Edited version of private advice

Authorisation Number: 1051829261228

Date of advice: 22 April 2021

Ruling

Subject: Grants and recoupments

Question 1

Are the grant monies received by the taxpayer from the Government Programmes assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are the grant monies received by the taxpayer from the Government Programmes assessable as statutory income under section 15-10 of the ITAA 1997?

Answer

No

Question 3

If the taxpayer incurs capital expenditure with the grant monies in respect of which it claims depreciation deductions under Division 40 of the ITAA 1997, will such amounts be an assessable recoupment under section 20-20 of the ITAA 1997?

Answer

Yes

Question 4

Is the taxpayer entitled to add the costs of constructing certain public works to the fourth element of the CGT cost base of the accommodation rooms, restaurant and food facility, retail centre and adventure hub?

Answer

Yes

Question 5

Will the taxpayer be required to reduce the cost base of the relevant assets referred to in question 4 by the amount of the grant monies received?

Answer

Yes

Question 6

Will the taxpayer be entitled to claim an amount for capital works under Division 43 of the ITAA 1997 for project costs incurred on public works to be delivered to obtain the grant monies and council development approval?

Answer

Yes

This ruling applies for the following period(s)

Year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The Unit Trust (DIUT) was established by trust deed on XX/XX/XXXX.

Company X (the Trustee) is the trustee for the unit trust.

The Trustee owns land in XXXX.

The Trustee is in the process of building a tourism accommodation and activity facility on the land. This will consist of accommodation rooms, a restaurant, adventure hub and a retail centre, as well as public infrastructure.

The Trustee plans to conduct short-stay accommodation and activities business from the facilities once construction is completed. Construction is expected to be competed some-time in 20XX.

The Trustee has been awarded Government Grant monies to assist with the construction of this facility.

The first grant is subject to the conditions set out in the Grant Agreement with a commencement date of XX/XX/XXXX and a completion date of XX/XX/XXXX. Pursuant to the Grant Agreement:

•         the grant is stated to be made for the purpose of promoting economic development of the area.

•         receipt of the grant monies is conditional on the Trustee applying the monies solely for the purposes of the 'Project'. This is described as 'the construction of an accommodation facility and amenities.

•         the grant monies are payable in three instalments each subject to completion of 'Payment Deliverables' referable to stages of planning and construction.

The Payment Terms of the Grant Agreement states that Payments will be made twice a year in arrears upon successful completion of the Payment Deliverables.

The Trustee has received the full amount payable even though not all the milestone conditions have been fully:

On XX/XX/XXXX, the Trustee was awarded a second grant to carry out the Project in accordance with the Project Plan and to use the Grant only for the purposes of the Project. The Project establishes an integrated tourism facility on the land owned by the Trustee with several on site components:

Furthermore, the Project was required to deliver improvements to public infrastructure.

The Trustee committed to expending not less than $XX million of Project Expenditure.

Payments were to be made in instalments upon the Trustee carrying out and completing the Project in accordance with the Project Delivery Milestones.

Information provided

You have provided the following documents in relation to the ruling request:

(a)          your private ruling application received on XX/XX/XXXX, and

(b)          supplementary information provided via email on XX/XX/XXXX.

Relevant legislative provisions

Income Tax Assessment Act 1997, Section 6-5

Income Tax Assessment Act 1997, Subsection 6-5(1)

Income Tax Assessment Act 1997, Section 15-10

Income Tax Assessment Act 1997, Section 20-20

Income Tax Assessment Act 1997, Subsection 20-20(1)

Income Tax Assessment Act 1997, Paragraph 20-20(1)(b).

Income Tax Assessment Act 1997, Subsection 20-20(2)

Income Tax Assessment Act 1997, Paragraph 20-20(2)(b)

Income Tax Assessment Act 1997, Subsection 20-20(3)

Income Tax Assessment Act 1997, Subsection 20-25(1)

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, Section 43-20

Income Tax Assessment Act 1997, Subsection 43-20(2)

Income Tax Assessment Act 1997, Subsection 43-20(3)

Income Tax Assessment Act 1997, Subsection 43-70(1).

Income Tax Assessment Act 1997, Subsection 43-75(1)

Income Tax Assessment Act 1997, Section 110-25

Income Tax Assessment Act 1997, Subsection 110-25(5)

Income Tax Assessment Act 1997, Subsections 110-45(3)

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Are the grant monies received by the taxpayer assessable as ordinary income under section 6-5?

Summary

The grant monies received by the Trustee will not be assessable as ordinary income to the Trustee under subsection 6-5(1).

