Edited version of private advice

Authorisation Number: 1051570313288

Date of advice: 23 August 2019

Ruling

Subject: Assessability of government grants

Question 1

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

Answer

No.

Question 2

Is the grant funding received by Company X assessable under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Is the grant funding received by Company X an assessable recoupment under Subdivision 20-A of the ITAA 1997?

Answer

Yes.

Question 4

Where expenditure in relation to the grant is deductible over two or more years, will section 20-40 of the ITAA 1997 operate such that the assessable recoupment to be included by Company X in assessable income in a particular year will equal the total amount of the deduction claimed in that year (in accordance with the method statement under subsection 20-40(2) of the ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 31 XX 20XX

Year ended 31 XX 20XX

Year ended 31 XX 20XX

Year ended 31 XX 20XX

Year ended 31 XX 20XX

Year ended 31 XX 20XX

The scheme commences on

XX Month 20XX

Relevant facts and circumstances

Company X is involved in the sporting industry and operates a sporting team.

Company X is a public company and is privately owned and does not have any tax exempt status.

Company X's principal activity is the fostering and propagation of its particular sport. Company X derives its revenue primarily from grants, corporate sponsorship, membership fees, royalties and merchandise sales. It also derives income from casual ticket/gate receipts. The business carried on by Company X does not include construction or ownership of a special purpose building (special purpose building).

Funding Agreements

Company X entered into agreements with the Federal Government and the State Government for the provision of grant funding to build a community special purpose building on the sporting facility it leases from the local Council (Council). The agreements were supplied with the application for private ruling and their contents form part of these facts.

The purpose of the Federal Government grants is to support needed infrastructure that promotes stable, secure and viable local and regional economies.

In accordance with the Federal Government grant guidelines, the outcome of the grant is to construct and upgrade facilities to provide long term improvements in social and economic viability of local communities.

The agreements in summary include:

a.    Company X entered into the first funding agreement with the Federal Government on XX 20XX. The aim was to understand whether the construction of a special purpose building at the sporting facility was viable and required engaging a number of external contractors.

b.    Following this process, it was determined that the construction of the special purpose building was viable. Company X and the Federal Government then agreed to terms for additional funds to be granted by the Federal Government to fund a portion of the construction costs of a special purpose building.

c.    Company X also negotiated with the State Government for additional funding to be granted to construct the special purpose building. This agreement was signed before the second Federal Government agreement.

The operation of the special purpose building is viewed by Company X as a separate business to that of the sporting team. It is anticipated that the special purpose building operation will require staff with different skill sets to manage and operate the business. Additionally, the staff of the special purpose building will be required to organise bookings and make space available for community groups and other sporting teams.

Company X will be responsible for the maintenance and associated operating costs for the special purpose building once construction has been completed. The maintenance costs are forecast to far exceed any potential revenue to be received.

Following the completion of the special purpose building on the Council's land, a long term lease will be entered with Company X as a tenant over an extended period.

Without the Government Grants, the special purpose building would not be built by Company X or Council as it is outside their core business and competency.

The current Company X business of operating a sporting team is not dependant on the construction of a special purpose building. The existing facilities are sufficient to support ongoing operations.

Purpose of the special purpose building

The Council has identified that sport and active recreation infrastructure is critical to the ongoing wellbeing, physical activity levels and social cohesion within its community. The development of high end accessible sporting facilities within existing venues will provide the Council with multipurpose facilities and flexible spaces to provide opportunities for development of relationships between elite and community sport. In addition, the integration of community focused education facilities will provide local schools, local community groups, local sporting clubs and local government programs with facilities to undertake community programs as well as volunteer training and engagement.

The Council, as owner of the sporting facility, will be required to provide land owners consent for the construction of the special purpose building as it strongly aligns with the community values and requirements. The development offers an opportunity to meet a pressing need of the collective Council sporting community and offer local athletes (not just Company X's sporting players) with state-of-the-art facilities, services and programs.

Company X's vision for the special purpose building includes the development and integration of female friendly training facilities to foster the development of female participation in sport, as well as significant community facilities which will enable Company X to expand its own community activities/programs and form stronger bonds within the Council and the community that supports it. The current facilities do not cater for these needs.

The new precinct facilities, associated services and programs will go beyond sport to support many parts of the community including school students and youth, parents and seniors. By providing new resources for community development, education and leisure, the rejuvenated precinct will assist to increase social engagement and break down isolation between community members and groups.

