Edited version of your written advice

Authorisation Number: 1012704346870

Ruling

Subject: Assessability of government grant

Question 1

Do the amounts received from the government authority constitute ordinary assessable income or an assessable capital gain to you, the private landowner, where the amount is received under an agreement whereby you will arrange for the completion of capital works such as fencing and establishing trees to establish a refuge?

Answer

No.

Question 2

Do the amounts received from the government authority constitute ordinary assessable income to you, the private landowner, where the amount is received under an agreement whereby you will arrange the maintenance of the area for the refuge, through the use of contractors?

Answer

Yes.

Question 3

Are the expenses associated with obtaining these payments to arrange the maintenance work deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 4

Is any capital gain made in relation to the payments you receive to arrange the maintenance work, reduced by the amount that is included in your assessable income as ordinary income?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commenced on

The scheme has commenced

Relevant facts

You submitted an application to obtain a grant.

Your grant application was based on a quote from a service provider.

The grant was paid to the joint owners of the private property.

Any work you have contributed has been on an "in-kind" basis only. All money spent is going to contractors. You do not have to use that specified contractor. It is possible for you to do the maintenance work yourself but that is not your intention.

You have to submit an annual report to the department summarising the work performed and the expenditure incurred.

Schedules of the agreement (among other things) sets out;

• the financial assistance, the activities, outcomes and completion timeframes for the project.

• information for the management of the land, and

• outlines a number of obligations the landholder has for the project including maintenance.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 15-10

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

All legislative references in this Ruling are to the ITAA 1997 unless otherwise indicated.

Detailed reasoning

Assessability of the grant payment

The lump sum payment received from the government is for two purposes:

• The first being the establishment of the project which requires the preparation of the site, the planting of trees and the establishment of suitable fencing. These expenses are seen to be of a capital nature as they are incurred to develop an asset of an enduring nature (capital works payment); and,

• The refuge then has to be maintained for a period of five years. Therefore part of the lump sum payment is for maintenance purposes, which will require the ongoing services of watering, whipper snipping, pest plant spraying and replacing planting failures. These types of expenses are seen as revenue expenses and not capital expenses as the services have to be provided on an ongoing basis and do not have an enduring benefit (maintenance payment).

Capital works payment

Section 6-5 - income according to ordinary concepts

Although the capital works payments are payable under the same contract as the maintenance payments, they are not payments for the performance of services. Capital works payments are payments to be applied towards the costs of capital works such as fencing and planting of trees. These costs are capital in nature. A subsidy that is intended to assist a recipient with capital costs is a receipt of a capital nature. Accordingly, a payment for capital works is not income according to ordinary concepts and is not assessable under section 6-5.

Section 15-10 - bounty or subsidy

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; and

• not assessable under section 6-5.

For a capital works payment to be considered assessable income under section 15-10, a relationship must exist between the payment and the carrying on of a business. You are not carrying on a business, the capital works payment does not constitute ordinary income or a bounty or subsidy and is not assessable income.

Capital gains tax

CGT event C2 under section 104-25 happens when the entitlement to receive the capital works payment is satisfied, that is, when the payment is made by way of reimbursement directly to the applicant or payment of expenses on the applicant's behalf.

However, any capital gain or capital loss made as a result of a payment of the capital works payment is disregarded under paragraph 118-37(2)(a).

Paragraph 118-37(2)(a) provides that any capital gain or capital loss that results from receipt of a payment as reimbursement or payment of expenses under a scheme established under legislation by an Australian government agency is disregarded. The capital works payment is paid under such a scheme.

Therefore the portion of the payment that relates to that expended on the capital works will not form part of your assessable income either as ordinary income or statutory income.

Maintenance payment

Section 6-5 - income according to ordinary concepts

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 each case.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (the Pipecoaters case), the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

In MIM Holdings Ltd v. Commissioner of Taxation 97 ATC 4420; (1997) 36 ATR 108 (the MIM case), Northrop, Hill and Cooper JJ, relying on Hayes v. FCT (1956) 96 CLR 47 and Reuter v. FC of T 111 ALR 716; 93 ATC 4037 said that 'amounts paid in consideration of the performance of services will almost always be income'.

