Edited version of private advice

Authorisation Number: 1051696037745

Date of advice: 8 June 2020

Ruling

Subject: Income tax - government payments

Question 1

Will the funds, received by Energy Co from the State Fund be assessable to Energy Co as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 ("ITAA 1997")?

Answer

Yes

Question 2

Will the funds, received from the State Fund, be assessable to Energy Co as statutory income under section 15-10 of the ITAA 1997?

Answer

No

Question 3

Will the funds received from the State Fund be assessable to Energy Co as a capital gain under section 102-5 of the ITAA 1997?

Answer

No

Question 4

If the answers to Question 1, Question 2 and Question 3 are 'no', will the funds received from the State Fund be assessable to Energy Co as statutory income under the assessable recoupment rules in Subdivision 20-A of the ITAA 1997?

Answer

Not applicable

Question 5

If the answer to Question 4 results in some of the Funds received (namely those relating to recouped expenses under Division 43 of the ITAA 1997) not being assessable to Energy Co as statutory income under the assessable recoupment rules in Subdivision 20-A of the ITAA 1997, will those Funds instead be cost base adjustments under subsection 110-45(3) of the ITAA 1997?

Answer

Not applicable

This ruling applies for the following period:

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

The scheme commences on:

1 July 2019

Relevant facts and circumstances

1. Head Co has undertaken the development of a Solar Farm since November 2018. The purpose of this Solar Farm was to demonstrate "'mid-scale' solar farms in regional [State]."

2. The Solar Farm will form part of a wider project known as the Solar Garden. A 'solar garden' is a fund-raising method where participants are rewarded with credits on their electricity bill rather than returns on capital (such as dividends).

3. Collectively, the Solar Farm and Solar Garden are referred to as "the Project".

4. Head Co has set up Energy Co (the Company) as a special purpose vehicle to facilitate the continuing development of the Solar Farm and to generate revenue from electricity generated from the Solar Farm. The Company will begin to produce income from its activities once the Solar Farm is constructed and commissioned.

5. According to the Project Summary for the Solar Garden (the Project Summary), "most agreements relating to the maintenance and operation of the physical and non-physical solar farm are held by the [Company]".

6. The Association is an association that has been involved in advocacy relating to solar gardens. The Association and Head Co intend to form a cooperative to carry on the Solar Garden business.

7. The Company is a wholly owned subsidiary of Head Co, however a call option agreement has been entered into allowing for the Association to acquire the entire issued share capital in the Company. The intention is that the call option will be exercised for the benefit of the cooperative.

8. The State Fund provides funding for energy projects benefiting the reliability and affordability of energy for regional State communities. It is an initiative established under State legislation. The Crown in Right of the State acting through the Department administers the State Fund.

9. The Association has secured funding from the State Fund to support the Project. To effect this, the Association and the State Fund entered into a funding agreement (the Funding Agreement).

10. The Funding Agreement requires the Association to construct the Solar Farm and develop the Solar Garden so that it is ready for use.

11. The Funding Agreement structures the payment of funding to the Association based on five milestones towards the development of the Solar Farm and Solar Garden. The funding is given for completion of these milestones and for no other purpose.

12. The payments to be made are:

Milestone 1 - $130,000

Milestone 2 - $300,000

Milestone 3 - $600,000

Milestone 4 - $270,565

Milestone 5 - $20,000

13. The Association and Company entered into a Novation Agreement that assigns the rights and responsibilities of the Funding Agreement of the Association to the Company.

Preliminary Activities

14. A number of development activities have been facilitated by Head Co, including:

feasibility studies;

landholder negotiations;

obtaining planning advice;

concept engineering; and

undertaking a preliminary network connection enquiry.

15. Head Co will continue to facilitate some development activities such as:

negotiating land agreements;

obtaining planning approval;

obtaining network connection approval;

negotiating with contractors and suppliers; and

obtaining insurance for the Company.

The Company will be charged for these services under a project development agreement.

