Private ruling: Income and deductions - timing
Date of advice: 13 August 2019
Published: October 2019
Ruling period: Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022
Date scheme commenced: 1 July 2019

Ruling: Q1: Is the Company assessed on the Points Purchased Fees at the time X Points are redeemed? | A1: Yes | Q2: Is the Company entitled to a deduction at the time the X Points are purchased for the obligation to provide benefits on redemption of those X Points? | A2: No

Relevant facts and circumstances: The Company has developed a loyalty program called (the Program). The Program operates as such: · various entities become members of the Program (Member) · Member purchase reward points (X Points) from the Company which are then allocated to clients from the Members (the Clients); and · Clients can redeem X Points for goods. There is no consideration being paid by the Clients to the Company at any stage; all payments to the Company are made by Member. The Company will derive revenue from a number of streams: · membership fees · payments for the purchase of X Points (Points Purchased Fees) · commission charged on Points Purchased Fees; and · rebates from the goods supplier. The terms of the X Points are contained in agreements with the Member and the Clients. The Company accounts for tax on an accruals basis and Points Purchased Fees will be identified in their accounts separately from other revenue streams.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1

Reasons for decision: Detailed Reasoning - Income: 'Ordinary income' includes income according to ordinary concepts under subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997). The point at which income is derived depends upon the method of accounting adopted, whether upon a receipts or earnings basis. The first method brings to account income when it is received, either actually or constructively, under subsection 6-5(4); and the second 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 (TR 98/1). 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 at 154. For this reason it is usual for income from a business of trading or manufacturing to be practically computed on an earnings basis, whilst professional income is more appropriately accounted for under the receipts method. 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 at p155 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 amounts 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. Arthur Murray considered the derivation of fees paid in advance for services where the taxpayer held fees in a separate account as 'unearned income' until services were rendered. Although the fees were not subject to any contractual right of refund, in practice refunds were sometimes given. The Commissioner assessed the fees received in advance as possessing the character of income from the moment of receipt; the taxpayer, however, accounted for the fees at the point services were rendered. In determining whether actual earnings were to be added to receipt in order to find income in the case before it, the High Court stated at 310 that the answer must be given in the light of the necessity for earnings which is 'inherent in the circumstances of the receipt'. Whilst the fees received by the taxpayer were not prevented from being considered immediately the beneficial property of the taxpayer, as payment in advance was not sufficient to affect any trust or charge or to place any legal impediment barring any dealing with the fees, it was a matter of business good sense that the taxpayer treat the fees received but not yet earned as subject to the contingency that the whole or part may have to be paid back should the agreed quid pro quo not be rendered in due course. Such an approach was in accord with established accountancy and commercial principles regarding payments received in advance of goods being sold or of services being provided. It was only with the discharge of the obligations attached to the prepaid fees that the amounts acquired the character of income. In this case, the Company receives Points Purchased Fees as the Member are regularly invoiced. The Company will keep separate accounts for income received under this revenue stream and 100% of the Points Purchase Fees will be expended on goods for the same dollar value (or donations in limited cases). In considering what would provide a substantially correct reflex of income in a relevant year, we consider it is appropriate to treat the Points Purchased Fees as unearned income; prepayment of future services. Accordingly, the Company will not be assessed on the Points Purchased Fees until such time as the Clients redeem their X Points for gift cards. | Detailed Reasoning - Deductions: 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, except where the outgoings are of a capital, private or domestic nature. For a loss or outgoing to be incurred there needs to be a presently existing liability of a pecuniary character ( Nilsen Development Laboratories Pty Ltd v. FC of T 144 CLR 616 at 624). Taxation Determination TD 2003/20 considers the timing of deductions available to consumer loyalty programs. Under a consumer loyalty program, customers are credited with points at a time when goods or services are supplied. Those points may, within the terms and conditions of the particular program, result in the customer being able to redeem points for certain rewards. When points are awarded under a consumer loyalty program, the reward provider may make a provision in its accounts for the estimated future liability. The actual expenses associated with the rewards would not normally be realised until the goods or services are actually supplied. We acknowledge in this case that regardless of whether a Client ever voluntarily redeems their X Points the Company will eventually redeem them via an automatic redemption (or donation) this is not sufficient to differentiate the Program from a loyalty program as described in TD 2003/20. To be deductible, the liability must be 'more than impending, threatened or expected' ( New Zealand Flax Investments Ltd v. FC of T (1938) 61 CLR 179 at 207). There are no time limits imposed on Clients or limits on the volume of points they can accrue. Accordingly, the Company will not be entitled to a deduction for the obligation to provide benefits from X Points until the X Points are actually redeemed by the Clients.