Private ruling: Income - derivation and special professional activities
Published: May 2015
Ruling period: Year ended 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 20XX

Ruling: Q1: Should the income relating to your writing activities be apportioned and declared in both the relevant and subsequent financial years? | A1: No. | Q2: Are you eligible to have special professional income averaging applied to the income earned from your writing activities in the relevant financial year? | A2: Yes.

Relevant facts and circumstances: You are the author of a book. During the relevant financial year you entered into a publishing agreement ('the Agreement') with a publisher to publish the book. Under the Agreement, you were paid an advance when each of the following events occurred: • signing the Agreement • the manuscript being delivered to the typesetter • the first publication of the book. These events all occurred during the relevant financial year and you received the advances in that year. The advances are treated as an advance of royalties. You will not receive further royalties until they exceed the amount advanced. Under the Agreement you are required to make personal promotions and appearances to promote the novel on and around the first publication. The publisher pays your pre-approved reasonable travel, accommodation and subsistence expenses incurred in promoting the work. The Agreement does not require you to repay any of the advances if you do not personally promote the book. Promotional appearances were performed in the relevant and subsequent financial years. You incurred expenses associated with writing the book in the 2012-13 financial year but did not receive income from this activity during the year. The net income from writing the book in the relevant financial year exceeds $2,500. You are a resident of Australia.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 405-5 | Income Tax Assessment Act 1997 Section 405-20

Reasons for decision: Summary: The advances received are required to be declared in your tax return for the relevant financial year as the events leading to their payment occurred in the relevant financial year. They cannot be apportioned between the relevant and subsequent financial years on the basis that the promotional appearances were contractual and occurred in more than one financial year. This is because the Agreement did not contain a contingency of repayment requiring you to repay all or part of the advances if you did not perform the promotional appearances. As an author you are a special professional and are entitled to have averaging applied to the income from your writing activities. The first year you are eligible to have the averaging applied is relevant financial year as this is the first year your net income from this activity exceeded $2,500. | Detailed Reasoning - Apportionment of income: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that the assessable income of an Australian resident includes ordinary income derived from all sources whether in or out of Australia, during the income year. Under section 6-5 of the ITAA 1997 income is assessable in the income period in which it is derived. Taxation Ruling TR 98/1 provides guidance on the factors which are relevant in determining the correct method to bring income to account for tax purposes. The courts have recognised two methods by which a taxpayer may derive income. Under the cash receipts method a taxpayer is taken to have derived only those amounts which they have received during the year. The fact that the taxpayer may receive a payment in advance and is yet to earn any fees is not relevant under this method. Under the accruals method a taxpayer derives income when they have earned the right to a payment, that is, when the amount is receivable or recoverable. This can be either when the work has been completed, or when a client is billed for work performed. Under the accruals method, the time of the actual receipt of money is of no relevance. Where an individual taxpayer, as opposed to a company, provides their knowledge or exercises skill as part of a business carried on by the taxpayer, the income of the business may represent a reward for the provision of those personal services. Where the income results primarily from the services rendered, or work performed by the taxpayer personally, it is generally assessable on a receipts basis. You received the advances as a result of exercising your personal skills - your writing skills. Thus, the receipts method would be the appropriate method to use in determining when you derived this income. | Detailed Reasoning - Contingency of repayment: Taxation Ruling TR 2014/1 (previously released as Draft Taxation Ruling TR 2013/D2) outlines the Commissioner's view on how commercial software developers derive income from agreements for the right to use proprietary software and the provision of related services. The principles in TR 2014/1 can be applied to other industries where contractual obligations exist. TR 2014/1 states that where an amount property attributable to a contractual obligation is subject to a 'contingency of repayment', the amount is derived for the purposes of section 6-5 of the ITAA 1997 when the obligation is fully performed or the contingency of repayment otherwise lapses. A 'contingency of repayment' in the event of non-performance refers to there being either: (i) a contractual obligation to make a refund (ii) a demonstrated commercial practice to make a refund, or (iii) contractual exposure exists for damages. Where a 'contingency of repayment' exists, it may be valid for income tax purposes to defer all or part of the contractual fee for: (i) the granting of the proprietary licence (ii) the hosted arrangement, and/or (iii) other 'additional services' which may or may not be bundled together with (i) or (ii) in the contract. Where no 'contingency of repayment' exists, the amount is derived when a recoverable debt arises in the contractual fee. Under the Agreement you received advance payments when certain events occurred. You are also required to make personal promotions and appearances to promote and publicise the book. Whilst the publisher pay expenses associated with the promotional activities you do not receive any additional specified amounts for these activities. Nor are you required to repay any part of the advance payments if you do not meet your promotional obligations. As no part of the advances paid to you is attributable to the promotional activities nor repayable if you do not perform the promotional activities, there is no 'contingency of repayment' in relation to non-performance. Therefore, the derivation of the advances cannot be linked to the performance of the promotional activities and the advances are derived when they are received. You are assessable on the advances in the year in which they were received, that is, the relevant financial year. | Detailed Reasoning - Special professional income averaging: An income averaging scheme applies to certain classes of 'special professionals'. The scheme, which is contained in Division 405 of the ITAA 1997 is designed to prevent such taxpayers from being pushed into higher tax brackets when income from their professional work in a year fluctuates above the average income for such work. The classes of special professionals subject to the income averaging scheme are: authors of literary, dramatic, musical or artistic works, inventors, performing artists, production associates and sportspersons. As the author of a book you are a special professional for the purposes of the income averaging scheme. The income averaging scheme only applies to the taxable professional income derived from the taxpayer's professional activities. Taxable professional income is calculated as assessable professional income less expenses associated with earning that income. Assessable professional income includes any royalties or advances on account of royalties you derive in relation to a literary, dramatic, musical or artistic work of which you are the author. The advance payments you received are considered to fall within the definition assessable professional income. That is, they are payments relating to the literary work of which you are an author. The first year you are eligible to have special professional income averaging applied to your writing activities is the relevant financial year. This is because this is the first year that your taxable professional income exceeded $2,500. Whilst your writing activities commenced in the previous financial year, the activity had an overall loss.