Edited version of your written advice

Authorisation Number: 1051307394219

Date of advice: 15 December 2017

Ruling

Subject: Income tax – assessable income – other types of income – government payments

Question 1

Will the government funding received by Company A which is used to acquire Division 40 assets only be assessable under Subdivision 20-A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Will the government funding received by Company A which is used to acquire Division 43 assets be assessable under either sections 6-5, 15-10 or under CGT Event C2 of the ITAA 1997?

Answer 2

No.

This ruling applies for the following periods:

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

The scheme commences on:

1 July 2017

Relevant facts and circumstances

Group A is an Australian resident business consisting of multiple companies that provides support services for a particular industry. Group A is not an income tax consolidated group for Australian taxation purposes.

New Facility Project

Company A was incorporated for the purpose of constructing a new Facility in a regional area. Company A does not form part of Group A but still held by the same controlling entities.

The Facility is expected to cost over $Xm and is estimated to be completed by 20XX. Once completed, Company A will lease the Facility to Group A and third parties to provide other services in that industry. The Facility will provide repair, maintenance and supply services, as well as provide training and provisioning.

Prior to seeking Government grants, Company A entered into a lease with the Company B so that Company A could construct the Facility in the regional area. The contract includes an option to extend the lease. Upon the expiration of the lease, all assets constructed as part of the Facility will be considered to be fixtures and will revert to Company B.

Company A then approached the Commonwealth Government and State Governments for grants (the Government grants) necessary for the purchase of infrastructure and assets. No operations will commence until the Funding Agreements have been finalised and entered into.

The Government grants will be used to reimburse Company A of assets purchased as part of the Facility project, consisting of assets deductable under Division 40 and 43 of the ITAA 1997.

Company A will also engage the services of Group A and third parties to assist with the construction and management of operations of the Facility.

Upon completion, Company A intends to sublet the Facility to Group A and third party operators. Company A intends to generate income from a range of sources:

(a) Rental income gained from subletting the Facility, and

(b) Service income gained by providing management of the Facility and other services.

Company A will not sublet the Facility until the Local Authority to approve the Facility before it can be used.

Commonwealth Government payments

Local Government Agency 1 (LCA 1) entered into a Funding Agreement with the Commonwealth. Company A was listed as Project Partner 1 on the application.

The Funding Agreement granted a sum of money to the LCA 1 to complete the Facility.

The Facility project consists of a number of milestones, commencing in the 20XX financial year and ceasing in the 20XX financial year. Upon the completion of each milestone, LCA 1 will use the Government grant money to reimburse Company A for the costs of construction (minus LCA 1’s administration fees).

State Government payments

Company A has also directly applied to a State Government for another sum of money to fund construction of the above capital assets.

Similarly to the Commonwealth government payments, any funds granted by the State Government will be applied as reimbursement for the purchase or construction of the above assets.

If successful with their application to the State Government, Company A would enter into a Funding Agreement similar to the Funding Agreement between LCA 1 and the Commonwealth Government, where any government payments made to Company A will be paid upon the completion of milestones and reimburse Company A for construction costs.

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 Subdivision 20-A

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 subsection 20-20(3)

Income Tax Assessment Act 1997 section 20-25

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 paragraph 118-37(2)(a)

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

1. Subdivision 20-A of the ITAA 1997 operates to include in a taxpayer’s assessable income any ‘assessable recoupments’ of certain amounts deductible by the taxpayer.

2. Specifically, section 20-20 of the ITAA 1997 provides that:

(1) An amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside this Subdivision.

(2) …

(3) 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.

3. Therefore, the payment must:

(a) Not be ordinary income under section 6-5 of the ITAA 1997,

(b) Not be statutory income under section 6-10 of the ITAA 1997,

(c) Be a recoupment of a loss or outgoing that the taxpayer:

(i) can deduct for the current year, or

(ii) has deducted or can deduct for an earlier year, and

(d) Be a recoupment of a loss or outgoing listed in section 20-30 of the ITAA 1997.

Ordinary income

4. Subsection 6-5(1) of the ITAA 1997 provides that a taxpayer’s assessable income includes income according to ordinary concepts.

5. While the legislation does not outline or define the characteristics of ordinary income, case law indicates that ordinary income generally falls into three categories:

(a) Income from rendering personal services,

(b) Income from property, or

(c) Income from carrying on a business.

6. The courts have also identified a number of factors that indicate whether an amount has the character of income:

(a) The receipt is earned,

(b) The receipt is expected,

(c) The receipt is relied upon,

(d) The receipt has an element of periodicity, recurrence or regularity, or

(e) The receipt is for the replacement of income.

7. No single factor is determinative of the receipt’s character, but some factors may be more relevant than others in light of the circumstances of the case: Federal Commissioner of Taxation v. Montgomery (1999) 198 CLR 639. Further, the High Court in Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 also stated that the nature of the receipt should be considered in light of the nature of the payment in the hands of the recipient.

8. Relevantly here, payments made to assist recipients with capital costs are more likely to be capital in nature and, therefore, not ordinary income: GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1.

9. The Government grants will be once-off payments to assist the taxpayer with capital costs, as outlined above. While these payments are made in instalments (on the completion of certain milestones), they are capital in nature. This is because they relate to establishing a profit yielding structure.