The special purpose building will leverage opportunities to apply learning from other sporting organisations as well as enable other sporting organisations to utilise facilities for the betterment of their organisations. This will allow for greater collaboration between different sporting codes and develop a culture of best practice application of joint learning.

The Federal Government grant broadly provides funding to schools, local councils, religious organisations and other community organisations. The grant provided to Company X relates to building an asset on land owned by Council to be utilised by the entire Council's community.

The Stage One Grant was payable in instalments on the completion of identified project milestones. Payments will be/were made on achievement of agreed milestones. Before any payment can be made, funding proponents (Company X) will be required to provide:

a tax invoice for the payment (GST exclusive) of the payment; and

a satisfactory progress report and supporting documentation providing evidence of meeting the requirements for payment.

Company X was duly paid the Stage One grant in the financial years ended 20XX, 20XX and 20XX.

The agreement states where funds are not spent in accordance with the Stage One Agreement, Company X must repay the funds.

The Stage One Agreement stipulates that the property must be used for the designated purpose. That is, the planning and design of the special purpose building.

Federal Government Funding- Stage Two

On XX 20XX, the Government Department and Company X entered into an agreement (Stage Two Agreement) to provide Company X with further funding (Stage Two Grant) for the construction of the special purpose building.

The funding under this agreement has the same purpose as detailed for Stage One.

The purpose of the completed project is to provide facilities to service Company X and various sporting organisations throughout the Council's region. In addition, educational and community facilities will be provided for community use.

The Stage Two Grant is payable in instalments on completion of identified project milestones and upon the receipt of a properly tendered invoice with all evidence that all paid funding has been expended or committed. The Stage two Grant will be duly paid to Company X in the financial years ended 20XX, 20XX and 20XX. The breakdown of milestones is provided in the Stage Two Agreement.

Where funds are not spent in accordance with the Stage Two Agreement with the Federal Government, Company X must repay the funds.

The Stage Two Agreement stipulates that the property must be used for the designated purpose. This is defined in the Stage Two Agreement.

State Government funding

On XX 20XX the State Government and Company X entered into an agreement (State Government Agreement) to provide Company X with funding (State Government Grant) for the development of a special purpose building. The special purpose building will provide access to many talented sports people on the Council's vicinity, and also much needed facilities through which Company X's wide range of community and social impact programs can be run for the benefit of all young people in the local community.

The State Government's vision is for its state to be regarded globally as a leader in the development and management of elite and community sports.

The project will include training and administration facilities for Company X and community facilities.

Company X believes that after construction of the special purpose building it can expand its own community activities/programs and form stronger bonds within the Council's community that it represents,

The State Government Agreement states the State Government has the right to withhold their funding if Company X does not secure the full amount of the Federal Government funding.

The State Government Grant is payable in instalments on the completion of identified project milestones, upon receipt of various reports or written evidences, and a properly rendered tax invoice. The instalments are detailed in the State Government Agreement.

Where funds are not spent in accordance with the State Government Agreement, Company X must repay the funds.

The State Government Agreement stipulates that the property must be used for the designated purpose (i.e. as a special purpose building).

The State Government Agreement states that Company X must establish a Project Control Group (PCG) that meets monthly to oversee the project implementation. The purpose of the PCG is to provide high-level stakeholder oversight and leadership of the special purpose building project.

The PCG is not controlled by Company X and decisions are made independently from the company.

Company X will not be directly involved in the construction process for the special purpose building. This will be undertaken by external contractors. As one of the requirements of the State Government Grant, the PCG was established to oversee the construction and engage and manage external contractors/providers.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-10

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 subsection 20-20(1)

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 subsection 20-25(1)

Income Tax Assessment Act 1997 section 20-40

Income Tax Assessment Act 1997 subsection 20-40(2)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Reasons for decision

The Federal Government and State Government grants received by Company X will not be assessable as ordinary income to Company X under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an entity's assessable income includes income according to ordinary concepts, called ordinary income. The Federal Government and State Government Grants will not be assessable under section 6-5 of the ITAA 1997 unless they are considered to be ordinary income.

Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business provides the Commissioner's view on the taxation treatment of government payments to industry to assist entities to continue, commence or cease business, including consideration of section 6-5 of the ITAA 1997. TR 2006/3 applies to schemes which involve bounties, subsidies, grants and rebates paid or funded by the Commonwealth or a State, Territory or local government, or government agency.