16. Activities the Company has conducted include:

Adopting a constitution;

Issuing ordinary shares;

Entering into a Deed of Novation for the Funding Agreement; and

Applying for a private ruling with the Australian Taxation Office

17. At present, the Company does not have any employees and its only tangible assets are nominal cash.

18. According to the Project Summary:

Concept design and feasibility have been completed for both [the Solar Farm and the Solar Garden]; all that is required is to build these two elements and commence the operation of the solar garden business, all while ensuring the community is participating actively in the design, building, ownership and operation of the emergent business.

The Funding Agreement

19. The recitals to the Funding Agreement give:

The Department agrees to provide the Department Fund, and the Recipient agrees to complete the Project and achieve the Outcomes, in accordance with the terms of this agreement.

20. Clause 4 of the Funding Agreement requires the Recipient to undertake the Project. As a result of the Deed of Novation, it is the Company that is required to undertake the Project.

21. On satisfactory completion of the milestones and payment criteria, the Company needs to make a request for payment in order to receive the funding.

22. The Company is required to spend, or legally commit, the funding received on "eligible expenditure" to be used to complete the project.

23. "Eligible expenditure" is defined in clause 2 of the Funding Agreement as:

expenditure (inclusive of GST but less related input tax credits the Recipient is entitled to claim) incurred by the Recipient on the Project:

1 after the date of this agreement that qualifies as eligible expenditure under the Guidelines; and/or

2 that the Department otherwise approves (in its absolute discretion) as eligible expenditure for the purposes of this agreement;

but excludes expenditure that is:

3 related to Detailed Design and is in excess of 10% of the Department Funding;

4 related to Conceptual Design and Project Feasibility;

5 a fee payable for lodgement of a local council development application; or

6 associated with planning assessments and approvals undertaken by the Department.

24. The Guidelines are defined in clause 1 of the Funding Agreement to be the "State Fund Guidelines".

25. At heading 3.3 "funding considerations" of the Guidelines, it is stated:

Applicants need to be aware that [State Fund] will only fund Eligible Expenditure. Eligible Expenditure will include capital expenditure on technology and equipment costs, grid connection and any civil or construction works.

26. Under clause 24, the Department is able to recover any Funding that is spent or used other than in accordance with the Funding Agreement, or that has not been spent or legally committed by the Company at the earlier of the date the Company performs its obligations or when the agreement is terminated.

27. Clause 11 requires the Company to provide reports and plans to the satisfaction of the Department. This includes meeting the requirements of the Department's Knowledge Sharing Plan.

28. The Department may terminate the Funding Agreement in accordance with its clause 23. The Company does not enjoy any specific rights in the Funding Agreement that allows it to terminate the agreement.

Funding Milestones

29. The first milestone is for "project establishment". The steps to occur in this milestone are:

Signed call option agreement

Evidence that the Certificate of Registration for the SPV has been issued

Submission of a preliminary connection enquiry

Execution of a deed of novation on terms acceptable to the Department transferring all of the Recipient's rights and obligations related to the Project to the SPV in accordance with clause 16.

30. The second milestone is for "early works". The steps to occur in this milestone are:

Signed project development agreement

Signed licence agreement relating to land use

Submission of tax ruling with the Australian Taxation Office together with proof of submission and copy of the tax ruling request

Receipt showing submission of Formation Rules and Disclosure Statement

Provide planning submission documentation

Provide land survey report

Provide geotechnical survey report

A Community Participation Plan

31. The third milestone is for "Financial close and approvals". The steps to occur in this milestone are:

Signed power purchase agreement (PPA)

Signed operations and maintenance agreement

Signed grid connection agreement

Signed EPC Contract

Provide the Workplace Health and Safety Plan

Provide the register of members of the SPV showing that the Recipient (or the Cooperative) holds 100% of the issued share capital of the SPV together with proof that 100% of the community investment has been achieved and the call option agreement has been exercised

Approved development application from relevant local council

32. The fourth milestone is for "Commissioning and operation". The steps to occur this milestone are:

Certificate of practical completion issued to the EPC contractor

PC contractor has submitted a payment claim for the practical completion milestone

Supply of commissioning test report and evidence of three days of full production as per appropriate parameters within the executed connection agreement

Provide final certified detailed design

33. The fifth milestone is for "knowledge sharing". The steps to occur in this milestone are:

Public Project Knowledge Sharing Report

Initial operational data and operational financial information

Sample electricity bill (de-identified) (proof that on-bill credit mechanism has been implemented)

Final Report

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-10

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Section 104-37

Reasons for decision

Reasons for Decision

Question 1

Will the funds, received by Energy Co from the State Fund be assessable to Energy Co as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 ("ITAA 1997")?

