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  • Review of ATO advice on scholarships

    Purpose and status of this discussion paper

    The purpose of this paper is to facilitate consultation between the Australian Taxation Office (ATO) and the community as part of the process of developing a potential ATO view on the application of the taxation law. This paper is prepared solely for the purpose of obtaining comments from interested parties. All views in this paper are therefore preliminary in nature and should not be taken as representing either an ATO view or that the ATO will take a particular view.

    This paper is not a publication that has been approved to allow you to rely on it for any purpose and is not intended to provide you with advice or guidance, nor does it set out the ATO’s general administrative practice. Therefore, this paper does not provide protection from primary tax, penalties or interest for any taxpayer that purports to rely on any views expressed in it.

    Date of issue

    1 February 2017

    Contact officer
    (for comments or further information)

    A request made under the Freedom of Information Act 1982 for access to a submission marked confidential will be determined in accordance with that Act.

    Please submit responses electronically to PAGIND&SMB@ato.gov.au

    Enquiries can be directed to:

     

    Final date for comments

    31 March 2017

    Introduction

    This paper discusses the exemption from taxation for amounts paid as a scholarship, bursary, educational allowance or educational assistance (herein shortened to scholarships as appropriate).

    Scholarships paid to a full-time student at a school, college or university are exempt from taxation, subject to specific exceptions and conditions (herein referred to as the scholarship exemption).

    There is no general statement of the ATO view on the application of the scholarship exemption. Income Tax Ruling IT 2581 Income Tax: The rendering of services by a scholarship holder, limits discussion to the operation of the former paragraph 23(z) of the Income Tax Assessment Act 1936 (ITAA 1936) particularly as it relates to scholarships and fellowships awarded by the National Health and Medical Research Council. The ATO has also produced a scholarship tool “Is my scholarship taxable?” but this is directed at the recipient of the scholarship, and offers limited assistance to those funding scholarships.

    Historically the main form of providing advice has been by way of class ruling. Each class ruling explains how the relevant provisions of the tax law apply to a specific class of participants for a particular scholarship scheme. They offer limited assistance to persons not described in the class ruling, or where arrangements differ from that described.

    We are concerned that using class rulings for scholarship advice is not giving a sufficient level of certainty for all taxpayers and may not be supporting a level playing field. Also, where there are a small number of scholarships offered, class rulings involve a disproportional application of resources by the ATO for little overall benefit to the community.

    Consequently, we are reviewing our approach to providing advice on the taxation of scholarships. We consider that general public advice clearly explaining the ATO view may significantly reduce the need for class rulings and provide greater assistance to taxpayers in applying the ATO view to future scholarships.

    We understand that scholarship arrangements have evolved over the years, as have approaches and methods to work and study. As a result, advice given previously (on a case by case basis) may no longer represent the current ATO view.

    This paper sets out our preliminary current thinking regarding the scholarship exemption provisions. It does not represent the ATO view at this time and therefore should not be relied upon or otherwise taken as indicating the approach we will ultimately take in forming the ATO view. Your honest and constructive feedback will assist us in this regard.

    Purpose

    This paper is to facilitate discussion and invite feedback so that we can provide clarity and certainty on the taxation of scholarships. At this time we anticipate providing a ruling on the scholarship exemption, updating our guidance material on our ATO website, and adding further detail in the ATO tool “Is my scholarship taxable?”

    We seek feedback on the approach suggested in this paper. We would benefit from knowing the details of current or contemplated scholarship arrangements, particularly those:

    • where you believe negative unintended consequences might arise if the approach suggested in this paper were to be adopted as the ATO view,
    • where our suggested approach does not assist in determining if the scholarship is exempt, or
    • that highlight aspects of our suggested approach that you oppose, question, or think further explanation is necessary.

    Legislation for Scholarships

    Section 51-1 of the Income Tax Assessment Act 1997 (ITAA 1997) makes it clear that the provisions following (including section 51-10) make exempt from income tax certain ordinary income and statutory income, subject to exceptions or special conditions, or both.

