Edited version of private advice

Authorisation Number: 1012625783311

Ruling

Subject: Primary Production Income

Question 1

Is the payment received by you for the construction of a facility ordinary income?

Answer

Yes

Question 2

Is the payment received by you for the construction of a facility primary production in nature?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commences on:

1 July 2013

Relevant facts and circumstances

You carry on a primary production business as a partnership.

The partners actively participate in the running of the business and have no outside employment.

You have been in the business of farming for many years.

You have entered into an agreement with an external company whereby you agree to take an input product for your partnership.

You have supplied a signed copy of the Agreement between the Supplier and yourselves in relation to the Scheme.

You will pay $X for the amount of input product used and $X for unused input product for the year.

As calculated on a page of the Agreement, the payment equates to X @ $X which equals $X. The schedule payments of the facility are split up as shown by a Clause of the agreement.

The construction will be completed by the Applicants in several stages.

Your queries relate specifically to the construction payments on a page of the Agreement.

In late 2013 $X was received by you in regards to the agreement and any further payments will possibly occur prior to late 2014.

The input product is offered to primary producers to be used by the primary producers in their businesses.

One part of the contract is the primary producer will purchase the input product, however you are not concerned about the treatment of this part of the contract for the ruling.

You are registered for GST.

You have confirmed that no eligible payments have been received in regards to the specific programs which may specify a statutory taxation treatment of the payments you receive in return for construction of a facility.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 6

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 Section 995-1

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Income Tax Assessment Act 1997 Subsection 6-10(3)

Income Tax Assessment Act 1997 Subsection 392-80(2)

Reasons for decision

Question 1

Summary

The payments you have and expect to receive from completing the phases of the construction of a facility from an external company are amounts of ordinary income.

Detailed reasoning

Assessable income

Assessable income is defined in Division 6 of the Income Tax Assessment Act 1997 (ITAA 1997) to include:

• Ordinary income, and

• Statutory income.

Statutory income

Section 6-10 of the ITAA 1997 provides that your assessable income includes statutory income amounts that are not ordinary income but are included as assessable income by another provision. Statutory income expands the scope of income for tax purposes from the concept of ordinary income.

Section 10-5 of the ITAA 1997 contains table of provisions, under which statutory income is included in assessable income. For example section 15-10 of the ITAA 1997 about subsidies and bounties.

Subsidy

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. One of the statutory income provisions listed in section 10-5 of the ITAA 1997 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."

Before considering whether an amount has been received in relation to 'carrying on a business' it is necessary to determine the meaning of Subsidy.

Subsidy is not defined in section 995-1 of the ITAA 1997. In Taxation Ruling TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business, it is recognised that payments of financial assistance by government are commonly referred to as 'bounties', 'subsidies' or 'grants', and as these terms are not defined, the ordinary meaning applies (Paragraph 94 of TR 2006/3):

"Subsidy is defined as '1. a direct pecuniary aid furnished by a government to a private industrial undertaking, a cultural organisation, or the like; 2. a sum paid, often in accordance with a treaty, by one government to another, to secure some service in return; 3. a grant or contribution of money'. The ordinary meaning adopted by case law is an 'aid provided by the Crown [government] to foster or further some undertaking or industry'."

Paragraph 98 of TR 2006/3 specifies that:

"some legislation provides that payments are deemed to be a subsidy for the purposes of section 15-10. For example, a payment, such as an energy grant or a cleaner fuel grant, that is a 'grant' or 'benefit' under section 8 of the Products Grants and Benefits Administration Act 2000 (PGBAA 2000) is, under section 56 of the PGBAA 2000, taken to be a subsidy for the purposes of section 15-10. However, if such a payment is received as ordinary income, it is assessable under section 6-5 rather than section 15-10."

In your case, you have received payments from a private company. You are not in receipt of an amount which would constitute a subsidy from a government agency.

Ordinary income

Subsection 6-5(1) of the ITAA 1997 specifies that your assessable income includes income according to ordinary concepts, referred to as 'ordinary income'. Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Subsection 6-5(4) of the ITAA 1997 specifies that when determining whether you have derived an amount of ordinary income, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct (See ATO ID 2001/647 Income Tax Assessable Income: Reinvestment of Unit Trust Distributions).

Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

• Are earned;

• Are expected;

• Are relied upon; and

• Have an element of periodicity, recurrence or regularity.

There is no definitive test to determine whether an amount is ordinary income and the bearing given to a particular characteristic is considered on a case by case basis. As the High Court said in FCT v Montgomery (1999) 198 CLR 639; 42 ATR 475:

"Each of the general propositions we have mentioned is qualified: income is often (but not always) a product of exploitation of capital; income is often (but not always) recurrent or periodical; receipts from carrying on a business are mostly (but not always) income."