Summary

The Funds received by Energy Co are assessable to Energy Co as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

34. Section 6-5 of the ITAA 1997 provides:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

35. 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 regarding the way in which certain provisions, including sections 6-5 and 15-10 of the ITAA 1997, apply to government payments to industry (GPI) to assist entities to commence, continue or cease business.

36. Paragraph 15A of TR 2006/3 provides:

GPI paid with the intention of funding the cost of building or constructing a substantial capital asset, but contingent on the performance of a contract to build or construct the asset, will generally be assessable under section 6-5 because the GPI will be derived in the course of carrying on a business of building or constructing the asset. While this will generally be the case where the entity is a company, it will be a question of scale and degree for other entities. The building or construction of the asset may alternatively be outside the course of business yet be the result of a transaction entered into with the purpose of making a profit.

37. Example 8A in paragraphs 54A - 54C describe a situation where a special purpose vehicle is created to receive a GPI in instalments to construct a renewable energy plant. After construction it will use the plant in the course of an electricity generation business or to lease to a related party for the same purpose. It was considered that in such a situation the GPI instalments were derived in the course of a business of constructing the plant and therefore assessable as ordinary income, as income received from an isolated transaction with a profit making purpose, or as a subsidy under section 15-10 of the ITAA 97.

38. TR 2019/1 Income tax: when does a company carry on a business? provides the following indicia as being relevant to determine if a company carries on a business:

whether the person intends to carry on a business

the nature of the activities, particularly whether they have a profit-making purpose

whether the activities are

- repeated and regular

- organised in a business-like manner, including the keeping of books, records and the use of a system

the size and scale of a company's activities including the amount of capital employed in them, and

whether the activity is better described as a hobby, or recreation.

39. A limited company is typically considered to have been made for the purpose of carrying on a business (see for example Brookton Co-operative Society Ltd v FCT [1981] HCA 28 and Inland Revenue Commissioners v Westleigh Estates Co Ltd [1924] 1 KB 390). While the company's profit-making activities arises after constructed has been completed, this is not an essential factor as given by Bowen CJ and Franki J in Ferguson v Federal Commissioner of Taxation (1979) 26 ALR 307 (Ferguson):

The nature of the activities, particularly whether they have the purpose of profit-making, may be important. However, an immediate purpose of profit-making in a particular income year does not appear to be essential. Certainly it may be held a person is carrying on business notwithstanding his profit is small or even where he is making a loss.

40. Completing the Project cannot be considered to be irregular and will not be completed in a manner more properly described as something akin to a hobby. The Company will have to operate systematically doing things such as keeping records in order to meet its reporting requirements under the Funding Agreement. It cannot be said that the activities of the

Company are of a non-commercial nature or that they are inconsistent with a conclusion that it is carrying on a business (such as those considered at paragraphs 36 and 37 of TR 2019/1).

41. In addition, the scale of the Project is significant. While the amount of capital required is significant, it is noted that this is less persuasive for a company than it is regarding a trust for example (Thomas v Commissioner of Taxation (Cth) (1972) 46 ALJR 397; 72 ATC 4094). Despite this, the scope of the Company's operations is not so insignificant or limited in scope that it cannot be considered to be carrying on a business.

42. It is possible for a preliminary business to be carried on, notwithstanding that the ultimate intention of the final business is predicated on engaging in the initial preliminary business. In Ferguson, Bowen CJ and Franki J gave at 313:

Clearly, one method would be to carry on a preliminary business in such a way that he would in due time have his herd of breeding cows so as to enable him to engage in the final business that he intended ultimately to undertake.

43.While the Funding Agreement mostly limits the expenditure to capital assets, ultimately the funding is made to facilitate the completion of the Project. The amount received by the Company from RFEC is contingent on the performance of a contract and not to allow the Company to commence an energy generation business.

