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Ruling

Subject: Assessability of a government grant

Question 1

Will government funding paid to a Unit Trust for the construction of a new training facility which will be leased to a related entity for the purpose of operating the business be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will government funding paid to the Unit Trust for the construction of a new training facility which will be leased to a related entity for the purpose of operating the business be assessable under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Will government funding paid to the Unit Trust for the construction of a new training facility which will be leased to a related entity for the purpose of operating the business be assessable under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer

No.

Question 4

Will government funding paid to the Unit Trust for the construction of a new training facility which will be leased to another entity for the purpose of operating the business be assessable under Subdivision 20-A of the ITAA 1997?

Answer

No, provided the funding is not expended on and deductions are not claimed in respect of any of the items listed in the table in section 20-30.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Relevant facts and circumstances

The Rulee applied for government funding in respect of the grant.

The funding Application and Program Guidelines forms part of the facts of this ruling. In part, it provides the following:

· As part of a Federal Budget the Australian Government announced the establishment of the Program. The Program has been designed to improve access to funding for infrastructure.

· The Program directs funding to the provision of essential infrastructure (capital works and equipment).

· The Program aims to improve access to services by providing funding to specified communities to establish new, or enhance existing facilities and to improve the resources available.

· A maximum of $X is available under the Program for eligible applicants seeking to provide services in specified communities.

· With regard to the $X grant the Guidelines state that this stream of funding is to be directed at capital works and/or refurbishments. This may consist of the acquisition or establishment of new buildings and/or fit-out or renovations of existing buildings. It may also consist of refurbishment of private premises to establish training facilities.

· Funding cannot contribute towards:

o projects in non-specified regions;

o state government facilities and entities;

o specialists;

o student accommodation;

o transport;

o research activity;

o support services;

o salaries, professionals, project officers, or management and administrative staff who are undertaking normal duties;

o strategic service planning;

o conference attendance;

o consumables;

o rental costs for residential accommodation. However, consideration may be given to projects that incorporate self-contained flats to provide short-term accommodation;

o recurrent costs, ongoing building and equipment maintenance and repair, rent/lease payments, annual licensing fees, insurance and state and local government statutory charges such as rates (exceptions may be made on a case by case basis e.g. in the short-term for the establishment of a new service); and/or

o retrospective costs, i.e. expenses incurred before contractual arrangements with the Commonwealth are completed, or for projects already completed.

· Unless prior approval from the Commonwealth is sought the property must not be sold for Y years following the release of the funds. If approval is given the purpose of the building must be retained until the Y year expiry.

The Program Funding Agreement (the Agreement) between the Commonwealth of Australia and the Rulee also forms part of the facts of this ruling. In part, it provides the following:

· unless the Rulee has obtained prior approval from the Commonwealth it must use or ensure that assets are used only for performance of this Agreement and for the intended purpose for that asset during the retention period for that asset.

· unless the Rulee first obtains written consent from the Commonwealth the Rulee agrees to use the capital works or ensure that the capital works are used for the intended purpose during the retention period.

· the Rulee must construct a 'new … facility' on the existing site that will provide extensive training facilities and resources. As a result of the funding the Rulee must be able to show that it has contributed towards additional and /or broader range of services, assisted with training, and increased access to and the ability to recruit and retain workers.

· that $X must be expended on the construction of the dedicated training component of the facility.

· the funding was to be received in the years ended 30 June 2011 and 2012 in three separate instalments.

In relation to the Rulee's circumstances with regard to this arrangement you have provided the following information in your Application and during subsequent telephone conversations and emails:

· The Applicant - The Rulee is a unit trust whose only role is to act as lessor with regard to the premises from which a related entity is conducting a business.

· The Funding - The funding was received for the purpose of undertaking capital works in relation to the training component of the new facility. None of the moneys were to be expended on plant or equipment.

· The Project - The Rulee will use the funding to build a training facility which will be incorporated into new premises which is also funded separately by the Rulee. The project will be undertaken in accordance with the Program Guidelines and the Agreement.

· The Previous Property - The pre-existing facility has been completely demolished and replaced by a new building.

· The New Facility - This consists of rooms in which to carry out pre-existing business. However, it also provides an additional dedicated area for training individuals on government training programs. The training facility comprises four rooms dedicated to teaching, a video conferencing/meeting room and a resource room containing a library, computers for electronic access to the university and electronic libraries and simulation equipment. You state that the funding was made specifically for the provision of building infrastructure for the training component.

· The Business - The Rulee was not involved in the previous business, nor will it be involved in the running of the business post construction. A separate related entity ran the previous business and will continue to run the business out of the new facility in accordance with the requirements under the Program Guidelines and the Agreement.

· Lease Arrangement - As lessor of the new facility the Rulee will have just one lease in place with the operator of the business.

· Other Activities - Other than in its capacity as lessor of the property that is the subject of this ruling the Rulee is not involved in any other income earning activities.

