Edited version of your private ruling

Authorisation Number: 1012462900389

Ruling

Subject: Government grant

Question 1

With regard to a government grant, did Trust X merely act as an agent for Trust Y with the latter being the actual beneficial recipient of the funding for taxation purposes?

Answer

Yes.

Question 2

Does the grant paid by the government via Trust X to Trust Y form part of the assessable income of Trust Y under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

Does the grant paid by the government via Trust X to Trust Y form part of the assessable income of Trust Y under section 15-10 of the ITAA 1997?

Answer

No.

Question 4

Does the grant paid by the government via Trust X to Trust Y form part of the assessable income of Trust Y under subdivision 20-A of the ITAA 1997?

Answer

Yes, in part, to the extent that the funding is expended on and deductions are claimed in respect of any of the items listed in the table in section 20-30 of the ITAA 1997.

Question 5

Does the grant paid by the government via Trust X to Trust Y form part of the assessable income of Trust Y under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

Trust Y owns buildings. It leases part of one building to Trust X. The rest are leased to unrelated entities. Trust Y conducts no other activities.

Trust X manages a business which operated from a building not owned by Trust X.

Trust X lodged an application for government funding to expand the business premises to include the area leased from Trust Y.

It was a requirement by the government authority that the funding be applied for in Trust X's name and the grant be paid to Trust X rather than Trust Y.

The refurbishment was funded by the grant paid in instalments and a contribution by Trust X.

The refurbishment resulted in additional rooms in which to carry out Trust X's business activities and additional depreciable assets.

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 20-25

Income Tax Assessment Act 1997 Section 20-40

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)

Reasons for decision

Question 1 - agency relationship

Under an 'agency agreement' an entity (the agent) may receive a payment from a third party on behalf of another entity (the principal). The relationship of the principal and the agent may arise from agreement or deed (express or implied), by the operation of law or retrospectively by the principal's ratification of the acts done by the agent.

The question of whether receipts or gains constitute assessable income in the hands of an agent need only be addressed by the agent if those receipts or gains are derived beneficially by that agent. Therefore, an agent who receives an amount which is required to be applied or dealt with on behalf of a principal entity, or as the principal directs, will not need to consider whether they have derived any assessable income. This question falls to the principal.

Application to your circumstances

You advise that the funding application was lodged in the name of Trust X and not Trust Y which was a requirement of the relevant government authority.

The amounts received were transferred from the government authority directly to Trust X. However, in accordance with the conditions of the Agreement the funding was allocated to the completion of the project, being the expansion of the business into the building owned by Trust Y.

In your case Trust X is acting as agent for Trust Y which is the principal in this transaction. Whilst there is no formal agreement in place the stringent requirements of the government authority ensured both entities cooperate with regard to the expenditure of the funding. The implied nature of the agreement is acceptable in these circumstances.

Despite no formal written agreement in relation to the passage of funds from Trust X to Trust Y, the nature of the funding Agreement and the actions of both parties strongly support the argument that Trust Y is the beneficial recipient of the funder under what could be described as an informal agency agreement.

It follows that any questions regarding the assessability of the grant will apply to Trust Y.

Question 2 - ordinary income

Section 6-5 of the ITAA 1997 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 of the ITAA 1997 is to include in assessable income those receipts which can be categorised as income according to ordinary concepts.

Although the expression 'income from 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 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 of the ITAA 1997.

ATO policy concerning government payments to industry 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 grant does not constitute ordinary income for either Trust X or Trust Y.

Trust X

As discussed in question 1, for the purposes of this arrangement Trust X was merely acting as 'agent' for a transaction in which the grant was beneficially received by the 'principal', that is Trust Y. It follows that Trust X is not assessable under section 6-5.

Trust Y

Whilst it was paid in separate instalments the funding did 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, was not sourced from property, and has not been derived directly by Trust Y in relation to its usual income earning activities.

Therefore, the grant is not assessable to Trust Y under section 6-5 of the ITAA 1997.