10. Therefore, the payments of the Government grants are not ordinary income according to section 6-5 of the ITAA 1997.

Statutory income

11. Subsection 6-10(1) of the ITAA 1997 provides that a taxpayer’s assessable income also includes some amounts that are not ordinary income (statutory income).

12. Section 10-5 of the ITAA 1997 lists types of statutory income.

13. Relevantly here, section 15-10 of the ITAA 1997 states that:

Your 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.

14. As highlighted by The Squatting Investment Co v. Federal Commissioner of Taxation (1953) 86 CLR 570; (1953) 10 ATD 126; (1953) 5 AITR 496, a bounty or subsidy includes a grant or financial assistance provided by the Government to assist businesses.

15. As stated in paragraph 10, the Government grants are not assessable as ordinary income under section 6-5 of the ITAA 1997. Therefore, it must be determined whether the Government grants will be received in relation to carrying on a business.

16. Taxation Ruling TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business expresses the Commissioner’s view on the characterisation of government payments made to assist recipients with their business.

17. Paragraph 4 of TR 2006/3 distinguishes the payment of grants into three categories:

(a) Payments to continue business;

(b) Payments to commence business; and,

(c) Payments to cease business.

18. Paragraph 100 of TR 2006/3 further states that the bounty or subsidy must be related to the continuing of a business or ‘carrying on’ of a business and not merely the commencing or ceasing of a business.

19. As explained in First Provincial Building Society Ltd v. Federal Commissioner of Taxation (1995) 56 FCR 320; (1995) 95 ATC 4145:

The expression ‘carrying on a business’ looks…to the activities of that business which are directed towards the gaining or producing of assessable income, rather than merely to the business itself.

20. Here, the Government grants are payments to reimburse Company A for the cost of capital assets used to construct the Facility. Company A will generate its income by subletting the Facility and providing services to Group A and third party operators following the completion of all milestones. As a result, the Government grants are directed at establishing the Facility and Company A’s future profit yielding structure. The Government grants do not relate to the gaining or producing of assessable income.

21. Therefore, the Government grants are not bounties or subsidies relating to carrying on a business.

Assessable recoupment

22. It has been determined that the Government grants do not satisfy the definition of ordinary income under section 6-5 of the ITAA 1997 or statutory income under sections 6-10 and 15-10 of the ITAA 1997. Therefore, it must now be determined whether the Government grants satisfy the conditions outlined in subsection 20-20(3) of the ITAA 1997.

23. Under subsection 20-20(3) of the ITAA, an amount received to recoup a loss or outgoing 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.

24. Section 20-25 of the ITAA 1997 defines a recoupment of a loss or outgoing as including:

(a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

(b) a grant in respect of a loss or outgoing.

25. Therefore, the Government grants are considered to be recoupments of losses or outgoings under section 20-25 of the ITAA 1997.

26. Here, the Government grants reimburse Company A for the loss and outgoings related to the purchase of Division 40 and 43 assets. According to the provisions outlined in Division 40 and 43, amounts can be deducted for those losses and outgoings for the current year.

27. However, according to Item 1.9 in the table listed in subsection 20-30(1), only the payments for outgoings relating to the purchase of Division 40 assets will be considered to be assessable recoupments.

28. As a result, the Government grants received by Company A which are used to acquire Division 40 assets will only be assessable under Subdivision 20-A of the ITAA 1997. The taxation treatment of Government grant monies used to reimburse Company A for the purchase of Division 43 will be considered by Question 2.

Question 2

29. As highlighted by the reasoning provided in paragraphs 4 to 28, the Government grant monies used to purchase Division 43 assets are not considered to be ordinary income under section 6-5 of the ITAA 1997, statutory income under sections 6-10 and 15-10 of the ITAA 1997, or assessable recoupments under Subdivision 20-A of the ITAA 1997.

30. Paragraph 128 of TR 2006/3 highlights that the CGT consequences of a government payment must be considered if the government payments are not assessable under the sections outlined above.

31. Relevantly here, CGT event C2 will occur when the Government grant is paid to Company A following the completion of a milestone. This is because the right to that portion of the grant money is released, discharged or satisfied and cannot be later claimed: paragraph 104-25(1)(b) of the ITAA 1997.

32. Therefore, it must be determined what CGT consequences arise following the CGT event C2 payments.

33. Paragraph 118-37(2)(a) of the ITAA 1997 provides that a capital gain or loss can be disregarded:

if you make it as a result of receiving a payment or property as reimbursement or payment of your expenses, or receiving or using a voucher or certificate, under a scheme established by an Australian government agency, a local governing body or a foreign government agency under an enactment or an instrument of a legislative character…

34. Under section 995-1 of the ITAA 1997:

Australian government agency means:

(a) the Commonwealth, a State or a Territory; or

(b) an authority of the Commonwealth or of a State or a Territory.

Local governing body means a local governing body established by or under a State law or Territory law.

35. LCA 1, the State Government and Commonwealth Government satisfy the definitions of a local governing body and Australian government agencies, respectively. As a result, their respective grants will constitute a ‘scheme established by an Australian government agency’ or ‘local governing body’.

36. Therefore, while a CGT event C2 will occur when the Government grant monies are paid on completion of each milestone, the capital gain or loss is disregarded due to the operation of paragraph 118-37(2)(a) of the ITAA 1997.

The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions.

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