Section 6-5 of the ITAA 1997 states that your assessable income includes income according to ordinary concepts derived by you as an Australian resident directly or indirectly from all sources, whether in or out of Australia during the income year.

Taxation Ruling TR 2006/3 at paragraph 84, explains that income according to ordinary concepts is not defined in the taxation legislation. The characteristics of ordinary income have been developed by case law and generally fall into three categories:

·         income from providing personal services,

·         income from the use of property, or

·         income from carrying on a business.

Also in TR 2006/3, an example (Example 9) is included of the income tax treatment of government payments in industry (GPI) to commence business. Paragraph 56 of the ruling provides that payments that are preliminary to a business being established are not ordinary income and are therefore not assessable under section 6-5 of the ITAA 1997.

Further, paragraph 139 of the ruling states that a payment 'to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income'. Rather, the payment will be regarded as capital in nature.

The Commissioner recently made an addendum to TR 2006/3 to state at paragraph 15A that a GPI paid with the intention of funding the cost of building or constructing a substantial capital asset, but contingent on the performance of the contract to build or construct the asset, will generally be assessable under section 6-5 of the ITAA 1997 because the GPI will be derived in the course of carrying on a business of building or constructing the asset.

However, it is not considered that Company X is carrying on a business of building or constructing the special purpose building. In fact, Company X will not be directly involved in the construction process for the special purpose building. This will be undertaken by external contractors and Company X does not possess the necessary experience or skill to construct or build the special purpose building. The PCG was established to oversee the construction and will engage and manage the external contractors and providers.

The Government grants are not ordinary income. Whilst they have/will be paid in separate instalments they do not possess the necessary elements of periodicity, recurrence or regularity that are common to receipts of ordinary income.

In addition, the Commonwealth and State Government grants are received to enable Company X to carry out the construction of the special purpose building. This involved preliminary expenses regarding the viability of a special purpose building and the construction of a special purpose building. It is not received from providing personal services, sourced from property or derived from any business activity.

The current business of Company X is the ownership and operation of a sporting team. The revenue of Company X is made up of grants, corporate sponsorship, membership fees, royalties and merchandise sales. This business does not include construction and ownership of a special purpose building. The Government grants received/ to be received, are not to assist with the continuing operations of Company X's business. This is supported by paragraph 85 of TR 2006/3 which states:

A payment which is provided for a purpose which is not part of the recipient's business will not be income in nature.

Paragraph 129 of TR 2006/3 also states;

A GPI to assist with the cost of evaluating whether to commence a business, or to enable a business to commence, are preliminary to establishing a business. As the GPI is preliminary to a business being established it is not ordinarily received in the normal course of trade, or a receipt for which business is being carried on.

Therefore, the grants will not be assessable as ordinary income to Company X under section 6-5 of the ITAA 1997.

Question 2

Summary

No, the Government grants will not be assessable to Company X as statutory income under section 15-10 of the ITAA 1997.

Detailed reasoning

Section 15-10 of the ITAA 1997 relates to bounties and subsidies and provides 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 of the ITAA 1997.

Paragraph 100 of TR 2006/3 states that a bounty or subsidy 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 101 of TR 2006/3 provides that a bounty or subsidy must be related to 'carrying on' the business and not merely for commencing or ceasing a business.

The purpose of the Government grants is to allow Company X to carry out the aims of building the special purpose building that it is for the benefit of the Council's community and so the grant cannot be considered as a subsidy or bounty received in relation to carrying on a business. Whilst Company X will receive the grants for this purpose, all construction work will be undertaken by external contractors and as per our response to Question1, we do not consider that Company X is in the business of construction of a special purpose building.

The Government grants are also not considered to be assessable as ordinary income under section 6-5 of the ITAA 1997 (see response to Question 1).

Therefore, the Government grants will not be assessable to Company X as statutory income under section 15-10 of the ITAA 1997.

Question 3

Summary

The Government grants received by Company X are considered to be an assessable recoupment under Subdivision 20-A of the ITAA 1997

Detailed reasoning

Under Subdivision 20-A of the ITAA 1997, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if amounts are not income under ordinary concepts or assessable income under another provision outside Subdivision 20-A.

Subsection 20-25(1) of the ITAA 1997 defines recoupment of a loss or outgoing inclusively as:

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

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

Subsection 20-20(1) of the ITAA 1997 states that 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.