Detailed reasoning

Subsection 6-5(1) provides that an entity's assessable income includes income according to ordinary concepts, called ordinary income. Therefore, for the grant monies to be assessable to the Trustee under subsection 6-5(1), the grant monies must be considered to be ordinary income. Furthermore, the ordinary income must be derived directly or indirectly from all sources during the income year by an Australian resident.[1]

There is no definition of 'ordinary income' in the income tax legislation. 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. Paragraph 84 in TR 2006/3 states:

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.

Example 9 in TR 2006/3 sets out the Commissioner's view on whether Government Payment Initiatives (GPI) paid to assist research of new business opportunities is ordinary income and assessable under section 6-5. Paragraph 56 of TR 2006/3 says that payments that are preliminary to a business being established are not ordinary income and nor assessable under section 6-5.

Further, paragraph 139 of TR 2006/3 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 issued 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. This is 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 the Trustee is carrying on a business of building or constructing the accommodation and facilities buildings. In particular, the Trustee will not be directly involved in the construction process for the accommodation and facilities buildings, which will be undertaken by external contractors. The Trustee does not possess the necessary experience or skill to construct or build the accommodation and facilities buildings.

The grants are not considered to be 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 two grants are received to enable the construction of the accommodation and facilities buildings. It is not received from providing personal services, sourced from property or derived from any business activity.

The Trust does not have a current business and will operate the accommodation and facilities buildings after the Project has been completed. Support is obtained from paragraph 85 of TR 2006/3 which says that 'a payment which is provided for a purpose which is not part of the recipient's business will not be income in nature.'[2]

Therefore, the grants will not be assessable as ordinary income to the Trustee under subsection 6-5(1).

Question 2

Are the grant monies received by the taxpayer assessable as statutory income under section

15-10?

Summary

The grant monies will not be assessable to the Trustee as statutory income under section 15-10.

Detailed reasoning

Section 15-10 states:

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.

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 two grants is to allow the Trustee to build accommodation and facilities to benefit and encourage tourism in the area of the land. As previously stated, the Trustee is not in the business of building or constructing the accommodation and facilities buildings. External contractors will construct or build the accommodation and facilities buildings, as the Trustee does not possess such experience or skills. Therefore, the grant monies will not be received in relation to carrying on a business for the purposes of paragraph 15-10(a).

As previously established in Question 1, the two grants are not considered to be assessable as ordinary income under section 6-5.

Therefore, the two grants will not be assessable to the Trustee as statutory income under section 15-10.

Question 3

If the taxpayer incurs capital expenditure with the grant monies in respect of which it claims depreciation deductions under Division 40, will such amounts be an assessable recoupment under section 20-20?

Summary

Where the Trustee incurs capital expenditure using the amounts received from the two grants and claimed deductions under Division 40, such amounts are assessable recoupments under subsection 20-20(2), as the amounts received is a recoupment of a loss or outgoing by way of an indemnity.

Detailed reasoning

Subsection 20-20(1) 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.

In Questions 1 and 2 above, it has been determined that the monies received from the two grants are not assessable as either ordinary income or statutory income.

Subsection 20-20(2) 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.

Subsection 20-25(1) states:

Recoupment of a loss or outgoing includes:

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

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

The Explanatory Memorandum to the Tax Law Improvement Bill 1996 states that the ordinary meaning of 'recoupment' encompasses any type of compensation for a loss or outgoing.

As the Trustee is receiving the 'grants' to expend on the tourism precinct, it will fall within the definition of 'recoupment'.[3]

For the purposes of subsection 20-20(2), for the recoupment to be an assessable recoupment, the grant monies have to be received by way of insurance or indemnity.

From the information provided, the grant monies were not received by way of insurance. It therefore needs to be determined if the grant monies were received by way of indemnity.

As 'indemnity' is not defined in either of the Income Tax Assessment Acts, it therefore take its ordinary meaning. The term 'indemnity' was considered in Denmark Community Windfarm Ltd v. FC of T 2018 ATC 20-646 (Denmark case). The Full Federal Court held that the meaning of the word 'indemnity' included 'a sum of money paid to compensate a person for liability, loss or expense incurred by the person' or 'compensation for damage or loss sustained' and 'something paid by way of such compensation'. The fact that the amounts were a government subsidy or rebate did not affect that position. The amounts bore the character of compensation for a liability, loss or expense incurred, The Full Federal Court held that the 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).

