Edited version of private advice

Authorisation Number: 1051758854057

Date of advice: 28 September 2020

Ruling

Subject: Assessable income

Question 1

Is the Funding assessable to the Company under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does the receipt of the Funding give rise to a capital gain for the Company?

Answer

Yes

Question 3

Would any capital gain made by the Company in respect of the Funding be disregarded under paragraph 118-27(2)(a) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

8 May 20XX

Relevant facts and circumstances

The Agreement

The Company entered into the Agreement with X to construct a facility.

Under the Agreement, X has committed funding to the Company which resulted from a scheme established by a Government authority, to construct the facility (Funding).

The Agreement provides for a number of funding milestones, where the Funding will be provided by X to the Company once certain project milestones are met.

Funding provided by X will only cover expenses incurred by the Company in constructing and operating the facility for a defined period.

A Government authority will have free use of the station for a defined period. Currently there is no agreement between the Company and the Government authority for use of the facility beyond this time however preliminary discussions have commenced.

The Agreement provides that all equipment and other items purchased with the Funding become the sole property and responsibility of the Company.

Further, any intellectual property created by the Company in the course of, or in connection with the performance of the Agreement remains the property of the Company.

The Agreement provides the Company the right to novate its rights and obligations under the Agreement to a related entity which has the financial and technical capacity to perform such rights and obligations.

Construction of the facility commenced in in the 20XX financial year, although construction was paused due to COVID-19 restrictions.

The facility will be available for public use.

The Company and its related entities view this project as providing an opportunity to further research and develop technology in the relevant industry, and explore its feasibility in the Australian market. In addition to the funding provided by X, the Company has contributed some money and resources (including staff) of its own to ensure the success of the demonstration.

Entities related to the Company have interests in similar industries.

The Company's related entities have assisted with other projects in the relevant industry and invested in the industry previously.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

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

Reasons for Decision

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income is income according to ordinary concepts. Although the expression 'income according to ordinary concepts' is not defined in the ITAA 1997, there is a substantial body of case law from which a number of factors have been drawn to determine whether an amount has the character of income according to ordinary concepts.

ATO policy concerning government payments to industry (GPI) is set out in Taxation Ruling TR 2006/3 (TR 2006/3). Broadly speaking, a GPI is assessable under section 6-5 of the ITAA 1997 (as ordinary income) or under section 15-10 if it is given to an entity to continue its business. On the other hand, a GPI is not assessable under either section 6-5 or section 15-10 if the payment is given to an entity to commencebusiness.

Paragraph 15A of TR 2006/3 states that:

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.

This is demonstrated by Example 8A of TR 2006/3:

54A. To support investment in renewable energy, the government offers a GPI with the intention of reimbursing part of the cost of constructing renewable energy plants. A corporate group which carries on an energy generation business undertakes preliminary work in respect of securing a GPI from the government. A special purpose vehicle (SPV) is then created within the group to receive the GPI and perform the relevant construction activities required under a contract with the government to receive the GPI. Before construction begins, the GPI is paid as a lump sum into a bank account to which the government and the SPV are joint signatories. Under the contract, upon the SPV satisfying each of a series of construction milestones for the construction of the plant, the government undertakes to allow the SPV to drawdown an instalment of the GPI funds. After construction is completed the SPV will either use the plant in the course of an electricity generation business of its own or lease the plant to a related party for use in the course of the related party's energy generation business.

54B. The GPI instalments are derived by the SPV for performance of the obligations under the contract relating to the construction of the plant. The instalments are therefore received in the course of a business of constructing the plant and are therefore assessable under section 6-5 in the income years in which the instalments are derived. Alternatively, the GPI instalments may be considered to have been derived from an isolated transaction entered into with an intention to profit.

54C. If the GPI is not ordinary income of the SPV, it is assessable under section 15-10 in the income year in which it is received.

Carrying on a business

Taxation Ruling TR 97/11 provides the Commissioner's views on what constitutes 'the carrying on of a business'. At paragraph 13 the following indicators are outlined:

·         whether the activity has a significant commercial purpose or character...

·         whether the taxpayer has more than just an intention to engage in business...

·         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity...

·         whether there is repetition and regularity of the activity...

·         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business...

·         whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit...

·         the size, scale and permanency of the activity..., and

·         whether the activity is better described as a hobby, a form of recreation or a sporting activity...

In considering these indicators against the facts of each case the Commissioner recognises that no one indicator is conclusive. The determination of the question is a matter of fact and degree and is generally the result of a process of weighing all the relevant indicators.

