Assessable income - refund of an investment fund management fee

Is a refund of a management fee regarded as ordinary income and included in the taxpayer's assessable income under 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. A refund of a management fee is regarded as ordinary income and included in the taxpayer's assessable income under section 6-5 of the ITAA 1997.

The taxpayer has investments with a Unit Trust.

The taxpayer is charged the maximum ongoing management fee which is payable monthly.

This fee is deducted from the assets of each investment fund and included in the unit price.

As the actual management fees are less than the maximum charged, the taxpayer is entitled to receive a refund for the difference. This refund is paid at the same time the taxpayer receives their trust distributions, however it is paid as a separate item. The taxpayer has received a refund of management fees each quarter.

The management fee is a necessary expense that must be incurred in earning income from the Unit Trust and is therefore a deductible expense for the taxpayer.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident for taxation purposes includes ordinary income derived directly or indirectly from all sources.

Subsection 6-5(1) of the ITAA 1997 states that 'ordinary income' is income according to ordinary concepts. Characteristics of what is ordinary income have evolved from case law. Such characteristics include receipts that: • are earned • are expected • are relied upon, and • have an element of periodicity, recurrence or regularity. • Whether a refund is considered to be income is dependent upon the nature and character of the refund itself.

The fact that the refund may be in respect of a deductible expense is not in itself determinative of this issue. This is supported by Hill J in Warner Music Australia Pty Ltd v. FC of T (1996) 70 FCR 197; 96 ATC 5046; (1996) 34 ATR 171. His honour noted at FCR 205 ...an amount will not be required to be included in assessable income merely because it constitutes a refund of (or a gain arising from the release of a liability in respect of) an amount which had been allowed as a deduction against the income of a previous year (at FCR 120). The amount in question must be otherwise income in ordinary concepts or within the definition of assessable income.

Therefore, whether the refund of management fees is assessable will depend on whether these payments exhibit the characteristics of ordinary income.

In HR Sinclair & Son Pty Ltd v. The Commissioner of Taxation (1966) 114 CLR 537; (1966) 14 ATD 194 (Sinclair's Case) it was held by the Full High Court that an amount received in refund of an expense was assessable income of the year in which it was received, due to the fact that the expense was necessary in earning revenue and therefore the refund of such an expense was also revenue in nature. Owen J held at CLR 547 that: The company's business was that of a saw-miller. It was in that capacity that it paid royalties for timber cut by it for the purposes of its business and it was in that capacity that it received the amount refunded. It was part of the proceeds of the business carried on by it and, in my opinion, properly found its place, as it did, in the company's profit and loss account for the year of its receipt and was taken into account in arriving at its net trading profit for that year...

This approach was also followed in Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 95 ATC 4691; (1995) 31 ATR 392. Drummond J considered the principles in Sinclair's Case and expressed the following at FCR 120: Counsel for the Commissioner also submitted that, while the court in H R Sinclair supra, rejected the proposition the Commissioner put forward in his first argument, it reached its conclusion that the receipt there in issue was assessable as income in reliance on the fact that it was a refund of outgoings which had been allowed as deductions against the income of previous years. But it was not that that caused the receipt to be treated as income. Taylor and Owen JJ, at CLR 544 and 547 respectively, both held that the fact that it was a refund of royalties paid in previous years identified it as a receipt produced by the activity of carrying on the taxpayer's business: it was for that reason that it was characterised as income.

It has been established that the ongoing management fee is an allowable deduction as it is a necessary expense that must be incurred in order to generate the taxpayer's investment income. In this respect, the fee is characterised as revenue in nature and therefore, the refund of such expenses is considered a revenue receipt. Thus, the refunded fees are regarded as receipts received by the taxpayer in the ordinary course of earning income from the Unit Trust.

In addition, these payments possess characteristics of income according to the ordinary concepts, as they are expected and have an element of periodicity, recurrence or regularity.

Therefore, the refund of the excess management fee is considered to be ordinary income and forms part of the taxpayer's assessable income under 6-5 of the ITAA 1997.