Relevant legislative provisions

Income Tax Assessment Act 1997, Section 6-5
Income Tax Assessment Act 1997, Section 6-10
Income Tax Assessment Act 1997, Section 10-5
Income Tax Assessment Act 1997, Section 15-10
Income Tax Assessment Act 1997, Subsection 20-20(3)
Income Tax Assessment Act 1997, Section 20-40
Income Tax Assessment Act 1997, Division 43
Income Tax Assessment Act 1997, Section 104-25
Income Tax Assessment Act 1997, Paragraph 118-37(2)(a)
Income Tax Assessment Act 1997, Subsection 110-45(3)

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 pertain to the ITAA 1997.

Question 1

A payment or other benefit received by a taxpayer is included in assessable income if:

· It is income according to ordinary concepts in terms of section 6-5, or

· If not ordinary income it may be included in your assessable income because it is caught under the general 'statutory income' provisions in section 6-10, as listed in section 10-5. Included in the list in section 10-5 are bounties and subsidies (section 15-10).

Ordinary Income

Section 6-5 states, in part, the following:

6-5(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

6-5(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The intent of section 6-5 is to include in assessable income those receipts which can be categorised as income according to ordinary concepts.

Although the expression 'income according to ordinary concepts' is not defined in the ITAA 1997, there is a substantial body of case law from which a number of factors have been drawn to determine whether an amount has the character of income according to ordinary concepts.

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity, even if the receipts are not directly attributable to services rendered. This view is supported by ATO Interpretative Decision report, ATO ID 2003/902 which cited the same reasoning in finding that a government grant paid in two instalments to a medical practitioner was not assessable under section 6-5.

ATO policy concerning government payments to industry (GPI) is set out in Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business. At paragraph 84, it provides that ordinary income generally falls within three categories:

· Income from providing personal services,

· Income from property, or

· Income from carrying on a business.

Application to your circumstances

The government grant does not constitute ordinary income.

Whilst it will be paid in separate instalments it does not possess the necessary elements of periodicity, recurrence or regularity that are common to receipts of ordinary income.

Further, in terms of TR 2006/3 it does not constitute income from the provision of personal services, is not sourced from property, and has not been derived directly from any existing business activity.

Question 2

Statutory Income - a Bounty or Subsidy

Under section 6-10 some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law. These amounts are 'statutory income'. . Subsection 6-10(1) refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5.

One of the statutory income provisions listed in section 10-5 is section 15-10, which deals with the treatment of bounties and subsidies.

Section 15-10 provides that 'assessable income includes a bounty or subsidy that:

(a) is received in relation to carrying on a business; and

(b) is not assessable as ordinary income under section 6-5.'

In relation to carrying on a business

In determining the correct treatment of the payment it needs to be considered whether the bounty or subsidy has been received 'in relation to carrying on a business.'

Taxation Ruling TR 97/11 provides the Commissioner's views on what constitutes 'the carrying on of a business'. At paragraph 13 he outlines the following indicators:

· whether the activity has a significant commercial purpose or character...

· whether the taxpayer has more than just an intention to engage in business...

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity...

· whether there is repetition and regularity of the activity...

· whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business...

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit...

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit...

· the size, scale and permanency of the activity..., and

· whether the activity is better described as a hobby, a form of recreation or a sporting activity...

In considering these indicators against the facts of each case the Commissioner recognises that no one indicator is conclusive. The determination of the question is generally the result of a process of weighing all the relevant indicators.

'In relation to

A grant '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 to" includes within its scope payments that have a direct or indirect connection to the business…' (Paragraph 100 of TR 2006/3)

In the Full Federal Court decision in First Provincial Building Society Ltd v. FC of T (1995) 128 ALR 118; (1995) 95 ATC 4145; (1995) 30 ATR 207; (1995) 56 FCR 320 (First Provincial), Hill J was discussing the antecedent of section 15-10, that is, paragraph 26(g) of the Income Tax Assessment Act 1936 (ITAA 1936). He stated that it is important to note that the former provision contained the words ' received in or in relation to carrying on of a business ... (emphasis added).' When the provision was incorporated into the ITAA 1997, it was rewritten as a bounty or subsidy 'you receive in relation to carrying on of a business.'

In First Provincial, Hill J specifically discussed the relationship between the terms 'received in relation to' and 'received in'. He concluded that the scope of the term 'received in relation to' was sufficiently broad enough to also cover the meaning of the narrower 'received in' which implied a more direct connection.

'Carrying on a business' or 'commencement'

The First Provincial case demonstrates that the scope of the phrase 'in relation to carrying on a business' in section 15-10 is to be interpreted widely. Payments made towards the restructuring of business operations with a view to improving overall efficiency are generally considered to be 'in relation to carrying on a business'. (Paragraph 102 of TR 2006/3)

'Some business restructures may not be in relation to carrying on a business, for example if a business changes its structure to facilitate a new activity …' (emphasis added). This is decided on the merits of each case. (Paragraph 102 of TR 2006/3)

To be assessable under section 15-10 the subsidy must relate to the 'carrying on' of the business, not merely to the commencement or cessation of it. the First Provincial case illustrates that the expression 'carrying on of the business' is limited to the activities of the business which are directed towards the gaining or producing of assessable income rather than merely to the business itself. (Paragraph 101 of TR 2006/3)

Government payments 'to commence or cease business' as opposed to 'in relation to carrying on a business' are not considered to be assessable as ordinary income under section 6-5 or as a bounty or subsidy under section 15-10.' (Paragraphs 103 and 128 of TR 2006/3.)

