Edited version of private ruling

Authorisation Number: 1011575068642

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Ruling

Subject: government grant

1. Will the Commonwealth funds that are received by you under the Program, that are to be used for the improvements to your own works, be assessable to you as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No.

2. Will the Commonwealth funds received by you under the Program that are to be used for the improvements to your own works be assessable as statutory income under section 15-10 of the ITAA 1997?

No.

3. Will the Commonwealth funds received by you under the Program that are to be used for the improvements to your own works be assessable as a capital gain under section 102-5 of the ITAA 1997?

No.

4. Will the Commonwealth funds received by you under the Program that are to be used for the improvements to your own works be an assessable recoupment under Subdivision 20-A of the ITAA 1997?

Yes.

This ruling applies for the following periods

Income year ended 30 June 2011

Income year ended 30 June 2012

Income year ended 30 June 2013

Income year ended 30 June 2014

Income year ended 30 June 2015

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Scheme consists of you and an unicorporated association.

You are the legal owner of the real property of the Scheme and have beneficial ownership of this real property. The expenses associated with your existing assets are paid for by the unicorporated association because the assets are held on behalf of it.

The unincorporated association of scheme members has been responsible for the operation of the scheme. The unincorporated association owns the plant and equipment.

The unincorporated association is the business operator of the Scheme as a whole.

The members of the unincorporated association contribute to the running costs of the Scheme.

Under the deed of association, it may appoint you to be agent or trustee with or without remuneration for such purposes as it thinks fit and in particular authorise you to enter into contracts relating to the implementation, maintenance or administration of the Scheme as such agent or trustee.

Program Grant Funding

The Program has been established to acquire rights that arise as a result of certain works undertaken.

You will enter into a funding agreement with the Commonwealth to give effect to the Program. The agreement provides for the acquisition of rights by the Commonwealth.

It was a requirement that the applicant for the funding be a body corporate and as such the unincorporated association was ineligible to apply for funding under the Program.

You amended your rules to facilitate the management of funding. It is anticipated that, if you accept money under Program, your role within the Scheme will be expanded, and you will be the legal and beneficial owner of the new infrastructure.

Under the agreement, part of the funding will be retained and used by you to be applied in accordance with the terms of the funding agreement and the guidelines. The remainder of the funds are for the Proponents in accordance with the agreement and the guidelines.

You will receive the funds for the Scheme upgrade in your own right. You will use the funds for improvement to your own works and actively manage the new works. You will establish a fund to maintain the new works.

The grant funding consists of an initial payment on signing of the Funding Agreement followed by payments on the satisfaction of specific milestones over a period of time.

There is no administration fee for you included in the funding. There are no other fees, commissions, payments or other amounts from the Commonwealth to you for your administration of the Program funding.

You will hold and administer and release funds for the Proponents' projects in accordance with the Funding Agreement and the individual contracts between you and each Proponent.

The Commonwealth may withhold or suspend a payment of funds in whole or in part until you have performed, to the Commonwealth 's satisfaction, your obligations (including the completion of a particular milestone or provision of a particular report) under the Funding Agreement that are preconditions to that payment of funds.

The Commonwealth may also withhold or suspend any part of a funding payment that relates to a Proponent's project until that Proponent has performed the part of its project under its contract with you as a precondition to either the payment of that funding by the Commonwealth to you or the release of that funding provided under the Funding Agreement by you to the Proponent.

You will act as the infrastructure asset custodian.

There is currently no agreement in place between you and the unicorporated association concerning the use of plant and equipment, as you do not own any plant or equipment.

There may be plans in the future for you and the unicorporated association to enter into an arrangement for the unicorporated association to access and use your plant and equipment. An access fee will be payable by the unicorporated association to you. The access fee will be treated as income.

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 118-20

Income Tax Assessment Act 1997 Section 118-24

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

Income Tax Assessment Act 1997 Subsection 104-25(1)

Income Tax Assessment Act 1997 Subsection 104-25(3)

Income Tax Assessment Act 1997 Subsection 104-20(1)

Income Tax Assessment Act 1997 Subsection 110-45(3)

Income Tax Assessment Act 1997 Paragraph 116-20(1)(a)

Income Tax Assessment Act 1997 Section 20-20

Income Tax Assessment Act 1997 Section 20-25

Further issues for you to consider

We have limited our ruling to the questions raised in your application. There may be related issues that you should consider including:

· Grant funds held for Proponents

· Interest on grant funds held for Proponents

· Transfer of rights from the unincorporated association to you

· Transfer of plant and equipment and property from the unincorporated association to you

· Transfer of assets from Proponents to you

You may apply for another ruling on these or any other matters.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Section 6-5 of the ITAA 1997 - income according to ordinary concepts

Subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of 'ordinary income' in income tax legislation it is necessary to apply principles developed by the courts to the facts of a particular case.