In the present case, the Trustee received the two Government grants to help reimburse the Trustee for the expenditure they have or will incur in relation to establishing a tourism facility; that included constructing accommodation, core infrastructure, services, restaurant and adventure hub. It is considered the grant monies constitute compensation for loss or expenses incurred by the Trustee and therefore received by way of 'indemnity for the purposes of paragraph 20-20(1)(b).

The second requirement in paragraph 20-20(2)(b) requires the Trustee to be able to deduct an amount for the loss or outgoing for the current year, or an earlier income year, under any provision of the ITAA 1997. In the Denmark case, it was held that the fact that the taxpayer claimed deductions under a certain provision, when it could have claimed deductions for the same expense under a different provision, did not preclude the assessability of the recoupment.

Where the Trustee incurs capital expenditure with the grant monies and claims depreciation deductions under Division 40 in the current or earlier income year will result in the second requirement in paragraph 20-20(2)(b) being satisfied.

As both requirements in subsection 20-20(2) have been satisfied means that the amounts received from the two grants is an assessable recoupment.

Alternatively, the two grants would be considered to be an assessable recoupment under subsection 20-20(3) if the amounts were not received by way of indemnity, as Division 40 is one of the provisions listed in section 20-30.

Question 4

Is the taxpayer entitled to add the costs of constructing certain public works to the fourth element of the CGT cost base of the accommodation rooms, restaurant and food facility, retail centre and adventure hub that is known as the Facility?

Summary

The Trustee is entitled to add the costs of constructing public works to the fourth element of the CGT cost base to the extent the costs increase or preserves the Facility's assets.

Detailed reasoning

Section 110-25 sets out the five elements of the cost base of a CGT asset. The most relevant element of the cost base to the costs referred to in your question is the fourth element. Subsection 110-25(5) states:

The fourth element is capital expenditure you incurred:

(c)           the purpose or the expected effect of which is to increase or preserve the asset's value; or

(d)          that relates to installing or moving the asset

For expenditure to fall within the fourth element, the expenditure must be of a 'capital nature'.

The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.1) Bill 2006 (the EM), which expanded the scope of subsection 110-25(5) states at paragraph 2.141:

The first change is that it is no longer necessary that the purpose of the expenditure be to increase the asset's value. Instead, it is now sufficient that the purpose or expected effect be to increase or preserve the asset's value. An example of expenditure that would now qualify for inclusion in the fourth element would be legal and other expenses incurred to preserve the value of a rental property by opposing a nearby development that would adversely affect the rental property's value. Another example would be the costs incurred in unsuccessfully applying for zoning changes.

Pursuant to the second grant, the Trustee is required to deliver specific improvements to public infrastructure:

Whether the costs incurred by the Trustee in delivering the above improvements fall within the fourth element of the cost base is a question of fact. For example, an upgrade to 3 phase power supply to the Facility would fall within the fourth element of the cost base but not to any upgrade to 3 phase power supply to the township. That is, any capital expenditure incurred by the Trustee with the purpose or the expected effect of which is to increase or preserve the asset's value will form part of the cost base of the Facility's assets under subsection 110-25(5).

Question 5

Will the taxpayer be required to reduce the cost base of the relevant assets referred to in question 4 by the amount of the grant monies received?

Summary

The Trustee will be required to reduce any element of the cost base of the relevant assets by the amount of the grant money received that formed part of any element of the cost base.

Detailed reasoning

Subsections 110-45(3) states:[4]

Expenditure does not form part of any element of cost base to the extent of any amount you have received as *recoupment of it, except so far as the amount is included in your assessable income.

Subsection 20-25(1) states:

Recoupment of a loss or outgoing includes:

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

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

As determined in Question 3, the grant monies are considered to be a recoupment of a loss or outgoing and included in assessable income as an assessable recoupment. Therefore, any expenditure can be included in any element of the cost base where the grant money has been included in assessable income as an assessable recoupment.

Question 6

Will the taxpayer be entitled to claim a deduction for capital works expenditure under Division 43 for project costs incurred on public infrastructure works to be delivered to obtain council development approval?

Summary

Whilst the capital expenditure was not incurred by the Trustee on land it owns, the capital expenditure was incurred to obtain council approval to build the Facility. The costs incurred in undertaking the public infrastructure works is considered 'in respect of' the construction of the capital works and therefore to fall within the definition of 'capital expenditure' in subsection 43-70(1).

Notwithstanding that the capital works on undertaking the upgrades are on public land adjoining the Trustee's land, the works are regarded as construction expenditure attributable to a 'construction expenditure area' in respect of that taxpayer under Division 43.

Detailed reasoning

Division 43 provides an allowable deduction for certain capital expenditure on assessable income producing buildings and other capital works.