44. It is therefore necessary to consider at what point the Company will have commenced that business.

45. In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320, Justice Hill provided:

...the relationship must be to the "carrying on" of the business. These words may perhaps be understood in opposition to a relationship with the actual business itself. They would make it clear, for example, that a bounty received, merely in relation to the commencement of a business or the cessation of the business, would not be caught. The expression "carrying on of the business" looks, in my opinion, to the activities of that business which are directed towards the gaining or producing of assessable income, rather than merely to the business itself.

46. This is considered in ATO ID 2010/38 (Withdrawn) Income Tax: Bounty and subsidies: financial assistance received in commencing a business - whether received 'to commence a business'. While this ATO ID has been withdrawn, it was done so because it was a straight interpretation of the law and not because it was incorrect or does not represent the ATO view.

47. ATO ID 2010/38 provides:

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. If there is a real connection, whether direct or indirect, between the bounty or subsidy and the carrying on of a business, it would be received in relation to carrying on a business.

Thus, a grant that is received in relation to an activity that is integral to carrying on a business (such as the acquisition of an asset that is necessary for the business) is received in relation to carrying on a business even though the activity may be carried out soon after the business commences and is preparatory to and not directly productive of assessable income.

In the present case, the grant was not to assist the taxpayer to reach the necessary point where it could be said that the taxpayer was committed (and such commitment was demonstrated in its activities) to proceed with the implementation of its purpose to carry on a business. The taxpayer was incorporated for the specific purpose of undertaking a project that included the design, procurement, construction and operation of an infrastructure asset and assumed responsibility for delivering the project through its activities soon after its incorporation. It is considered that the taxpayer commenced carrying on the business of delivering the project from that point in time. While the receipt of the grant was important

and assisted the taxpayer to carry on its business, the commencement of its business was not dependent upon the receipt of the grant. Accordingly, the receipt of the grant is not received to commence a business.

48. Based on the representations made in the Project Summary, the activities that must be completed under the Funding Agreement do not go to the feasibility of the Project. The Company is not merely considering whether or not it should commence its business but has made the determination that it will undertake business activities.

49. The Company will already be committed to implementing its purpose to carry on a business. This is because by deciding to enter into the novation agreement the Company has committed itself to completing the milestones. This commitment is not conditional on receiving the funding, because funding is only paid in instalments based on the completion of the milestones.

50. The circumstances of the Company are therefore differentiated from example 9 of TR 2006/3 which presents a situation where an entity receives a GPI to assist them in undertaking market research, feasibility studies or preparation of business plans for operation in another industry. In that situation, the GPI is considered to be received to commence business.

51. However, the circumstances surrounding the Company are similar to the facts presented in example 8A. The Company will be carrying on a business throughout the completion of the Project rather than after the project has been completed. It is therefore necessary to consider if the receipt has the nature of being income according to ordinary concepts.

52. The characteristics of ordinary income have been developed by case law and generally fall into three categories:

income from providing personal services;

income from property; or

income from carrying on a business.

53. 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.

54. The amounts payable under the Funding Agreement will be earned and are expected to be paid. The funding received for completing certain milestones are ultimately used to carry out its business and are therefore relied upon. However, the amounts payable under the Funding Agreement lack periodicity, recurrence and regularity.

55.While periodicity, recurrence and regularity are influential factors, they are of diminished value when generated in the context of carrying on a business. The unanimous decision of the High Court in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 at 215 in discussing periodicity, regularity and recurrence gave:

...valuable though these considerations may be in categorizing receipts as income or capital in conventional situations, their significance is diminished when the receipt in question is generated in the course of carrying on a business, especially if it should transpire that the receipt is generated as a profit component of a profit-making scheme. If the profit be made in the course of carrying on a business that in itself is a fact of telling significance.

56. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124, the appellant received amounts from a government department that were applied towards capital assets. The High Court held that the amounts were received as part of the appellant's assessable income on the basis that there was no contingent sale of a capital asset by the taxpayer, and that the amount was not dissociated from the taxpayer's business.

