Edited version of private ruling

Authorisation Number: 1011830701628

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Ruling

Subject: Exceptional Circumstances Exit Grant

Question 1

Is the Exceptional Circumstances Exit Grant (ECEG) assessed as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No.

Question 2

Is the ECEG assessed as a bounty or subsidy under section 15-10 of the ITAA 1997?

Answer: No.

Question 3

Does a D1 capital gains tax (CGT) event under section 104-35 of the ITAA 1997 happen in relation to the restrictive covenant upon receipt of the ECEG?

Answer: Yes.

Question 4

For the purposes of section 152-12 of the ITAA 1997 and the basic conditions for accessing the small business CGT relief provisions, was the right created in relation to the restrictive covenant 'inherently connected' with your interest in the goodwill of the partnership business?

Answer: Yes, provided the goodwill satisfied the active asset meaning and test.

This ruling applies for the following period:

Year ended 30 June 2010

Relevant facts and circumstances

The ECEG is an Australian Government package that is administered on the government's behalf by Centrelink. It is payable to farmers who's farm enterprise is located in an Exceptional Circumstances drought declared area and, having met certain eligibility criteria, sell their farm and undertake not to become an owner or operator of a farming enterprise again within a period of five years. The Exit Grant is for an amount of up to $150,000, subject to an assets test.

In the year ended 30 June 2010 you applied for and received a payment under this scheme and sold the farm which was a pre CGT asset.

The farm was operated in partnership.

You could not apply for the grant until the contract for sale of the property had been signed.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 6-5

Income Tax Assessment Act 1997, subsection 6-5(1)

Income Tax Assessment Act 1997, section 15-10

Income Tax Assessment Act 1997, section 104-10

Income Tax Assessment Act 1997, section 104-35

Income Tax Assessment Act 1997, subsection 104-35(2)

Income Tax Assessment Act 1997, section 108-5

Income Tax Assessment Act 1997, subsection 115-25(3)

Income Tax Assessment Act 1997, section 152-10

Income Tax Assessment Act 1997, paragraph 152-10(1)(a)

Income Tax Assessment Act 1997, paragraph 152-10(1)(d)

Income Tax Assessment Act 1997, section 152-12

Income Tax Assessment Act 1997, section 152-35

Income Tax Assessment Act 1997, paragraph 152-40

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Note: Unless otherwise stated, all subsequent legislative references are to the ITAA 1997.

Question 1

Subsection 6-5(1) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of ordinary income in income tax legislation, it is necessary to apply principles developed by the courts to the facts of a particular case.

In accordance with Taxation Ruling TR 2006/3, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

A generally decisive consideration is whether the payment is the product in a real sense of any employment, services or business carried on by the recipient. A payment that is provided for a purpose which is not part of the recipients business will not constitute ordinary income.

Application to your circumstance

The receipt of your ECEG is neither a normal incident of your business nor provided in relation to the purpose for which your business was carried on. The receipt was derived subsequent to you having made a commitment to sell your business and associated property, and paid because you agreed not to carry on a business of primary production within five years of the payment date.

A compensation receipt generally takes the character of the item it replaces. Accordingly, because an amount received subsequent to the disposal of your primary production business and property and in relation to the imposition of a restrictive covenant would be capital in nature, so to is the compensation amount paid to you.

It follows that the ECEG does not constitute ordinary assessable income under section 6-5.

Question 2

Section 15-10 provides that an amount is included in assessable income if it is a bounty or subsidy received in relation to carrying on a business which is not already caught as ordinary income under section 6-5.

The terms bounty and subsidy are not defined in income tax legislation. The ordinary meaning adopted by case law is an aid provided by the Crown (government) to foster or further some undertaking or industry. It is now well accepted that a subsidy or bounty includes a financial grant made by a government.

In accordance with TR 2006/3, a bounty or subsidy will be in relation to carrying on a business when there is a real connection between the payment and the business. The term 'in relation' includes within its scope payments that have a direct or indirect connection to the business. However, a bounty or subsidy must be related to carrying on the business not merely for commencing or ceasing a business.

Therefore, Government payments to industry received by an entity as assistance either to cease a business or give or sell part of the profit yielding structure of the business are not in relation to the carrying on of the business.

Application to your circumstance

The receipt of your ECEG is neither a normal incident of your business nor provided in relation to the purpose for which your business was carried on. The receipt was received subsequent to you having committed to the sale of your business and associated property and paid in relation to a restrictive covenant in which you are precluded from owning or operating a farming business again for a period of five years.

Therefore, the ECEG is not a bounty or subsidy in relation to the carrying on of a business for the purposes of section 15-10. Accordingly, no part of the total receipts constitutes assessable income under section 15-10.

Questions 3

CGT event A1 happens under section 104-10 if you dispose of a CGT asset by affecting a change of ownership from you to another entity, whether because of some act or event or by operation of law.'

CGT event D1 happens under section 104-35 when a contractual or other legal or equitable right is created in favour of another entity.

The Commonwealth is an entity for the purpose of CGT event D1.

Application to your circumstance

An A1 CGT event happened when the partnership farm was sold which was prior to your having lodged the application for the ECEG. The facts of your case do not support the conclusion that another A1 CGT event happened in relation to the receipt of the ECEG.

A contractual right was created when you entered into an agreement with the Commonwealth to abide by the condition of a restrictive covenant which precludes you from owning or operating an agricultural enterprise for at least five years.

Whilst the disposal of your farm satisfied a qualification requirement in relation to your eligibility to apply for the ECEG, it remains that the funding was paid in relation to the right (restrictive covenant) which is a separate CGT asset which was created upon the signing of the agreement. It follows that the appropriate CGT event is D1.

Under subsection 104-35(2) you will make a capital gain if the capital proceeds from creating the restrictive covenant are more than the incidental costs you incurred in relation to it. You will make a capital loss if the capital proceeds are less than the incidental costs you incurred in relation to it.

Question 4

The basic conditions for relief under Division 152 are contained in section 152-10. Paragraph 152-10(1)(d) outlines the requirement that the active asset test under section 152-35 must be met. However, the ITAA 1997 provides an exception for CGT event D1 in that section 152-12 applies in place of both paragraphs 152-10(1)(a) and 152-10(1)(d).

Subsection 152-12(2) provides the 'basic condition that the right you create that triggers the CGT event must be inherently connected with a CGT asset of yours that satisfies the active asset test.'

Application to your circumstance

In your case, we consider that the right created in relation to the restrictive covenant which triggered the D1 CGT event will be 'inherently connected' to the goodwill attributable to your interest in the partnership business (provided of course that the goodwill satisfies the active asset meaning and test as required in terms of sections 152-40 and 152-35 respectively).

That is, if the goodwill was an active asset the requirements under section 152-12 will have been satisfied.

Providing the remaining basic conditions in Subdivision 152-A are met the small business 50% active asset reduction in Subdivision 152-C will apply to any capital gain derived in relation to the restrictive covenant and the receipt of the ECEG.

Further issues for you to consider

CGT discount

A capital gain from a CGT event D1 is not a discount capital gain in accordance with subsection 115-25(3).

Other basic (& specific) conditions for relief

Note, providing the other basic conditions in Subdivision 152-A are met a capital gain may be reduced or deferred if you satisfy the requirements of the other small business CGT concessions available under Division 152. The concessions available are:

Small business 15 year exemption (Subdivision 152-B)

Small business retirement exemption (Subdivision 152-D)

Small business roll-over (Subdivision 152-E)

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