The ongoing maintenance payment is the product, in a real sense, of the services rendered by the landholder.

The fact that the payment is made in a lump sum does not alter this conclusion as the timing of the payment is determined solely by a government requirement that the funding be paid out this way.

The funds received are included in the taxpayer's income regardless of whether the taxpayer performs the services themselves or engages the services of a contractor. The authority for this statement is found in JB Chandler Investment Co Ltd (in voluntary liquidation) and Another v. FC of T (1993) 47 FCR 588; (1993) 93 ATC 5182; (1993) 27 ATR 340. In that case the Full Federal Court found that the entering into of an agreement by which a taxpayer is bound to render specific services is sufficient to stamp the consideration received in exchange for entering into the agreement as income. It is not essential that the taxpayer in fact actively render any service.

Although the maintenance activities are to be undertaken for a minimum period of 5 years under the agreement, the payment is made in a single lump sum. Accordingly, a question arises as to when the payment received under this agreement is assessable. Taxation Ruling TR 98/1 states that when accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. Where income results primarily from the services rendered, or work performed by the taxpayer personally, it is generally assessable on a receipts basis and the total amount received under the agreement is assessable in the income year that it is received.

However there are circumstances in which an advance payment is made where the amount received is not derived as income when it is received, but as it is earned. The High Court in Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673 (the Arthur Murray case) referred to the significance of an amount not being income unless it had been earned.

The Administrative Appeals Tribunal (AAT) in Case U7 87 ATC 127; Tribunal Case 20 18 ATR 3120 (Case U7) considered that there was a close analogy between the taxpayer's situation and that of a prepayment under a contract for future services. The AAT applied the principles arising from the Arthur Murray case, notwithstanding that the taxpayer was not held to be contracting to render future services to the Commonwealth. In Case U7 the taxpayer had received an advance of grant monies that it would become entitled to on making certain expenditure on agreed research and development activities. The taxpayer's entitlement to the grant was in direct proportion to the proper expenditure on that work and the AAT considered that the taxpayer, in the year in question, had not done all that was required of it to earn the full amount prepaid to it.

The decisions in both the Arthur Murray case and Case U7 support the position taken in Taxation Ruling TR 2006/3 which states that 'an assessable [government payment to industry] that is an advance payment is derived by the recipient to the extent that the recipient has done everything necessary to be entitled to retain the amount received'.

It is considered that the lump sum payment to the landholder for maintenance activities to be provided over the term of the contract is to be accounted for as it is earned over the period of the contract. This means that your income tax returns for each year covered by the agreement will include an amount for ongoing maintenance based on the activities undertaken in each year.

Section 8-1 General deductions

You are entitled to claim tax deductions for any deductible expenses incurred in the course of producing assessable income as represented by the maintenance payments. If the work is completed by a contractor the full amount is going to be tax deductible. This will mean the net income will be zero as the assessable income will be equal to expenses.

If you were to carry out the maintenance work yourself you would be able to claim the normal revenue expenses incurred in doing this type of work.

Capital gains tax

CGT event C2 under section 104-25 happens when the entitlement to receive the ongoing maintenance payment is satisfied, that is, when the payment is made to the applicant.

However, any capital gain made as a result of the payment of the maintenance payment is reduced under paragraph 118-20(1)(a).

Paragraph 118-20(1)(a) provides that any capital gain is reduced if, a provision of the Act outside Part 3-1 includes an amount (for any income year) in the assessable income because of the event. In this case the whole amount of the maintenance payment will be included in assessable income as and when it is earned. Consequently, any capital gain resulting from CGT event C2 happening in relation to the maintenance payment will be reduced to zero in accordance with paragraph 118-20(2)(a).

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