In general terms, a deduction cannot be claimed in respect of an amount of capital works expenditure that qualifies for a capital works deduction pursuant to Division 43 under any other provision of either of the Income Tax Assessment Acts.

A capital works deduction is only available for expenditure on the kinds of capital works broadly categorised under three headings in section 43-20, as follows:

(a)          buildings

(b)          structural improvements, and

(c)           environmental protection earthworks

To obtain Council Development Approval specific public infrastructure had to be upgraded to certain specifications pursuant to the Planning Permits.

Given the public infrastructure works under consideration, the relevant capital works heading is 'Structural Improvements'. As the term 'Structural improvements' is not defined in subsection 43-20(2), it will take its ordinary meaning. However, subsection 43-20(3) does provide the following examples:

Some examples of structural improvements are:

(a)          sealed roads, sealed driveways, sealed car parks, sealed airport runways, bridges, pipelines, lined road tunnels, retaining walls, fences, concrete or rock dams and artificial sports fields, and

(b)          earthworks that are integral to the construction of a structural improvement (other than a structural improvement described in subsection (4)). For example, embankments, culverts and tunnels associated with a runway, road or railway.

The upgrades listed on the Planning Permit (the upgrades) are considered Structural Improvements under subsection 43-20(3) and fall within the definition of capital works. However, you can only deduct an amount for capital works if the capital works have a construction expenditure area. Subsection 43-75(1) provides that for capital works to have a construction expenditure area, the construction expenditure must have been incurred by an entity that, at the time the construction expenditure was incurred, was to own or lease the capital works.

To obtain Council approval to build the Facility, the Trustee was required to commit to upgrading public infrastructure that was not on their land. These upgrades were required to improve road use and accessibility to the Facility. That is, the upgrades are on public land and not on land owned by the Trustee. Therefore, the Trustee would not be able to claim a deduction for the capital works for construction expenditure not incurred on land it owned or leased.

However, a deduction for capital works under Division 43 is based upon the amount of 'construction expenditure', which is defined in subsection 43-70(1) as:

Construction expenditure is capital expenditure incurred in respect of the construction of capital works.

The phrase 'in respect of' in subsection 43-70(1) is a factor to take into account when determining if an amount qualifies as construction expenditure. The breadth of the words 'in respect of' indicates some connection or relation between the expenditure and the construction of the capital works. It is not only expenditure in constructing the new cabins, but also expenditure incurred 'in respect of' the construction of the Facility that will qualify for a deduction under Division 43.

The Joint Explanatory Memorandum to the Income Tax Assessment Bill 1996 and Taxation Ruling TR 97/25 provide examples of construction expenditure that support this reading of subsection 43-70(1). Paragraph 9 in TR 97/ relevantly states:

We consider that construction expenditure includes:

- preliminary expenses such as architecture fees, engineering fees, foundation excavation expenses and costs of building permits; (emphasis added)

- ...

The term 'building permits' is not defined in the legislation nor is a definition given in TR 97/25. Therefore, it would take its ordinary meaning. It is considered that the ordinary meaning of 'building permits' is interchangeable with 'Construction Certificate', 'development application approval' or 'planning approval' and like terms which grant permission to undertake capital works. The Commissioner is of the view a 'Planning Permit' that includes building and other requirements to be met to obtain Council approval would fall within the term 'building permits' for the purposes of TR 97/25. Therefore, the expenditure incurred by the Trustee for the public works required by the Council is considered to be construction expenditure.

In the present case, the Trustee would not have received council approval to build the Facility without agreeing to undertake the upgrades to public works. These enforceable requirements are set by council and must be completed as part of the Facility, thus are considered to be costs that flowed as a direct consequence of constructing the various buildings. There is a sufficient connection between the expenditure and the construction of the various buildings.

Accordingly, the capital expenditure incurred to do the upgrades is considered to be in respect of the construction of the various buildings and is construction expenditure as defined in subsection 43-70(1).

Notwithstanding that the capital works on undertaking the upgrades are on public land adjoining the Trustee's land, the works are regarded as construction expenditure attributable to a 'construction expenditure area' in respect of that taxpayer under Division 43. Thus, any deductions that are allowable to the taxpayer will arise upon the completion of the construction of the various buildings and apply for any income year during which the Trustee uses the area for the purpose of producing assessable income.

[1] Subsection 6-5(2)

[2] Reckitt & Colman Pty Ltd v FC of T (1974) 74 ATC 4185 at 4187 per Mahoney J.

[3] Paragraph 20-25(1)(b)

[4] Where the reduced cost base is involved refer to subsection 110-55(6)

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