Edited version of your written advice

Authorisation Number: 1012942154170

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Date of advice: 28 January 2016

Ruling

Subject: Assessable Income: Government Grant

Question 1

Is the grant funding to be received by the entity assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the grant funding to be received by the entity assessable under section 15-10 of the ITAA 1997?

Answer

No

Question 3

On the basis that capital allowances are claimed on the entity assets under Division 40, will the grant funding received by the entity be an assessable recoupment under Subdivision 20-A of the ITAA 1997?

Answer

Yes

Question 4

Where the cost of the entity assets is deductible over two or more years under Division 40 of the ITAA 1997, will section 20-40 of the ITAA 1997 operate such that the total assessable recoupments to be included in the entity's assessable income in a particular year will equal the total amount of the depreciation deduction claimed in that year (under the method statement under subsection 20-40(2)?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 2020

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The project involves the design, construction and operation of an asset in Australia.

To assist with the funding of the construction of the assets, the entity has applied, and been conditionally approved, for grant funding from the Australian government.

The grant funding will be received by the entity on a staggered basis over the construction period of the assets, commencing from the date of signature of the Agreement, with the final amount to be received prior to the end of 20XX (subject to the satisfaction of certain milestones under the Agreement).

The grant funding to be received by the entity will be used 100% to fund the construction of the entity assets.

The balance of the funding for the entity assets will be sourced through other equity contributions into the entity.

The entity currently has no assets and the grant funding will be the first amount received by it.

All operating costs of the entity assets will come out of the profits of the entity, following construction of the entity assets.

Once constructed, the entity assets will constitute depreciating assets of the entity, which will claim capital allowances for the decline in value of the entity assets under Division 40 of the ITAA 1997.

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 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

Reasons for decision

Question 1

Section 6-5 Ordinary Income

Section 6-5 of the ITAA 1997 provides that 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. Ordinary income does not include receipts of a capital nature.

The term 'ordinary income' is not defined in the ITAA 1997. Its meaning has evolved from case law, which has laid down certain established tests to determine whether receipts can be deemed as ordinary income.

Taxation Ruling TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business discusses the way in which various tax provisions apply to government payments to industry to assist the recipient to continue, commence or cease a business.

A ‘government payment to industry' is defined in TR 2006/3 as a payment by the government, or entity chosen by the government to administer government funds.

Government payments to commence business include payments for the commencement of a business or to assist with the purchase of depreciating assets.

Regarding such payments, paragraphs 128 and 139 of TR 2006/3 state:

128. Government payments to industry [GPI] to commence or cease business are not assessable as ordinary income under section 6-5 or as a bounty or subsidy in relation to carrying on a business under section 15-10. However, the GPI may be taken into account in determining whether there is an assessable recoupment under Subdivision 20-A. If the GPI is not assessable under any of these provisions, the recipient will need to consider whether there are any CGT consequences.

139. A GPI paid to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income as the GPI is capital in nature. The GPI will not be assessable under section 15-10 if it is received in relation to the commencement of a business.

At the time government commits to the provision of grant funds to the entity, it will not be carrying on a business (in the context of characterising an amount as ordinary income).

The design and construction of the asset is a preliminary activity undertaken to commence the entity's intended business and does not, of itself amount to a business.

Although the grant funding will be received by the entity on a staggered basis over the construction period of the entity assets the funding will not fall within the meaning of ordinary income.

Question 2

Section 15-10 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 of the ITAA 1997.

ATO ID 2010/38 Income Tax Bounty and subsidies: financial assistance received in commencing a business - whether received 'to commence a business' provides guidance on when a business commences for the purposes of section 15-10 of the ITAA 1997.

The commencement of a business is a specific point in time and a question of fact. The crucial point is where the taxpayer is committed to proceed with the implementation of its purpose to carry on its business. ATO ID 2010/38 states:

A bounty or subsidy is received to 'commence a business' if the bounty or subsidy is to enable the recipient to reach the necessary point where the recipient is committed (and such commitment is demonstrated in its activities) to proceed with the implementation of its purpose to carry on a business. However, a bounty or subsidy that is received in relation to activities of an entity as it commences its business is not received to commence the business if the decision to commence is not dependent upon the receipt of the bounty or subsidy…

To be assessable under section 15-10 of the ITAA 1997, the grant must be in relation to the carrying on of a business. 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)

It is accepted that the grant funding will be used to fund the construction of the entity assets and is not in relation to existing business activities but to commence a new activity and therefore the grant is not assessable under section 15-10 of the ITAA 1997.

Question 3

Assessable recoupment Subsection 20-20(3)

Division 20 of the ITAA 1997 includes amounts in your assessable income to reverse the effect of certain kinds of deductions.

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.

Further at paragraph 27 of TR 2006/3:

A GPI received to assist the recipient to commence business with the purchase of a depreciating asset, the cost of which is deductible under Division 40, is assessable under the assessable recoupment provisions in Subdivision 20-A 

Subsection 20-20(3) states:

An amount you have received as recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:

(a) You can deduct an amount for the loss or outgoing for the current year; or

(b) You have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

under a provision listed in section 20-30

There are two elements to be satisfied for the amount to be included in assessable income. Firstly, whether the amount was received as recoupment of a loss or outgoing, and secondly, whether an amount for that loss or outgoing can be deducted in the current year, or has been or can be deducted in an earlier year.

Where the grant is used to fund depreciating assets, such as necessary equipment it is an assessable recoupment (in the year amounts are deductible under Division 40 of the ITAA 1997) under subsection 20-20(3) of the ITAA 1997.

As the funds are not otherwise assessable, they will be an assessable recoupment under Subdivision 20-A to the extent that the deductible loss or outgoing is a deduction under Division 40 of the ITAA 1997.

Question 4

Section 20-40 Capital Allowances

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 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.

Further at paragraph 140 of TR 2006/3:

to the extent that the GPI is a recoupment of the cost of the depreciating asset (for which capital allowance deductions are available for the decline in value), it is an assessable recoupment under Subdivision 20-A. The amount of assessable recoupment may be included over more than one income year, limited to the amount that can be deducted under Division 40.

The grant funds should be assessed for tax purposes under Subdivision 20-A, and in accordance with the method statement contained in section 20-40 of the ITAA 1997.

Conclusion

The grant funds should not be considered ordinary income under section 6-5 as the receipt of the funds lacks the necessary connection with business activities.

The grant funds should not be assessable under section 15-10 as the grant funds are not derived in the course of carrying on a relevant business.

Consequently, the grant funds should be an assessable recoupment for tax purposes under Subdivision 20-A.

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