Arthur Murray Dance School was a landmark decision regarding tax precedent, which affects how pre-paid income derived from a contract is taxed when it straddles several tax years.
In Sydney, the Arthur Murray Dance School provided lessons to its clientele after being paid for the service (payment up-front). This is not an uncommon practice in many membership/pre-paid subscription-based services.
For example, take a dancer who pays for a year’s worth of lessons up-front, in June. The school is given $1,200 for the year, and the student receives $100 worth of dance lessons each month from July to June of the following year. The question is then, when is Mr Murray to declare the $1,200 – is it in June when the money was received, or is it in the following year when he provides the dance lessons?
The Australian Tax Office believed that the income should be declared when the money was paid initially. However, Mr Murray challenged the decision in court, arguing that if the lessons weren’t provided, the money would need to be returned; thus, he was only holding it in trust until he provided the lessons.
In deciding Arthur Murray, the Court found that amounts received in advance for dancing lessons were not derived until the lessons were actually given. The payments were only considered assessable income after they had been earned by giving the lesson.
This has become known as the Arthur Murray Principle, and can sometimes be applied to other types of pre-paid income, such as pre-paid advertising, prepaid web service fees, prepaid gym memberships, and construction contracts that are paid up-front with the services to be provided over the following 12-month period.
There are rules that need to be followed if you wish to follow this principle, however. The money must still be at risk to you – you can’t tell someone they can’t receive a refund on a full-year gym membership, and then expect to defer the tax on that income.
There are also instances where you will be taxed on the money when it is received. The main types of income this generally applies to are wages, interest and rents received.
If you, for example, receive two years of rent upfront, it is taxable at the time of receiving it. If however, you are paid wages on the 1st of July for a period that ended on the 30th of June, you will not be taxed until the following year.
This rule of income extends to businesses where the ATO believes that their income is akin to earning wages, such as accountants, solicitors and other professionals that earn all of their income from their own personal services.
If you’re unsure how these principles may apply to you, do not hesitate to contact us.