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Ruling

Subject: Government payment

Will government funding paid in relation to the construction of a new facility to a sole purpose rental entity, which is leased to another entity for the purpose of operating a business, be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

No.

Question 2

Will government funding paid in relation to the construction of a new facility to a sole purpose rental entity, which will be leased to another entity for the purposes of operating a business, be assessable under section 15-10 of the ITAA 1997?

Advice/Answers

No.

Question 3

Will government funding paid in relation to the construction of a new facility to a sole purpose rental entity, which will be leased to another entity for the purposes of operating a business, be assessable under the capital gains tax provisions of the ITAA 1997?

Advice/Answers

No. However please see Reasons for Decision as to other consequences of the grant.

This ruling applies for the following periods:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

A company in its own capacity and in its capacity as trustee for a trust (property owner) entered into a Funding Agreement with the Commonwealth to construct a new facility to allow expansion of the existing business and to provide scope for new product development.

The new facility will enable the company to increase production of existing products and services and introduce new products and services.

The property is owned by the property owner. The facility is leased to the company (business operator), from which it operates a business.

The total consideration construction cost of the building was budgeted to be $X. Under the Agreement, a total payment of 50% of $X (excluding GST) was payable to the property owner in instalments. The property owner was required to contribute the balance.

In accordance with the agreement, a budget was provided:

The Funding Agreement provides that the recipient of the payment is the company in its own capacity and as trustee for the trust.

The company in its own capacity (rather than its capacity as a trustee of the trust) was also named a recipient under the Funding Agreement because it was a requirement of the Funding Agreement that the facility constructed with the grant be used to develop the economy of the area where the company carries on its business.

A clause of the Funding Agreement states:

Subject to any other provision of this agreement, the Recipient will carry on and maintain its business in (a certain location) for the Agreement Period and will not, except with the prior written consent of the Commonwealth, relocate all or any part of its business out of (a certain location) during the Agreement Period.

A further clause of the Funding Agreement sets out what the grant cannot be used for. It states:

The recipient must not spend the funds on:

(a) ongoing, routine business costs (e.g. administrative, operational and maintenance costs) including employee salaries and wages…

Construction and fit-out of the building was completed in the relevant year.

All funding was received during the relevant year.

The business operator commenced operations in the building in the relevant year.

The grant was received in the bank account of the property owner, that is, the trust. All recipient contributions were paid by the property owner and any depreciation or capital write off claims will be made by the property owner. The property owner was also the entity that took out and maintained the appropriate insurance policy as required by the Funding Agreement.

The property owner is the legal owner of the facility and its only activity is to act as lessor in relation to this property. There are no other tenants in the building and the property owner does not own or intend to acquire any other properties.

Relevant legislative provisions

Section 6-1 of the ITAA 1997

Section 6-5 of the ITAA 1997

Section 6-10 of the ITAA 1997

Section 10-5 of the ITAA 1997

Section 15-10 of the ITAA 1997

Subdivision 20-A of the ITAA 1997

Division 40 of the ITAA 1997

Section 118-20 of the ITAA 1997

Section 118-37 of the ITAA 1997

Reasons for decision

Question 1

Section 6-1 of the ITAA 1997 provides that a taxpayer's assessable income includes ordinary income and statutory income.

Ordinary income, pursuant to section 6-5 of the ITAA 1997, is income according to ordinary concepts.

The courts have identified a number of factors which indicate whether an amount has the character of income. A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity. However these characteristics are not always essential as in some circumstances proceeds from an isolated transaction received as a lump sum may also be income.

In your situation, the payments received are a one-off payment (albeit paid in four instalments as certain milestones are met).

In G P International Pipecoaters Pty Ltd v FC of T (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court commented on the characterisation of a payment that was intended to assist the recipient with capital costs, saying that such receipts would be capital in nature and therefore not ordinary income.

It is concluded that the payments received are not ordinary income in accordance with section 6-5 of the ITAA 1997.

Question 2

Statutory income, pursuant to section 6-10 of the ITAA 1997, is amounts that are not ordinary income but are included in assessable income by other provisions. Many of these provisions are listed in section 10-5 of the ITAA 1997. Relevantly, bounties or subsidies may be included in assessable income under section 15-10 of the ITAA 1997.

Section 15-10 of the ITAA 1997 provides that assessable income includes a bounty or subsidy that:

(a) you receive in relation to carrying on a business; and

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

A bounty or subsidy includes a grant and other financial assistance provided by Government to assist businesses (The Squatting Investment Co v FC of T (1953) 86 CLR 570; (1953) 10 ATD 126; (1953) 5 AITR 496).

In your situation, the grant is a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997.

As discussed in Question 1 above, the grant is not assessable as ordinary income under section 6-5 of the ITAA 1997.

In this case, the Commissioner is satisfied that the company as trustee for the trust is the recipient of the grant because it received all the funding from the grant into its bank account. In addition, it:

· is the owner of the property to which the improvements were made, and

· undertook all the financial obligations in respect to the recipient contributions including payment of the balance of construction costs; and

· took out and maintained insurance as required under the Funding Agreement; and

· intends to claim deductions for Capital Allowances and Capital Works in relation to the property.

The remaining issue is whether the grant was received in relation to the carrying on of a business.

Taxation Ruling TR 2006/3 provides the Commissioner's view on government payments which are paid to assist entities to continue, commence, or cease business. It is the Commissioner's view that 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 to' includes within its scope payments that have a direct or indirect connection to the business (paragraph 100 of TR 2006/3).

In this situation, the entire grant was used by the property owner to construct the facility and to install plant and equipment in the facility. The property owner is the legal owner of the facility and its only activity is to act as lessor in relation to this property. There are no other tenants in the building and the property owner does not own or intend to acquire any other properties.

Taxation Ruling TR 97/11 provides the Commissioner's view on what constitutes 'the carrying on of a business'. With reference to the indicators provided in paragraph 13 of TR 97/11, the derivation of rental income from a single source does not generally constitute the receipt of business income. The Commissioner is satisfied that the property owner's activity of leasing the facility to the business operator is not the carrying on of a business.

Notwithstanding the operation of a business from the facility by the business operator, the Commissioner is satisfied that the requisite connection between the receipt of the grant by the property owner and the carrying on of a business does not exist.

Therefore, although the grant is a bounty or subsidy received by the trustee, it is not assessable income as it was not received in relation to carrying on of a business.

Question 3

Paragraph 118-37(2)(a) of the ITAA 1997 provides that a capital gain or capital loss is 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 under an enactment of an instrument of a legislative character.

In relation to this, the Revised Explanatory Memorandum 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.

The grant meets these requirements and therefore the payment of the grant will not give rise to a capital gain.

However, there are capital gain consequences when the property is eventually disposed of.

Paragraph 6 of TR 2006/3 provides that if the payment recoups expenditure forming one of the elements of the cost base, the cost base is taken never to have included the original expenditure, thus potentially increasing a future capital gain or decreasing a future capital loss.

Assessable Recoupment

Section 118-20 applies to reduce any capital gain arising because of the receipt of a government payment to the extent that the payment also represents assessable income under any other provision of the income tax law.

To the extent that the grant is received to fund the cost of depreciating assets, it is an assessable recoupment under subdivision 20-A of the ITAA 1997 if the requirements of that subdivision are satisfied.

If the cost of a depreciating asset is deductible under Division 40 of the ITAA 1997 over two or more income years, section 20-40 applies so that the total 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 other income years to the extent that further amounts are deductible under Division 40 of the ITAA 1994.

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