Application to your circumstances

The government grant does not constitute an assessable bounty or subsidy.

To be considered assessable under section 15-10 the receipt must be in relation to the carrying on of a business.

o The Rulee applied for the government funding and then constructed the new facility. The Rulee will own the land and buildings, however it will not be operating the business. This will be conducted by a related entity.

o The Rulee's only activity will be to act in the capacity of lessor in relation to the facility and to derive a single periodical rental payment from the entity that will be operating the business.

o The Rulee will not own any other rental properties and therefore is not considered to be conducting a business in this regard. Further, it will not be involved in any other income earning activities outside of the leasing of the facility.

With regard to the use of the funding, we find that it is not used in relation to:

· increasing the efficiency of an existing business

· the actual carrying on of the business activity

· the carrying on of a rental property business, or

· any other type of business activity.

Taking into account the indicators in TR 97/11, as the extent of your activities as a lessor align more readily with the type of activities generally undertaken by an investor it is clear that you are not carrying on a business in this regard.

As you are not carrying on this business or a business of leasing properties any receipts in relation to the funding are on capital account and are not assessed under section 15-10 as bounties or subsidies.

Question 3

Capital gains tax provisions

Section 104-25 deals with cancellation, surrender and similar endings to CGT assets, a CGT event C2. A C2 event occurs when the ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. This would occur when a taxpayer's rights under an agreement come to an end - generally at the time the taxpayer's obligations have been discharged and the taxpayer receives payment.

A capital gain occurs if the capital proceeds from the ending of the rights are more than the asset's cost base.

CGT exemption under paragraph 118-37(2)(a)

Paragraph 118-37(2)(a) provides, in part, that a capital gain may be disregarded if you make it as a result of receiving a payment as reimbursement or payment of your expenses under a scheme established by an Australian government agency or local governing body.

In relation to this paragraph, the Revised Explanatory Memorandum (EM) in relation to the Tax Laws Amendment (2006 Measures No. 3) Act 2006 provides that the requirement that 'the scheme be established under an enactment or an instrument of a legislative character would be satisfied where the scheme is established that way either expressly or by necessary implication. An enactment would include an Appropriation Act (or equivalent) having regard to associated documentation such as budget papers. An instrument of a legislative character would include regulations (and similar instruments) and local government by-laws.'

Application to your circumstances

Under the Program the government created rights in the Rulee to receive payments upon the completion of several milestones as stated in the Agreement. These rights were satisfied under CGT event C2 when the government made the payments to the Rulee.

The Rulee will make a capital gain equal to the difference between the capital proceeds and the cost base of the rights.

CGT exemption under paragraph 118-37(2)(a)

The Introduction to the Program Guidelines states that the grant funding was announced by the Australian Government in the Federal Budget and that the Commonwealth administers the Program.

We find that the Program meets the requirements of paragraph 118-37(2)(a) as outlined in the revised EM and the grant complies because it is a payment received as reimbursement or payment of expenses incurred in relation to the Program.

Therefore, any capital gain made by the Rulee from the C2 CGT event will be disregarded under paragraph 118-37(2)(a).

Cost Base Reduction

Although there is no capital gain at the time, there are capital gain consequences when the property is eventually disposed of. To the extent that the grant is received to fund the cost of purchasing land and buildings or for constructing or renovating buildings, it is a recoupment of those costs. This recoupment reduces the cost base of the property as per subsection 110-45(3).

Question 4

To the extent that a government grant is received to fund the cost of depreciating assets or some other expense contained in section 20-30 it is an assessable recoupment under subsection 20-20(3).

If the cost of a depreciating asset is deductible under Division 40 over two or more income years, section 20-40 applies so that the total of assessable recoupments to be included in assessable income at a particular time is limited to the total amount of the loss or outgoing that can be or has been deducted at that time. Any part of an assessable recoupment that is not included in assessable income in the year of receipt because of this limit is assessable in later income years to the extent that further amounts are deductible under Division 40 for the depreciating asset in the later income years.

If the expenditure is in relation to Division 43 capital works only then the assessable recoupment provisions do not apply.

Application to your circumstances

You advise that the grant will be spent solely on Division 43 capital works.

For an amount to be considered an assessable recoupment subsection 20-20(3) requires that the expenditure be incurred and then a corresponding deduction be claimed under one of the provisions listed in the table provided under section 20-30.

As Division 43 is not listed in that table it follows that this particular government funding stream is not subject to the Subdivision 20-A assessable recoupment provisions.

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