Assessable Income: securitisation arrangement - profit emerging basis of returning assessable income

Can a company (the taxpayer) undertaking a securitisation arrangement bring to account as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) the net profit (being the difference between a lump sum paid under an agreement to assign future receivables and the future receivables) emerged annually on an accruals basis?

Yes. The taxpayer can bring to account as assessable income under section 6-5 of the ITAA 1997 the net profit emerged annually on an accruals basis.

The taxpayer is a company incorporated for the purpose of securitising assets and providing finance for a public-private partnership project.

The taxpayer acquires, through entering into an agreement to assign future rental payments (receivables) to be generated by a tax exempt body (the originator).

Under the securitisation agreement, the definition of receivables is limited to the debt obligation owed to the originator when such an amount becomes due and payable to it.

The receivables continue to be payable to the originator, however it instructs payments be made directly to the taxpayer. In the event that the payer of the receivables defaults, the taxpayer's recourse is only against the originator.

In exchange for acquiring the right to the receivables, the taxpayer pays to the originator a lump sum payment. The receivables to be received will, over time, exceed the lump sum payment made.

The taxpayer prepares its financial accounts using an accruals basis of accounting.

In Norman v. Federal Commissioner of Taxation (1963) 109 CLR 9; (1936) 13 ATD 13; (1963) 9 AITR 85 the taxpayer purported to assign all right, title and interest in and to certain interest and dividends he may have been entitled to receive over a specified period. That is, the purported assignment was of a sum of money (interest and dividends) which did not exist but was expected to arise.

Dixon CJ, pointed out that for the assignment to be effective, the taxpayer must denude himself of all right to the interest. Windeyer J, set out the important distinction between the assignment of a presently existing right to either present or future income and a future right. The former constituting a chose in action which has an existence in law and thus can be transferred or assigned. The latter is yet to come into existence and is not property that is capable of assignment (although equity will recognise the attempted assignment of a mere expectancy for consideration as an agreement to assign something when it comes into existence).

In Shepherd v. Federal Commissioner of Taxation (1965) 113 CLR 385; (1965) 14 ATD 127; (1965) 9 AITR 739 the taxpayer purported to assign to family members by deed poll all right, title and interest in and to an amount equal to ninety per centum of the income which may accrue from royalties during a period of three years from the date of the assignment. In that case, the majority concluded the taxpayer had assigned his presently existing right to the royalties, rather than the royalties themselves.

In this instance, the assignment is of the receivables rather than the right to those receivables. However, equity would recognise the assignment as an agreement made for value to assign the receivables when they become payable to the originator. That is, the purported assignment is not effective in denuding the originator from continuing to derive the receivables - the originator continues to derive them but has directed that the receivables be payable to the taxpayer.

As the taxpayer is not assigned the right to the receivables, the payments it receives may not have the character of income. The character of the payments may be determined by reference to the scope of the transaction, venture or business in or by reason of which the money is received, and also the taxpayer's purpose in engaging in the pertinent transaction, venture or business ( G P International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1). In the present case, the transaction has the character of a 'business deal' entered into with the object of purchasing the receivable with a view to generating a profit ( Federal Commissioner of Taxation v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693).

The specific question of whether a net profit could be included in 'gross income' was considered by Mason J in Commercial and General Acceptance Ltd. v. Federal Commissioner of Taxation (1977) 137 CLR 373; 77 ATC 4375; (1977) 7 ATR 716. His Honour reviewed pertinent judicial discussion of the concepts of assessable income and taxable income as then appeared in the Income Tax Assessment Act 1936 and expressed the conclusion that if it is not apparent that a receipt of money, in the circumstances in which it is received, is income, it may well be the case that a net figure included in the receipt will be stamped with the character of income.

Ordinarily for tax purposes, a receipt of money is either income or capital which in the context of carrying on a business is divided into fixed and circulating capital. An assignee that enters into an assignment to acquire money that is not income would normally enter into the assignment as a business deal with the object of outlaying capital in the hope of getting back the outlay and more, that is, a profit. The money outlaid is thus circulating capital and its return would normally constitute a mixture of circulating capital and profit, or if a loss results, just circulating capital.

The characterisation of the outlay of money on the purchase of receivables as circulating capital in the circumstances of this case is not dissimilar to the way in which the High Court regarded money as circulating capital in Coles Myer Finance Ltd v. Federal Commissioner of Taxation (1993) 176 CLR 640; 93 ATC 4214; (1993) 25 ATR 95. It is borrowed money which the taxpayer turns to account by purchasing a money stream from which it recovers its investment and a profit. Moreover, the characterisation of the outlay as circulating capital in these circumstances forecloses its deductibility as an outlay on revenue account.

In The Commissioner of Taxes (S.A .) v. Executor Trustee and Agency Co. of South Australia Ltd (1938) 63 CLR 108; (1938) 5 ATD 98; (1939) 5 ATD 187, Dixon J, pointed out as a general proposition 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 realizable form'. The expression 'come home' is apt to describe the point when income can be said to be 'derived'. Differentiating between income coming home in a 'realized' form and a 'realizable' form can be said broadly to capture the difference between bringing income to account on a receipts or cash basis and on an earnings or accruals basis.

Dixon J also expressed the view, that the admissibility of the chosen method of accounting for income depended on 'whether in the circumstances of the case it is calculated to give a substantially correct reflex of the taxpayer's true income'. His Honour also pointed out 'to a great degree the question whether income can be properly calculated on one basis alone or upon either, must depend upon the nature of the source of the income'.

Ordinarily, income by way of net profit would be brought to account as income as the excess of receipts in that year over that proportion of the outlay which is referable to their acquisition. This is the orthodox method of emerging profit which was articulated by Gibbs J in X C O Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 343; 71 ATC 4152; (1971) 2 ATR 353. This is not to say, however, that circumstances cannot exist where it is appropriate to bring profit to account on an accruals basis. As indicated above, the correct reflex of income will depend upon the nature of the source of the income. In other words, if a taxpayer is sufficiently confident of realising a profit that he is prepared to bring it to account as earned and derived before realisation, then the Commissioner is justified in dealing with it in the same fashion. Authority for this approach is found in the High Court's decisions in Commissioner of Taxes (Q) v. Burke (1926) 38 CLR 314 and Federal Commissioner of Taxation v. Thorogood (1927) 40 CLR 454.

Accordingly, in this case and under these circumstances, the income received from the assignment of the receivables is the net profit and it is appropriate for that net profit to be emerged annually on an accruals basis.