Subsection 20-20(2) of the ITAA 1997 states that an amount received as recoupment of a loss or outgoing is an assessable recoupment if:

(a)  received by way of insurance or indemnity; and

(b)  you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

In accordance with the definition of recoupment of a loss or outgoing provided in

subsection 20-25(1) of the ITAA 1997 the government grants were amounts received in respect of the recoupment of a loss or outgoing, even if we have determined that the loss or outgoing is on capital account.

In respect of the second requirement the government grants were clearly not received by way of insurance. Therefore, we need to consider if the grants were/will be received by way of indemnity.

The term "indemnity" is not defined in either of the Income Tax Assessment Acts. It therefore must take its ordinary meaning.

The term "indemnity" was recently considered in Denmark Community Windfarm Ltd v. Federal Commissioner of Taxation 2018 ATC 20-646 (Denmark Case). In the Denmark case, the Full Federal Court affirmed the Federal Court decision that a government grant provided to a taxpayer to assist in the cost of acquiring and installing wind turbines was an amount received by way of indemnity as it was compensation for expenditures incurred by the taxpayer. Consequently, the grant was held as an assessable recoupment under subsection 20-20(2) of the ITAA 1997. The Full Court stated at paragraph 39:

. In the present case, the amounts received by Denmark under the Grant were received pursuant to the Agreement dated 18 May 2011. The Agreement provided that the Grant was to meet 50% of the Eligible Project Costs to be incurred by Denmark in the construction of two wind turbines, up to a maximum of $2,487,800. The Grant was payable in instalments on the completion of identified project milestones. In these circumstances, the amounts received by Denmark fell within the ordinary meaning of the word "indemnity", which includes, as noted by the primary judge at [50], "a sum of money paid to compensate a person for liability, loss or expense incurred by the person". The fact that the amounts were a government subsidy or rebate does not affect the position. The amounts nevertheless bear the character of compensation for a liability, loss or expense incurred.

In this case, the State and Federal Governments will/have provided funding in relation to the construction of a capital asset as part of their respective grant programs. The agreement was for the grants to fund most but possibly not all, of the costs incurred in construction of the special purpose building. It is considered these amounts constitute compensation for loss or expense incurred by Company X.

The government grants are intended to reimburse Company X for the expenditure they have or will incur in relation to the construction of the special purpose building. This is demonstrated by the requirement for all funding to be expended and documentation provided of funding expended and milestones reached.

We have therefore determined that for the purposes of the definition of recoupment of a loss or outgoing in subsection 20-25(1) of the ITAA 1997, the State and Federal Government grants paid/payable to Company X are to be a recoupment of a loss or outgoing.

That loss or outgoing has been determined to be by way of "indemnity". Therefore for the purposes of satisfying subsection 20-20(2) of the ITAA 1997 to be an assessable recoupment, Company X must be able to deduct an amount for the loss or outgoing for the current year, or have deducted or can deduct an amount for it for an earlier income year, under any provision of the ITAA 1997.

Company X can deduct an amount for the loss or outgoing under any provision of the Act, namely Division 40 of the ITAA 1997 to the extent that the infrastructure is a depreciating asset and Division 43 to the extent that the infrastructure is capital works.

As the funding received by Company X under the respective State and Federal Government grants will be considered to be an assessable recoupment under subsection 20-20(2) of

the ITAA 1997, it is not necessary to determine whether it would also be an assessable recoupment under subsection 20-20(3). That subsection includes in assessable recoupments amounts received as recoupment of a loss or outgoing except by way of insurance or indemnity for which you can deduct an amount for the loss or outgoing under a provision listed in section 20-30.

Question 4

Summary

Yes, on the basis that the assessable recoupment in any particular year will include all Division 40 and Division 43 of the ITAA 1997 amounts pertaining to the special purpose building. This will be calculated in accordance with the method statement outlined at subsection 20-40(2).

Detailed reasoning

Section 20-40 of the ITAA 1997 provides that if expenditure in relation to the grant is deductible over two or more income years, the total of assessable recoupments to be included in assessable income at a particular time is limited to the amount of 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 in later income years.

Paragraph 140 of TR 2006/3 states in this regard:

To the extent that the GPI is a recoupment of the cost of a 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 of ITAA 1997.

Whilst this quotation is in regard to Division 40 of the ITAA 1997, it should also apply to Division 43 Capital Works deductions made each year by Company X. That is, each year's assessable recoupment will equal the deductions made under both Division 40 and Division 43.

Therefore, the Government Grants will be assessed for tax purposes in accordance with the method statement contained in section 20-40 of the ITAA 1997.

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