    Item 2.1A in section 51-10 makes exempt from income tax amounts paid as a scholarship, bursary, educational allowance or educational assistance to a full-time student at a school, college or university subject to exceptions and conditions listed in section 51-35.

    Section 51-35 is as follows:

    The following payments made to or on behalf of a full-time student at a school, college or university are not exempt from income tax under item 2.1A of the table in section 51-10:

    1. a payment by the Commonwealth for assistance for secondary education or in connection with education of isolated children;
    2. a Commonwealth education or training payment;
    3. a payment by an entity or authority on the condition that the student will (or will if required) become, or continue to be, an employee of the entity or authority;
    4. a payment by an entity or authority on the condition that the student will (or will if required) enter into, or continue to be a party to, a contract with the entity or authority that is wholly or principally for the labour of the student;
    5. a payment under a scholarship where the scholarship is not provided principally for educational purposes;
    6. an education entry payment under Part 2.13A of the Social Security Act 1991.

    In arriving at our view we are obliged to interpret the legislation purposively. This requires an examination of the predecessor to section 51-35, being paragraph 23(z) of the ITAA 1936.

    Where relevant, the former provision will be discussed within this paper. Much of the case law on the scholarship exemption was decided on the former provision, but we consider some of this jurisprudence to be relevant to the application of the current legislation to contemporary situations.

    Aspects of the exemption, exceptions and conditions are discussed below.

    Scholarship, bursary, educational allowance or educational assistance

    Item 2.1A in section 51-10 states “a scholarship, bursary, educational allowance or educational assistance….” is exempt from tax. The words 'scholarship, bursary, educational allowance or educational assistance' are not defined in the ITAA 1997.

    Based on common interpretation (dictionary definition) and interpretation from the Courts, we propose to give broad meaning to these terms based on the following characteristics:

    • the scholarship, bursary, educational allowance or educational assistance is open to a wide range of candidates
    • is in the form of financial or other aid to pursue some form of education
    • is an amount allotted or granted to meet or assist with expenses or requirements
    • the selection of recipients is based on merit or some other rational criterion [see Re Leitch (deceased) [1965] VR 204], and
    • the education of the recipient is at least one of the purposes for which the scholarship is provided [see FCT v. Hall (1975) 6 ALR 457; 75 ATC 4156; (1975) 5 ATR 450].

    Full-time student

    A condition for exemption from income tax is that the recipient has to be a full-time student. The ITAA 1997 does not define full-time.

    The common meaning for full-time is something which occupies a person all the time, as opposed to part-time.

    We propose broadly adopting the rules for Austudy entitlement to determine whether a student is full-time. These rules require a student to be doing at least 75% of the equivalent full time load for the course they are enrolled in for the given study period (for example, semester, trimester or year).

    The alternative is to specify the number of hours per week, such as 35 or 40 hours. This method would be more easily applied across more course loads, including Research and PhD students.

    At a school, college or university

    Item 2.1A in section 51-10 requires the student to be full-time at a school, college or university. Again these terms are not defined in the ITAA 1997.

    We propose to state that any school or registered education or training provider authorised to deliver the school curriculum or an Australian qualification (as defined by the Australian Qualifications Framework) will satisfy the meaning of school, college or university.

    An Australian qualification includes Certificates, Diplomas, Bachelor degrees, Masters degrees and Doctoral degrees.

    We accept that the education does not have to be undertaken physically at the school, college or university. Students undertaking a full-time course may undertake training or study at an external site, which includes study from home if they are undertaking study by distance education.

    Commonwealth payments

    Paragraphs 51-35(a) and 51-35(b) specify the following are not exempt under section 51-10:

    1. a payment by the Commonwealth for assistance for secondary education or in connection with education of isolated children, and
    2. a Commonwealth education or training payment.

    We do not think much explanation is required for these types of payments. Note that a Commonwealth education or training payment is defined in section 52-145 of the ITAA 1997.

    Payments of these kinds may be exempt under item 2.1B of section 51-10, or Subdivision 52-E or 52-F of the ITAA 1997.