Other factors which have helped courts determine whether an amount has the characteristics of ordinary income include whether:

• the receipt is derived from disposing of a right or advantage as part of the process by which the profit-earning structure or organisation operates to obtain regular returns,

• the amount is a "flow" separate from the asset or activity which generated it,

• the amount is a payment made by force of a contractual or other legal obligation and not voluntarily, and

• the amount replaces lost income or revenue assets.

Earned and The 'come in' principle

An amount can only be ordinary income if it has been realised i.e. derived by an entity (comes into the entity). For example in FC of T v Cooke & Sherden (80 ATC 4140, 4149; (1980) 42 FLR 403, 416) a taxpayer who was selling soft drinks was awarded a free holiday from his supplier, in this case the principle relied upon was that the receipt of an amount which saves a taxpayer from incurring expenditure, does not automatically equate to the receipt of ordinary income; "income is what comes in, it is not what is saved from going out".

The character of an item in the recipient's hand

The character of an amount is determined in the hands of the person who derives it, which is extended by a doctrine of constructive receipt, to an amount dealt with on the persons behalf or as they direct (See subsection 6-5(4) and 6-10(3) of the ITAA 1997).

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (GP International Pipecoaters) the taxpayer, a company established for the sole purpose of undertaking a contract to coat gas pipes, received 'establishment costs' to pay for the construction of a plant to carry out the pipe-coating process. The High Court held that the 'establishment costs' were income in the taxpayer's hands, even though they were received for the purpose of construction of the plant.

ATO ID 2002/1090 Income Tax Assessable income: Grant to undertake a feasibility study in which a company which received grant payments, concluded that:

"the taxpayer was established in order to conduct a feasibility study. The taxpayer is in the business of conducting a feasibility study, therefore, any amounts received in relation to the feasibility study are income from the carrying on of the business. The receipt, in these circumstances, is income according to ordinary concepts. Therefore the grant is ordinary income and assessable under section 6-5 of the ITAA 1997."

This differs to the scenario in ATO ID 2001/715 Personal tax Assessability of grants paid under the First Home Owner Scheme where a grant of money received by the taxpayer was deemed to have no connection with employment, services rendered, investment or the operation of a business.

Relied upon & Expected

In most cases, where an amount is expected to arise from an earning activity, there will be a sufficient nexus to be ordinary income. For example, an amount received as a gift in Scott v FC of T (1966) 117 CLR 514, where it was held that a payment from a former client was not for services performed. See also ATO ID 2002/644 Income Tax Assessability of Prize where a windfall gain was deemed not assessable.

However ATO ID 2002/944 Income Tax Assessable income: food vouchers received for child-minding determined that food vouchers received by a baby sitter did not represent a regular form of income as there was no;

• Set time for payment,

• Regular amount, and

• They were less than market rates.

As such they did not have the characteristics of ordinary income.

Mutuality Principle

The amount must be received from an external source unless assessable under a specific provision. Amounts received by an individual or an entity which have been made by the individual or entity cannot be income derived (thus not ordinary income) due to the mutuality principle (North Ryde RSL Community Club Ltd v FCT [2002] 49 ATR 579).

Periodic, recurrence, regular

A common recognition of an amount being ordinary income is whether it is periodic and regular. Woellner 2013 states that "this simply reflects common experience, as the main examples of ordinary income, such as payments of salary and wages, are periodic, regular and repetitious." For this reason, these characteristics are significant but not decisive.

A taxpayer who undertook duties at a college and received accommodation and money for personal expenses was held to be ordinary income as the money was received on a regular basis was earned, expected and relied upon see ATO ID 2002/205 Income Tax Income: Money received for personal expenses while residing at a college.

Character of the right disposed of

The nature of the right, thing, or advantage disposed of in exchange for an amount has been an important determinative factor. Where a business taxpayer exchanges an asset or advantage which was revenue in nature, the amount received is ordinary income. An amount resulting from the sale of a structural or capital or non-current asset would be a capital receipt, unless the transaction was in the ordinary course of carrying on that particular business (Moneymen Pty Ltd v FCT (1990) 21 ATR 1142).

Income as a flow

The "tree and fruit" analogy is commonly cited by courts, where income is considered as the fruit (the revenue) flowing from the tree (the capital) (see Pitney J in Eisner v Macomber (1919) 252 US 189 at 206 and as applied by Commissioner of Taxation v McNeil (2005) 60 ATR 275).

Payments made under a contractual or other legal obligation and not voluntarily

Commentaries have argued that an amount made under a contractual agreement are easier to identify as ordinary amounts, compared to voluntary amounts. However, voluntary payments can be ordinary amounts where there is sufficient connection between the payment and a taxpayers business activities. In FCT v Co-operative Motors Pty Ltd (1995) (31 ATR 88), there was a voluntary payment made in the context of a business "Accordingly, in substance and reality the sum received was not a mere gift but the product of the taxpayer's income earning activity and as such was assessable income".

