Private ruling: Small business entity aggregated turnover
Date of advice: 21 March 2018
Published: June 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2017

Ruling: Q1: Is a refund of R & D tax offset received in a year of income included in ‘Aggregated Turnover’ for Small Business Entity under section 328-115 of the Income Tax Assessment Act 1997 ? | A1: No

Relevant facts and circumstances: 1. In the Year ended 30 June 2016 Company A claimed the R&D tax offset and received $X. 2. Person A is the sole director and the public officer of Company A and Company B which is the trustee for Trust A. 3. Trust A and Company A are connect entities for the purposes of subsection 328-115(2) of the Income Tax Assessment Act 1997 . 4. Turnover of Trust A and Company A are included in the aggregate turnover. 5. Trust A is assessing the aggregated turnover for an income year to apply the Small Business Entity concessions.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 4-10 | Income Tax Assessment Act 1997 subsection 4-10(3) | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(1) | Income Tax Assessment Act 1997 section 63-10 | Income Tax Assessment Act 1997 Division 67 | Income Tax Assessment Act 1997 section 328-115 | Income Tax Assessment Act 1997 subsection 328-115(1) | Income Tax Assessment Act 1997 subsection 328-115(2) | Income Tax Assessment Act 1997 section 328-120 | Income Tax Assessment Act 1997 subsection 328-125(1) | Income Tax Assessment Act 1997 subsection 328-120(1) | Income Tax Assessment Act 1997 subdivision 355-C | Income Tax Assessment Act 1997 s ection 995-1

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. The R&D tax offset received by Company A is not ordinary income and is not included when the Trust A determines its aggregate turnover under section 328-115. | Detailed Reasoning - Detailed reasoning: 1. Aggregated turnover is defined in section 328-115 and subsection 328-115(1) and (2) states: | Detailed Reasoning - 328-115(1): Your aggregated turnover for an income year is the sum of the relevant annual turnovers (see subsection (2)) excluding any amounts covered by subsection (3). Note: For small business CGT relief purposes, additional entities may be treated as being connected with you or your affiliate under sections 152-48 and 152-78. | Detailed Reasoning - 328-115(2): The relevant annual turnovers are: (a) your *annual turnover for the income year; and (b) the annual turnover for the income year of any entity (a relevant entity) that is *connected with you at any time during the income year; and (c) the annual turnover for the income year of any entity (a relevant entity) that is an *affiliate of yours at any time during the income year. | Detailed Reasoning - Connected Entities: 2. Under subsection 328-125(1), an entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity. 3. Person A is the sole director of Company B as trustee for the XXXX XXXXX XXXX. He is also the sole director of Company A. Both entities are connected entities and each entity’s annual turnover is included in the aggregated turnover for the purpose of Small Business Entity concessions | Detailed Reasoning - Annual Turnovers: 4. Annual turnover is defined in section 995-1 as having the meaning given by section 328-120 and subsection 328-120(1) states: An entity's annual turnover for an income year is the total *ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business. 5. Ordinary income is defined in section 995-1 to have the meaning given by section 6-5 and subsection 6-5(1) states: Your assessable income includes income according to ordinary concepts, which is called ordinary income . | Detailed Reasoning - Ordinary Income: 6. There is no specific guidance on what is meant by 'income according to ordinary concept' and much of the Commissioner’s view on the meaning of the phrase relies on a number of factors identified by the courts which indicate whether an amount has the character of income according to ordinary concepts. It has been determined that a frequent characteristic of income receipts is an element of periodicity, recurrence or regularity ( FCT v. Dixon (1952) 86 CLR 540). Other characteristics of income that have evolved from case law also include receipts that: - are a product of any employment, services rendered, or any business;. - has a character of income in the hands of the recipient; - are earned; - are expected; and - are relied upon. 7. The Explanatory Memorandum accompanying Tax Laws Amendment (Small Business) Bill 2007 summarises the meaning of the phrase in the following paragraphs which demonstrate some consistency with the view established by the court: 2.15 In general, income is derived in the ordinary course of carrying on a business if the income is of a kind that is regularly or customarily derived by the entity in the course of carrying on its business, arising out of no special circumstance or unusual event. Similarly, the income is derived in the ordinary course of carrying on a business if the income, although not regularly derived, is a direct result of the normal activities of the business. 2.16 Ordinary income may be derived in the ordinary course of carrying on a business even if it is not the main type of ordinary income derived by the entity. Similarly, the income does not need to account for a significant part of the entity's overall receipts. It is sufficient that the ordinary income is of a kind derived regularly or customarily in the carrying on of a business. | Detailed Reasoning - R & D Tax Offset: 8. The way that you work out how much income tax you must pay is sets out in section 4-10 using the formula contained in subsection 4-10(3): Income Tax = (Taxable Income x Rate) – Tax Offsets 9. Effectively, tax offsets can reduce your tax payable to zero and in some instances they can produce a refund from the Commissioner if they are ‘Refundable Tax Offsets’ (subject to the rules on how we must apply credits, including refunds, to running balance accounts or against a particular tax debt). Division 63 explains what happens if your tax offsets exceed your basic income tax liability and it depends on the type of tax offset. 10. Refundable tax offsets can reduce the amount of tax you are liable to pay to an amount less than zero, which essentially is the excess of the tax offset, resulting in a refundable amount. 11. If your R & D aggregated turnover is $20 million or less, you can claim an R & D refundable tax offset subject to meeting all other R & D requirements. Additionally, whether a refund of excess R & D tax offset arises will depends on the relevant entity’s taxable income in an income year. Therefore, a tax refund arising from excess refundable tax offsets, although may be recurring from year to year, is not a regular periodical payment that can be expected or relied upon. 12. A refund of a tax offset by its character is not an amount that is earned in respect to the day to day carrying on the business. It does not have the character of income in the hands of the recipient and cannot be attributed to the ordinary course of carrying on the business. 13. R & D tax offset is not income in accordance the meaning of ordinary income under section 6-5. The ability to receive a refund of excess tax offsets is based on the operation and construct of the following legislative provisions: - Item 40 of section 63-10, - Division 67, and - Subdivision 355-C (entitlement to an R & D tax offset) 14. Therefore, R & D tax offset is not included in working out small business entity’s aggregated turnover under section 328-115.