Income tax: property development: where the estimated profits method of recognising income from long term construction contracts (Income Tax Ruling 2450) is adopted, how is an estimated 'ultimate loss' arising under a contract to be recognised?

The estimated contract loss is to be spread over the period taken to complete the contract in a manner that reflects the progress of the contract.

Paragraph 26 of IT 2450 equates 'ultimate profit or loss' with 'notional taxable income' expected to arise under a particular contract and indicates that this notional taxable income is to be spread over the years taken to complete the contract.

Paragraphs 31-32 provide examples of methods acceptable to the Commissioner by which the notional taxable income may be spread across the years taken to complete the contract. These methods largely reflect those outlined in paragraph 10 of Australian Accounting Standard (AAS) 11. Importantly, all of the latter methods meet the requirement stated in paragraph 31 of the Ruling, concerning the recognition of 'notional taxable income in a manner that reflects progress of a contract.'

Paragraph 18 of AAS 11 provides that where a loss is probable from a contract, 'provision is to be made for the foreseeable loss on the contract regardless of the amount of work performed on the contract'. This approach is unacceptable for income tax purposes. It is inconsistent with the approaches outlined in the Ruling for the spreading of notional taxable income. Also, it does not fulfill the basic principle of income tax law that the liability to income tax is an annual event, and therefore only income and losses that have been derived or incurred in an income year are brought to account.