    Payments for employment or wholly or principally for labour

    To be exempt, the payment must not be subject to either of the following conditions listed in section 51-35:

    1. a payment by an entity or authority on the condition that the student will (or will if required) become, or continue to be, an employee of the entity or authority; or
    2. a payment by an entity or authority on the condition that the student will (or will if required) enter into, or continue to be a party to, a contract with the entity or authority that is wholly or principally for the labour of the student.

    These words were inserted as former subparagraphs 23(z)(i) and (ia) of the ITAA 1936 at the time when subparagraph 23(z)(i) was repealed. Note that the repeal of subparagraph 23(z)(i) also introduced former subparagraph 23(z)(ib) which has since become paragraph 51-35(e) of the ITAA 1997 – discussed further in this paper.

    The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 1) 1997 which introduced former subparagraphs 23(z)(i), (ia) and (ib) of the ITAA 1936 said “This does not change the tax treatment of any payments that are presently exempt under (paragraphs 23(z) and 23(zaa)).”

    In 1999 paragraph 23(z) of the ITAA 1936 was replaced by section 51-35 of the ITAA 1997. The Explanatory Memorandum to the Taxation Laws Amendment Bill 1999, which introduced this section, stated that the rewritten provisions “restate the effect of the ITAA 1936.”

    We consider the court decisions regarding these former provisions to be relevant to the application of the current legislation. For clarity, some scholarships that may have been excluded from the exemption under the former subparagraph 23(z)(i), that is, before it was repealed and subparagraphs 23(z)(i), (ia) and (ib) introduced, may be relevant to the application of paragraphs 51-35(c) and (d) of the ITAA 1997 as well as paragraph 51-35(e) – discussed further in this paper.

    We propose the following in respect of applying paragraphs 51-35(c) and (d):

    • Payments received by a student "on the condition" that they will (or will if required) become, or continue to be, an employee of the payer or enter into, or continue to be, a party to a contract for labour with the payer are excluded from the exemption. Whether such a condition exists is determined at the time the scholarship is granted.
    • We intend to interpret the word “condition” broadly to include any form of stipulation, contingency, or requirement.
    • There does not need to be a contract or legal relationship between the scholarship provider and the recipient. Where the granting of the scholarship is in anyway conditional upon the student working with the provider, even expectation of an employment or contract for labour relationship, then the scholarship will not be exempt [see FCT v. Ranson [1989] FCA 491, (1989) 25 FCR 57; (1989) 90 ALR 533; 89 ATC 5322; (1989) 20 ATR 1652].
    • The scholarship will not be exempt if the recipient performs any employee or contract for labour services as a condition of the granting of the scholarship. This extends to research conducted for or on behalf of the scholarship provider, even where the recipient is undertaking a research scholarship, if the granting of the scholarship is conditional on such services performed [see FCT v. Hall 75 ATC 4156].
    • We consider the words “will (or will if required)” to include the rendering of employee or contract for labour services immediately or at some appointed time in the future, or the continuation, where the recipient is already rendering such services. “If required” demands that the services will be provided if the person or authority so requires [see Polla-Mounter v. FCT (1996) 34 ATR 447; 96 ATC 5249].
    • We consider a contract “wholly or principally for the labour of the student” has the same scope as that in subsection 12(3) of the Superannuation Guarantee (Administration) Act 1992. This provides that “If a person works under a contract that is wholly or principally for the labour of the person, the person is an employee of the other party to the contract.”
    • The exception to the exemption would apply where a student is bonded to serve his or her benefactor at the time of receiving payments or in the future, whether the bond is to the government (e.g. in the case of teacher trainees paid by the government) or to a private employer who has provided the funds to the former student/ their future employee.
    • The mere fact that a scholarship recipient has to lodge an annual progress report to the provider does not, by itself, constitute a requirement to render services and will not result in a loss of the exemption. On this basis, we previously found payments under National Health and Medical Research Council (NHMRC) scholarships would generally be exempt, but NHMRC fellowships would not (see Taxation Ruling IT 2581).
    • It is the nature of the relationship between relevant parties that is important and not simply the payer and payee. If the school, college or university is an agent or trustee of the scholarship funder (provider), it is the relationship between the scholarship provider and recipient that is relevant. In such cases the exemption will not apply where the recipient is (or will become) an employee, or has (or will enter into) a contract for labour with the actual scholarship provider [see Case D72 72 ATC 422 for an example of agency].

