In 1987, the Bangles and Bon Jovi were at the top of the charts and (rumour has it) some of us were wearing Swatch watches. The Australian Taxation Office (ATO) also released IT 2450 which set out guidance on the recognition of income from long term construction contracts. In those 30 years, a number of related tax determinations have been issued and new accounting standard AASB 15 revenue from contracts with customers is coming into effect. This week the ATO released a draft ruling TR 2017/D8 to update their guidance. The final tax ruling is intended to take effect from 1 January 2018.
It would appear the draft Ruling does not change the ATO’s view. Rather, it is intended to expand its guidance to cover the treatment of expenses and make reference to the new accounting standard. However, the key difference for business may not be with the Ruling but with the fundamental differences that can now exist between the income tax treatment and AASB 15.
Key points of the ruling include:
- ‘Long term’ construction contracts are contracts where construction work extends beyond one year of income. Accordingly, a construction contract of less than twelve months may still be ‘long term’ if it straddles two income years.
- A deferral of the recognition of profits and losses until completion of the contract remains unacceptable.
- There continues to be two methods which may apply in recognising the income derived and expenses incurred under a long term construction contract for income tax purposes – the basic approach and the estimated profits basis.
- Under the basic approach, all progress and final payments received in an income year are assessable with deductions allowed for expenses incurred and permitted under law. This may result in upfront payments being assessable in the year of receipt and differences from the accountin treatment adopted.
- Where taxpayers adopt the estimated profits basis, it is acceptable to recognise the ultimate profit or loss over the term of contract, provided the method of accounting for the long term construction contract is in accordance with accepted accounting practices and has the effect of allocating the profit or loss on a fair and reasonable basis. However, this does not necessarily mean the tax treatment will mirror the accounting treatment. Certain tax adjustments are still required under the estimated profits basis as AASB 15 does not necessarily bring into line the accounting recognition of revenue with tax law which requires income to have been derived. Similarly, expenses will only be deductible where they are identified as likely having been incurred over the period of the contract. Estimations of costs are likely to be required each year and estimations will need to be well documented.
- The allocation of notional taxable income adopted for a contract must reflect the progress of the contract and the particular method used will depend on the nature of the contract. The method adopted must be applied consistently for all years of the contract.
On first blush, there do not appear to be any obvious differences between IT 2450 and TR 2017/D8. However, we continue to compare the two rulings to identify any differences of interest which may initially pass under the radar.
Submissions on the draft ruling are due by 1 December 2017. If you would like to part of a consultation process with KPMG Tax, please contact us.