Replacement principle (Compensation and damages)

This principle is most applicable to compensation cases, where an amount is received in order to replace an item. If the item had been income in nature, the replacement amount would therefore be income, even where paid as a lump sum (FCT v Inkster (1989) 20 ATR 1516). There has been cases of a wider application by the courts of the replacement principle see FCT v Dixon (1952) 86 CLR 540.

Isolated transactions

The Myer Emporium principle established that an isolated business transaction can be an amount of ordinary income, where there was an aim of profitability.

This expands the traditional notion of what can be ordinary income, by transactions entered into separate from the ordinary course of business (FCT v Myer Emporium Ltd (1987) 163 CLR 199; 18 ATR 693, see also Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income).

Additional considerations

Other scenarios which the courts have considered:

• A reduction in the amount of a liability can give rise to a gain that is ordinary income, and

• An amount subject to a contingency or condition does not prevent it from being ordinary income.

Capital gains are not ordinary income

As indicated, not every amount will have the character of ordinary income. Capital gains are not ordinary income, but can be assessable under another provision. The difference between ordinary income and capital gains is still important due to:

• The Capital Gains Tax (CGT) provisions do not catch all capital gains, and

• the amount of tax payable on income and capital profits may differ depending on whether it is taxed under the income tax regime or the CGT regime.

CGT can apply to every disposal of an asset acquired or deemed to have been acquired on or after 20 September 1985, regardless of whether the gain would normally be treated as a capital gain. If the gain is also assessable as ordinary income, the amount of the capital gain is reduced accordingly.

Application to your circumstances

You are a farming partnership and have agreed to build the Facility in order to receive input products. You receive payment once you have met the each stage of the agreement.

So far you have received a partial payment of the total you are expecting.

Your circumstances are similar to those in GP International Pipecoaters, as although arguably the amounts you are receiving are to construct the infrastructure to process the input product, these amounts are still income in your hands as they have a connection to the operation of your business.

In addition:

• You are expecting and relying on receiving these payments from an external source, as a direct result of finishing the stages of construction,

• The payments are periodic and recurring in line with completion of the stages your partnership are able to complete.

• The payments are received as the contractual agreement is satisfied, they are not gifted, or voluntary payments made to your partnership.

• The payments are received throughout the completion of the contract and not as an isolated or lump sum payment.

There is sufficient connection between your business activities and the amounts received, the amounts were not merely a gift but the product of your income earning activity's. The payments were not received from a government source and as such is not assessable as a subsidy statutory income under section 15-10 of the ITAA 1997.

The payments you are receiving from completing each stage of the Facility paid by an external company under the Agreement are income according to ordinary concepts. Therefore these payments will form part of your assessable income as per subsection 6-5(1) of the ITAA 1997.

Question 2

Summary

The ordinary income amounts are assessable primary production income.

Detailed reasoning

Subsection 392-80(2) of the ITAA 1997 states that assessable primary production income is the amount of assessable income that was derived from, or resulted from, the carrying on of a primary production business. A primary production business is defined by section 995-1 of the ITAA 1997, to be a business of:

(a) "cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment; or

(b) maintaining animals for the purpose of selling them or their bodily produce (including natural increase); or

(c) manufacturing dairy produce from raw material that you produced; or

(d) conducting operations relating directly to taking or catching fish, turtles, dugong, bêche-de-mer, crustaceans or aquatic molluscs; or

(e) conducting operations relating directly to taking or culturing pearls or pearl shell; or

(f) planting or tending trees in a plantation or forest that are intended to be felled; or

(g) felling trees in a plantation or forest; or

(h) transporting trees, or parts of trees, that you felled in a plantation or forest to the place:

(i) where they are first to be milled or processed; or

(ii) from which they are to be transported to the place where they are first to be milled or processed."

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production, discusses that a person will be carrying on a business of primary production where they satisfy the above definition in section 995-1 and that activity amounts to the carrying on if a business.

"Business" is defined in section 995-1 as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee', however in order to determine whether a business is actually being 'carried on' TR 97/11 refers to case law.

Indicators of carrying on of a primary production business have been developed from case law as follows;

• 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,

• 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.

These are only indicators, there is no conclusive test as to whether a business is present, instead each factor must be weighted on a case by case basis.

Application to your circumstances

You carry on a business of primary production; you and your spouse as a partnership have been farmers for several years and do not have outside employment.

Part of your business activities involved contracting with a private company to receive input product for purposes related directly to your business activities. Part of this agreement involved you establishing infrastructure to enable use of this input product for which you are receiving amounts of ordinary income as each stage of construction is completed. Therefore these payments of ordinary income are connected to your primary production business and are assessable as primary production income as per subsection 392-80(2) of the ITAA 1997.

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