    Payments not principally for educational purposes

    Paragraph 51-35(e) specifies the following is not exempt under section 51-10:

    1. a payment under a scholarship where the scholarship is not provided principally for educational purposes;

    These words were inserted as former subparagraph 23(z)(ib) of the ITAA 1936 at the time when subparagraph 23(z)(i) was repealed. Recall that the repeal of subparagraph 23(z)(i) also introduced former subparagraphs 23(z)(i) and (ia) which have since become paragraphs 51-35(c) and (d) of the ITAA 1997 – these were discussed previously in this paper.

    The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 1) 1997 which introduced former subparagraphs 23(z)(i), (ia), and (ib) of the ITAA 1936 said that the purpose of the amending bill was solely to replace current references to specific Commonwealth education or training programmes in the Pay As You Earn, rebate and exemption provisions in the ITAA 1936 with a generic term. It added that “This does not change the tax treatment of any payments that are presently exempt under (paragraphs 23(z) and 23(zaa)).”

    In 1999 paragraph 23(z) of the ITAA 1936 was replaced by section 51-35 of the ITAA 1997. The Explanatory Memorandum to the Taxation Laws Amendment Bill 1999, which introduced this section, stated that the rewritten provisions “restate the effect of the ITAA 1936.”

    Again, we consider the court decisions regarding these former provisions to be relevant to the application of the current legislation. Because of the split into three provisions in 1997 when subparagraph 23(z)(i) of the ITAA 1936 was repealed and former subparagraphs 23(z)(i), (ia) and (ib) introduced, much of the case law crosses over the application of paragraphs 51-35(c), (d), and (e) of the ITAA 1997.

    We consider the introduction of the words in 1997 that have become known as paragraph 51-35(e) demonstrates an intent to further restrict the circumstances of exemption, in comparison to the former provision.

    Consequently, and due to the evolution of scholarship arrangements, we now consider it is likely that a range of contemporary or recently offered scholarships would not be exempt because of paragraph 51-35(e) of the ITAA 1997. This is because the scholarships are “not provided principally for educational purposes.”

    We make the following observations as grounds for discussion and comment:

    • To be exempt from income tax, the law specifies that it must be provided principally for educational purposes. This means there can be collateral advantages [as was the case in Hall] so long as the primary purpose is for educational purposes. It is not enough that an educational purpose is a by-product or incidental purpose of the scholarship.
    • To be educational they must provide for the giving or imparting of instruction [see Chesterman v. FCT [1923] HCA 241; (1923) 32 CLR 362 (at 385-6)].
    • It is the purpose of the ‘provider’ of the relevant payment, and not the student, that is paramount [see Hall at 4263].
    • We intend to specify that the ‘provider’ is not necessarily the payer. Where a party other than an educational institution ‘funds’ the scholarship and the student’s activities have some relationship or connection to that party providing the funds, such as working with or for the provider, or working towards outcomes potentially beneficial to the provider, the ‘funder’ can be the provider for the purposes of applying paragraph (e) and analysing the ‘purpose’ of that party, rather than the payer [see Hall and Polla-Mounter].
    • The ‘provider’ is determined from factors that include the terms and conditions of the scholarship, the source and control of the funds and the identity and activities of the scholarship recipient.
    • Because paragraph (e) is based on a different test of providing a scholarship for a particular ‘purpose’, the focus on ‘purpose of the provider’ seemingly allows an examination of relevant ‘benefits’ obtained by the provider to inform purpose. It is considered that a relevant principal purpose other than an educational one can arise where there is an obtaining of outcomes for the provider from scholarship recipient activities that benefit, or can benefit, the provider in the same way an employee or contractor working for the provider would.
    • An appropriate test for the provision of commercial activities where the party has funded the scholarship is one of equivalence of output to the funder. That is, if the recipient’s activities produce an output equivalent to what a similarly experienced employee or contractor would produce, then the principle purpose is considered to be something other than the provision of education. This would be the case in some industry placement scholarships. In this context, the extent of input, control over scholarship participant roles and activities is relevant.
    • Similarly, where a the funding of research by way of scholarship enables commercially useful outcomes to a funder that could simply have been undertaken by a contractor undertaking the same research for remuneration, the matching of the hypothetical output with the scholarship outcome can suggest that from the funder’s point of view that they have simply spent money in an indirect way to obtain commercial research outcomes.
    • A ‘principal purpose’ need not involve commercial benefits. For example in a government program for a bonded scholarship, the fact that there is an intended work outcome such as geographical placement, means that the principal purpose of the provider of the scholarship is not one (principally) of providing education. Rather the principal purpose is one of ensuring that certain activities are provided in a particular area by the former student, consistent with the main purpose of the government, being its policy intent, and not providing education to a particular student or students.
    • Allowances paid to research workers are indistinguishable in nature from salaries and are not scholarships [see Case 63 (1965) 12 CTBR(NS) 63].
    • Payments received in the capacity of an employee [see Case J58 77 ATC 499] or company executive [see Case N28 81 ATC 154], rather than as a student, will not qualify.

