the second method brings to account income when it is earned, being when a recoverable debt is created (see Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings ). The adoption of either accounting method is appropriate if in the circumstances it gives a substantially correct reflex of the income: see Commissioner of Taxes (South Australia) v The Executor Trustee and Agency Company of South Australia Limited (1938) 63 CLR 108 ( Carden's Case ) per Dixon J. For this reason it is usual for income from a business of trading or manufacturing to be practically computed on an earnings basis [1] . However, there are exceptions to this and whether an accounting method gives a substantially correct reflex is a conclusion to be made from the circumstances relevant to the taxpayer and the income. In Carden's Case , which concerned unpaid professional fees of a medical practitioner, and whether book debts should have been included in assessable income in the relevant year, Dixon J stated that 'in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form'. For an amount to have 'come home' requires the amount received to be unaffected by legal restrictions such as by reason of a trust or charge, and that the situation is reached in which they might properly be counted as gains completely made, so that there is neither legal nor business unsoundness in regarding them without qualification as income derived ( Arthur Murray (NSW) Pty Limited v the Federal Commissioner of Taxation (1965) 114 CLR 314 ( Arthur Murray ) at 318). In the circumstance of an advance payment, a receipt may not be derived as income when it is received, but as it is earned. In Arthur Murray , the taxpayer had adopted a practice of selling courses of dancing lessons of varying duration. Although the students had no legal right to refunds if courses were abandoned, amounts received as fees were credited in the taxpayer's books of account to an 'Untaught Lessons Account'. At regular intervals, the amount of fees attributable to lessons that had been given was transferred from the 'Untaught Lessons Account' to an 'Earned Tuition Account'. Amounts paid for lessons which remained untaught were also transferred to the 'Earned Tuition Account' when it became apparent that the students would not attend. The High Court held that it was not appropriate to assess the taxpayer on a cash receipts basis. Two factors which influenced the Court to favour the taxpayer's method of returning income were the possibility of the taxpayer being required to refund some of the amounts it had received for dancing lessons and the correct accounting treatment of payments received in advance of services to be rendered. In discussing the possibility of having to make a refund, the Court was not seeking to find any contractual obligation to do so (there was none) but rather whether in a practical sense a situation could arise where a refund would have to be made. After referring to the circumstance in which the payments were received, i.e., that they had become the beneficial property of the taxpayer and there was no legal impediment which prevented the taxpayer from enjoying the receipt, the Court said (at CLR 319; AITR 689 and ATD 100): But those circumstances nevertheless make it surely necessary, as a matter of business good sense, that the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back, even if only as damages, should the agreed quid pro quo not be rendered in due course. The possibility of having to make such a payment back (we speak, of course, in practical terms) is an inherent characteristic of the receipt itself. In our opinion it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company. The mere possibility of having to refund money received cannot, of course, be itself sufficient to defer derivation of income. If it were, a vendor of goods would not derive income from a sale during a period where the possibility of a damages claim in respect of the goods existed. However, what is crucial to the Court's reasoning in the above passage is the possibility of a refund 'should the agreed quid pro quo not be rendered in due course'. Following on from their statement about the relevance of the possibility of a refund, the High Court said (at CLR 319; AITR 689 and ATD 100): For that reason it is not surprising to find, as the parties in the present case agree is the fact, that according to established accountancy and commercial principles in the community the books of a business either selling goods or providing services are so kept with respect to amounts received in advance of the goods being sold or of the services being provided that the amounts are not entered to the credit of any revenue account until the sale takes place or the services are rendered: in the meantime they are credited to what is in effect a suspense account, and their transfer to an income account takes place only when the discharge of the obligations for which they are the prepayment justifies their being treated as having finally acquired the character of income. The Administrative Appeals Tribunal (AAT) in Case U7 87 ATC 127; Tribunal Case 20 18 ATR 3120 (Case U7) considered that there was a close analogy between the taxpayer's situation and that of a prepayment under a contract for future services. The principles arising from the Arthur Murray case were applied by the AAT in Case U7 , notwithstanding that the taxpayer was not held to be contracting to render future services to the Commonwealth. In Case U7 the taxpayer had received an advance of grant monies that it would become entitled to on making certain expenditure on agreed research and development activities. The taxpayer's entitlement to the grant was in direct proportion to the proper expenditure on that work and the AAT held that the prepayment was not income in the taxpayer's hands until it had been 'earned' by incurring the relevant expenditure. ATO Interpretative Decision ATO ID 2004/193 similarly considers whether grant funds used to acquire an asset are derived by a taxpayer for the purposes of section 6-5 in the income year in which the asset is acquired. The terms of the Deed under which the relevant grant funds were provided provides for a refund of funds to the Government agency where the funds were used to acquire assets which were later disposed of during the grant period and the Commissioner concluded that the funds used to purchase the assets have 'come home' to the taxpayer when expended. In terms of the quid pro quo referred to in the quote from Arthur Murray above, the quid pro quo occurs when the grant monies have been spent for the intended purpose. At that point, the taxpayer has done everything necessary to earn the income. Pursuant to the Prepayment Program terms, the Supplies are not provided to the customer at the time the customer pays the Prepayment Amount. The Supplier has a liability to provide the Supplies to the customer upon the placement of their order or orders within X months of the Prepayment Amount being made. For accounting purposes, the Supplier will record the receipt in relation to the Prepayment Amount as deferred revenue in a prepayment account. The Supplier will then return as income from sales for accounting purposes a portion of the deferred revenue as Supplies are provided following receipt of the customer's order. Prepayment Amounts received under the Prepayment Program are not earned until the liability to provide the Supplies to the customer is satisfied (despite the Prepayment Amount not being refundable to the customer). The agree quid pro quo under the Prepayment Program is rendered when the Supplier provides the Supplies ordered by the customer and it is at this point that the Supplier has done everything necessary to 'earn' the income. The crediting of the Prepayment Amount to the prepayment account (which, in effect, is a suspense account) and the subsequent transfer of the Prepayment Amount to an income account when the discharge of the Supplier's obligations for which they are the prepayment justifies the treatment as having acquired the character of income of the Supplier at that point. It is therefore considered that income derived by the Supplier as provided for by section 6-5 under the Prepayment Program is income earned at the time Supplies are provided to the customer. Where the Prepayment Amount (or a portion thereof) is not used within X months and expires, the Supplier is deemed to have derived the income at the point of expiration. [1] See paragraphs 49 to 51 of TR 98/1.