Question 3

Under section 6-10 of the ITAA 1997 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) of the ITAA 1997 refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5 of the ITAA 1997.

One of the statutory income provisions listed is section 15-10 of the ITAA 1997, which deals with the treatment of bounties and subsidies.

Section 15-10 of the ITAA 1997 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 a 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 view of the factors used to determine if you are in business for tax purposes.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

· whether the activity has a significant commercial purpose or character

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

· whether there is regularity and repetition of the activity

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

· whether the activity is planned, organised and carried out in a businesslike manner such that it is described as 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.

No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression.

'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 ARC 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. 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 of the ITAA 1997 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 of the ITAA 1997 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 of the ITAA 1997 or as a bounty or subsidy under section 15-10 of ITAA 1997 (paragraphs 103 and 128 of TR 2006/3).

Application to your circumstances

The grant does not constitute statutory income for either Trust X or Trust Y.

Trust X

As discussed in question 1, for the purposes of this arrangement Trust X was merely acting as 'agent' for a transaction in which the grant was beneficially received by the 'principal', that is Trust Y. It follows that Trust X is not assessable under section 15-10 of the ITAA 1997.

Trust Y

To be considered under section 15-10 of the ITAA 1997 the receipt must be in relation to the carrying on of a business.

You advise that Trust Y's only activity is the leasing of buildings. Other than collecting rent it has no involvement with the business activities conducted on the premises.

Whilst Trust Y does lease property to unrelated parties, taking into account the indicators in TR 97/11, these activities are not considered to be sufficient to constitute a business of leasing properties. Trust Y's activities as a lessor align more readily with the type of activities generally undertaken by a passive investor it is clear that Trust Y is not carrying on a business in this regard.

As Trust Y is not carrying on a business any receipts in relation to the funding are not 'received in relation to carrying on a business' as is the requirement for assessability as a bounty or subsidy under section 15-10 of the ITAA 1997.

The receipt is on capital account and must be considered with regard to the CGT provisions (see question 5).

Question 4 - recoupment

Recoupment is a defined term and has the meaning given by subsection 20-25(1) of the ITAA 1997. Under paragraph 20-25(1)(b) of the ITAA 1997, a recoupment of a loss or outgoing includes a grant in respect of the loss or outgoing.

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 of the ITAA 1997 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 the 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 of the ITAA 1997 for the depreciating asset in the later income years.

Application to your circumstances

To the extent that the money is used to fund the cost of depreciating assets, such as necessary equipment and furniture, it is an assessable recoupment under subsection 20-20(3) of the ITAA 1997.

Question 5 - capital gains tax

Section 104-25 of the ITAA 1997 deals with the cancellation, surrender and similar endings to CGT assets, CGT event C2. A C2 event occurs when the ownership of an intangible 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.

Paragraph 118-37(2)(a) of the ITAA 1997 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 governing by-laws.'

Application to your circumstances

The grant is not considered to be a capital gain for either Trust X or Trust Y.

Trust X

As discussed in question 1, for the purposes of this arrangement Trust X was merely acting as 'agent' for a transaction in which the grant was beneficially received by the 'principal', that is Trust Y. It follows that Trust X is not assessable under the CGT provisions of the ITAA 1997.

Trust Y

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

As Trust X was an agent for Trust Y, the latter made a capital gain equal to the difference between the capital proceeds and the cost base of the rights.

However, we find that the grants program meets the requirements of paragraph 118-37(2)(a) of the ITAA 1997 as outlined in the revised EM and the funding complies because it is a payment received as a reimbursement or payment of expenses incurred in relation to the grants program.

Therefore, any capital gain made by Trust Y from the C2 CGT event will be disregarded under paragraph 118-37(2)(a) of the ITAA 1997.

Cost base reduction

Although there is no capital gain at the time of the payments, there may be capital gain consequences when the property is eventually disposed of. To the extent that the money 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 section 110-45(3) of the ITAA 1997.

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