BALDWINS • FoodLegal

Australian Lawyers and Consultants

Buying Work in Progress:
now a tax deductible expense, or not ?

December 2002 (reviewed January 2003)

Buying or selling a professional practice or service business? Recent amendments to the Income Tax Assessment Act 1997 ("the 1997 Act as amended") reduce the possibility of double taxation arising from the purchase of work in progress.

A work in progress amount?

The law now defines work in progress by reference to a "work in progress amount". Broadly, a work in progress amount is a payment in respect of work that has been partially performed for a third party but not yet completed to the stage where a recoverable debt has arisen, but does not include goods (section 25-95(3)(b) of the 1997 Act as amended).

Why was there a need for legislative change?

Previously, courts had held that an amount paid to purchase was on capital account and non-deductible (Couglan v FC of T 91 ATC 4505). Yet at the same time, the courts had held that a payment received by a partner retiring from a partnership for that partner’s share of the work in progress was assessable income (Crommelin v DC of T 98 ATC 4790). And so the scene for double taxation was set: a purchaser received no tax deduction for purchasing work in progress, yet the vendor was assessable on the receipt while the purchaser would be assessable in full on the full debt (including the same work in progress) when the work was eventually billed (by the business purchaser) to the clients.

The Taxation Commissioner had discretionary power to offer some relief from double taxation through Taxation Ruling IT 2551 which provided that where an amount in respect of work in progress was included in the assessable income of an outgoing partner, it should be shown in the accounts of the reconstituted partnership as an advance to the outgoing partner, and that when the work in progress was completed and billed, the amounts billed would not be regarded by the Australian Taxation Office as income of the partnership to the extent that it was attributable to the advance.

However, IT 2551 was withdrawn on 23 September 1998 as a result of the decision in Crommelin, leaving the issue of double taxation a lingering problem.

The new deal: deductible and assessable

In essence, the new law avoids double taxation by granting a tax deduction for a work in progress amount (section 25-95(1) of the 1997 Act). However the new law is not without its complications. Payment for a work in progress amount will be deductible in the year it is paid to the extent that either:

• a recoverable debt has arisen in respect of the completion or partial completion of the work as at the end of that income year; or
• the taxpayer reasonably expected that a recoverable debt would arise in respect of the completion or partial completion of that work within 12 months after the amount was paid.

The new law provides that the remainder, if any, of a work in progress amount is deductible in the following income year (section 25-95(2) of the 1997 Act).

The availability of a deduction for the payment of a work in progress amount is a positive step forward against the liability risk of double taxation. However it would appear that the deduction is still dependent on whether a recoverable debt has arisen by the end of the income year in which the work in progress amount is paid or by the taxpayer showing a reasonable expectation that a recoverable debt arise within 12 months after payment of the work in progress amount. To the extent that some work may not be billed within twelve months, there is a possible timing difference between the derivation of the income assessable in respect of the disposal of the work in progress (eg. by an outgoing partner) and a tax deduction available to the acquirer of the work in progress (eg. the remaining partners).

For further information, contact Joe Lederman at BALDWINS, Australian Lawyers & Consultants.

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