    Education entry payment

    Subparagraph 51-35(f) specifies the following is not exempt under section 51-10:

    1. an education entry payment under Part 2.13A of the Social Security Act 1991.

    It is our understanding that education entry payments paid pursuant to the Social Security Act 1991 are paid to assist recipients with the up-front costs of education and training. This might include the costs of enrolling in a course to develop their skills, obtain a qualification or to improve their employment prospects. Notwithstanding the policy intent of the education entry payment, the recipient has absolute discretion as to how they spend the money.

    We propose that these payments are intended to be taxable.

    References

    ATOlaw topic(s)

    Income tax – assessable income – other types of income – scholarships

    Income tax – exempt income – scholarships

    Legislative references

    paragraph 23(z) of the ITAA 1936

    paragraph 23(z)(i) of the ITAA 1936

    paragraph 23(z)(ia) of the ITAA 1936

    paragraph 23(z)(ib) of the ITAA 1936

    paragraph 23(zaa) of the ITAA 1936

    item 2.1A in section 51-10 of the ITAA 1997

    item 2.1B of section 51-10 of the ITAA 1997

    paragraph 51-35(a) of the ITAA 1997

    paragraph 51-35(b) of the ITAA 1997

    paragraph 51-35(c) of the ITAA 1997

    paragraph 51-35(d) of the ITAA 1997

    paragraph 51-35(e) of the ITAA 1997

    section 51-1 of the ITAA 1997

    section 51-10 of the ITAA 1997

    section 51-35 of the ITAA 1997

    section 52-145 of the ITAA 1997

    subdivision 52-E of the ITAA 1997

    subdivision 52-F of the ITAA 1997

    subsection 12(3) of the Superannuation Guarantee (Administration) Act 1992

    part 2.13A of the Social Security Act 1991

    Case references

    Case 63 (1965) 12 CTBR(NS) 63

    Case D72 72 ATC 422

    Case J58 77 ATC 499

    Case N28 81 ATC 154

    Chesterman v. FCT [1923] HCA 241; (1923) 32 CLR 362 (at 385-6)

    FCT v. Hall (1975) 6 ALR 457; 75 ATC 4156; (1975) 5 ATR 450

    FCT v. Ranson [1989] FCA 491, (1989) 25 FCR 57; (1989) 90 ALR 533; 89 ATC 5322; (1989) 20 ATR 1652

    Polla-Mounter v. FCT (1996) 34 ATR 447; 96 ATC 5249

    Re Leitch (deceased) [1965] VR 204

    Other references

    Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 1) 1997

    Explanatory Memorandum to the Taxation Laws Amendment Bill 1999

    IT 2581 Income Tax: The rendering of services by a scholarship holder

    scholarship tool Is my scholarship taxable?

    ATO references

     

    Last modified: 30 Jan 2017QC 51051