57.While lacking periodicity, recurrence and regularity, the amount received is ultimately payable on the performance of a contract to be completed in the course of carrying on a business. It has the character of income in the hands of the Company despite being restricted to use on capital assets. The amounts received from the State Fund under the Funding Agreement are therefore assessable under section 6-5.

58. Alternatively, because the Company's situation is in line with example 8A of TR 2006/3, the amount received would be assessable as amounts derived from an isolated transaction entered into with a profit-making intention.

Question 2

Will the funds, received from the State Fund, be assessable to Energy Co as statutory income under section 15-10 of the ITAA 1997?

Summary

The Funds received by Energy Co are not assessable to Energy Co as statutory income under section 15-10 of the ITAA 1997.

Detailed reasoning

59. Section 15-10 of the ITAA 1997 states:

Your assessable income includes a bounty or subsidy that:

- you receive in relation to carrying on a *business; and

- is not assessable as *ordinary income under section 6-5.

60. 'Subsidy' is not defined in the taxation laws and instead takes its ordinary meaning. A subsidy is defined in The Macquarie Dictionary online to mean:

a grant by a government to a company, organisation or individual, for which it receives nothing in return.;

a sum paid, often in accordance with a treaty, by one government to another, to secure some service in return; and

any grant or contribution of money towards the cost of some purchase or endeavour.

61.Windeyer J described a subsidy in Placer Development Ltd v. Cth (1969) 121 CLR 353 at 373 as an:

...aid provided by the Crown [government] to foster or further some undertaking or industry

62. The State Fund grant is a State initiative established under State legislation.

63. The State Fund grant falls within the definition of a subsidy. As outlined above, the grant will be received in relation to carrying on a business but will be assessable as ordinary income under section 6-5 of the ITAA 1997.

64. Therefore, the State Fund grant will not be assessable under section 15-10 of the ITAA 1997.

Question 3

Will the funds received from the State Fund be assessable to Energy Co as a capital gain under section 102-5 of the ITAA 1997?

Summary

The Funds received by Energy Co are not assessable to Energy Co as a capital gain under section 102-5 of the ITAA 1997.

Detailed reasoning

65. Section 102-5 of the ITAA 1997 gives:

Your assessable income includes your net capital gain (if any) for the income year.

66. Section 104-25 of the ITAA 1997 states: (1) CGT event C2 happens if your ownership of an intangible *CGT asset ends by the asset:(a) being redeemed or cancelled; or

(b) being released, discharged or satisfied; or ...

(2) The time of the event is: (a) when you enter into the contract that results in the asset ending; or

(b) if there is no contract - when the asset ends.

(3) You make a capital gain if the *capital proceeds from the ending are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's *reduced cost base.

67. In order to receive the funds for completing the milestones under the Funding Agreement, the Company must request payment of the funding after completion of a milestone. As such, when the Company completes a milestone it holds an intangible asset being the right to payment of the funding.

68.When the funding is paid, it is in satisfaction of that intangible asset and CGT event C2 occurs.

69. Section 118-37 of the ITAA 1997 gives:

(2) A *capital gain or *capital loss is 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. 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...

70. 'Australian government agency' is defined in subsection 995-1(1) of the ITAA 1997 as being: (a) the Commonwealth, a State or a Territory; or

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

71. The State Fund is administered by the State, acting through the Department. Therefore, the State Fund is a scheme established by an Australian government agency.

72. As a result, any capital gain or loss received by the Company with respect to the Funding Agreement will be disregarded by subsection 118-37(2) of the ITAA 1997.

73. In the alternative, section 118-20 of the ITAA 1997 would apply as any capital gain would already be included in the Company's assessable income as outlined above.

Question 4

If the answers to Question 1, Question 2 and Question 3 are 'no', will the funds received from the State Fund be assessable to Energy Co as statutory income under the assessable recoupment rules in Subdivision 20-A of the ITAA 1997?

Summary

This question is not applicable because answers to question 1 is 'yes'.

Question 5

If the answer to Question 4 results in some of the Funds received (namely those relating to recouped expenses under Division 43 of the ITAA 1997) not being assessable to Energy Co as statutory income under the assessable recoupment rules in Subdivision 20-A of the ITAA 1997, will those

Summary

This question is not applicable as there was not an applicable answer to question 4.

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