Significant commercial purpose or character

The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. A way of establishing that there is a significant commercial purpose or character is to compare the activities with those of a taxpayer who is carrying on a similar activity that is a business. Any knowledge, previous experience or skill of the taxpayer in the activity, and any advice taken by the taxpayer in the conduct of the activity should also be considered.

Purpose and prospect of profit

This factor requires an examination of whether objectively there is a real prospect of making a profit from the relevant activity. The intention of making a profit can be contrasted with the actual realisation of profit and it cannot be concluded that there is no business because there is no profit. However, profit motive is only seen as one factor and its absence does not necessarily mean that a taxpayer cannot be carrying on a business as indicated in IRC v Incorporated Council of Law Reporting for England and Wales (1889) LR 22 QBD 279 per Lord Coleridge at 293.

Viewed another way, it is the overall purpose that is relevant, not the purpose of a particular transaction or event. Thus, in Ferguson v FCT (1979) 37 FLR 310; 9 ATR 873; 79 ATC 4261 the taxpayer was successful in claiming deductions because of his long-term plans for commercial viability.

Where a taxpayer undertakes a transaction with the intention of achieving financial gain, it will not matter that the chances of doing so are extremely slim (Glennan v FCT (1999) 90 FCR 538; 41 ATR 413).

Size, scale and permanency

The larger the scale of the activity, the more likely it is that the taxpayer is carrying on a business. However, this is not conclusive as a person may carry on a business in a small way. As the size or scale of the activity is not determinative, it is important that this indicator not be considered in isolation, but rather in conjunction with the other indicators.

Application to your circumstances

In this case, a significant amount of capital has been committed to the construction of the facility; beyond what would could be reasonably expected from a project that served no commercial purpose. Entities related to the Company have considered and assisted in other projects in the relevant industry previously, indicating there has been a significant level of prior knowledge or research to have taken place prior to entering into the Agreement.

The construction of the facility has been entered into in a business-like manner, given the formal nature of the Agreement and the Funding. A significant level of record-keeping would be required to meet the requirements of the Agreement. Employees from related entities will be engaged as contractors or via secondment in relation to the construction and operation of the facility.

You have contended that the likelihood of any significant revenue of being derived from the facility is low. While we appreciate that the prospect of profit may be inhibited in the short to medium term given the initial stages the industry is in; there is no indication or evidence that the prospect of profit in the future is completely removed. We consider that there is potential for future financial gain for the Company; this is supported by the fact that the Company will retain ownership of the refuelling station and any intellectual property that is created in connection with the performance of the Agreement.

There is an element of repetition, as the Company has also acquired other assets related to the industry. You have advised that these assets derive minimal revenue, however as discussed above a business can be carried on in a small scale.

Accordingly, after weighing up the business indicators and the objective facts surrounding your circumstances, we consider that the Company is carrying on a business and in line TR 2003/6 the Funding will be assessable under section 6-5 of the ITAA 1997.

Capital gains tax

Section 104-25 of the ITAA 1997 deals with cancellation, surrender and similar endings to CGT assets - CGT event C2. GCT event C2 occurs when the ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. This would occur when a taxpayer's rights under an agreement come to an end; generally at the time the taxpayer's obligations have been discharged and the taxpayer receives payment.

A capital gain occurs if the capital proceeds from the ending of the rights are more than the asset's cost base.

CGT exemption under paragraph 118-37(2)(a)

Paragraph 118-37(2)(a) of the ITAA 1997 provides, in part, that a capital gain may be disregarded if you make it as a result of receiving a payment as reimbursement or payment of your expenses under a scheme established by an Australian government agency or local governing body.

In relation to this paragraph, the Revised Explanatory Memorandum (EM) in relation to the Tax Laws Amendment (2006 Measures No. 3) Act 2006 provides that the requirement that 'the scheme be established under an enactment or an instrument of a legislative character would be satisfied where the scheme is established that way either expressly or by necessary implication. An enactment would include an Appropriation Act (or equivalent) having regard to associated documentation such as budget papers. An instrument of a legislative character would include regulations (and similar instruments) and local government by-laws.'

The Company has acquired a legal right as a result of entering into the Agreement, being the right to receive the Funding. The right is a CGT asset as defined under subsection 108-5(1) of the ITAA 1997.

CGT event C2 will occur when the right is extinguished which is when the right is satisfied by the Company receiving the Funding. However, in accordance with paragraph 118-37(2)(a) of the ITAA 1997 and capital gain made by the Company will be disregarded, as the payments will be made under a scheme established by a Government agency.

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