Prepayments

Whether prepayments of income retained by the taxpayer on sale of a business are income or capital?

The prepayments (at the date of sale of the taxpayer's business) are income.

The taxpayer sells a business in accordance with an agreement for sale. Until the date of sale prepayments received by the business are brought to account at the time the goods or services that the prepayments relate to are delivered.

Prepayments are advance amounts which are brought to account as income in the taxpayer's accounts only when earned ( Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 315). That is, the income is said to have been earned at the time the goods or services that the prepayments relate to have been delivered, for it is at this time that the seller's obligations have been fulfilled.

Under the terms of the agreement the taxpayer's obligations to customers will be fulfilled on sale of the business. Thus, prepayments of income outstanding at this time and retained by the taxpayer will acquire the character of income.