The question of whether an amount is a product of the taxpayer's services (that is, paid in consideration of the performance of the taxpayer's services) has been considered in a number of High Court decisions. The following guidance is afforded by those decisions:

· the whole of the circumstances must be considered

· a generally decisive consideration is whether the receipt is the product in a real sense of any employment of, or services rendered by the recipient, or of any business, or any revenue production activity carried on by the recipient, and

· other considerations that are relevant, but not decisive include:

o the motive of the donor (payer) in paying the amount

o the regularity and periodicity of the payment however a payment in a lump sum does not require a conclusion that the payment is capital, and

o the recipient's expectation that an amount will be received.

We consider that, having regard to you objects and how your activities correspond to these objects you will be carrying on a business that includes:

(a) administration of the Program funding for Proponents

(b) renewing, upgrading or installing new infrastructure for your own use

(c) ownership and operation and maintenance of the infrastructure, and

(d) provision of the use of plant and equipment to the unincorporated association for a fee.

The issue that still needs to be considered is when you actually commence carrying on business.

Once you are firmly committed to the renewing, upgrading or installing new infrastructure and administration of funding for Proponents you are considered to be carrying on a business. This occurs at the time government funding is obtained.

Taxation Ruling 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business (TR 2006/3) provides the ATO view on the income tax implications of government payments to industry to assist entities to continue, commence or cease business.

At paragraph 139 of TR 2006/3 it states that:

A Government Payment to Industry (GPI) paid to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income as the GPI is capital in nature.

The funds are not received in the ordinary course of business (as required to satisfy the ordinary concept of ordinary income). This position is supported by the decision in First Provincial Building Society Ltd v. Federal Commissioner of Taxation (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207 (First Provincial).

The funds are to augment your capital and are to be used for upgrading or installing infrastructure. Accordingly, the funds are not to be awarded for a reduction in income, to assist with business operating costs, or directed towards expanding your business or similar purpose. Therefore, the funds do not possess the traits usually associated with ordinary income and as a result will not attract the operation of section 6-5 of the ITAA 1997.

The funding is capital in nature.

Question 2

Section 15-10 - bounty or subsidy

Where the government payment to industry is not assessable as ordinary income consideration needs to be given to whether section 15-10 of the ITAA 1997 applies.

A government payment to industry is assessable under section 15-10 of the ITAA 1997 in the income year in which it is received if it is:

· a bounty or subsidy

· received in relation to carrying on a business, and

· not assessable as ordinary income under section 6-5 of the ITAA 1997.

In paragraph 94 of TR 2006/3 a subsidy is defined and this definition includes grant or contribution of money.

The funds under the Program are direct pecuniary aid furnished by a government body to a private industrial undertaking.

The Program funds you receive fall within the definition of a subsidy for the purposes of section 15-10 of the ITAA 1997.

Will the Program funding be received in relation to carrying on a business?

'Business' is defined in section 995-1 as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

A subsidy will be 'in relation to' carrying on a business when there is a real connection between the subsidy and the business. The term 'in relation to' includes within its scope subsidies that have a direct or indirect connection to the business. As stated by Hill J in First Provincial when considering the former paragraph 26(g) of the ITAA 1936:

The words 'in relation to' are words of wide import. They are capable of referring to any relationship between two subject matters in the present case the receipt of the bounty or subsidy, on the one hand, and the carrying on of the business, on the other ... the degree of connection will be 'a matter of judgment on the facts of each case'... What is necessary, at the least, in the present context is that there be a real connection...the relationship need not be direct, it may also be indirect.

The expression 'carrying on of the business' looks to the activities of the business which are directed towards the gaining or producing of assessable income rather than merely to the business itself. In First Provincial, the Full Federal Court held that although the receipt lacked the necessary connection with the taxpayer's business activities to constitute ordinary income, it was received in relation to the carrying on of the taxpayer's business because the payment assisted the taxpayer to continue to carry on the taxpayer's business activities as a building society.

In O'Grady v. Northern Queensland Company Limited (1990) 169 CLR 356 (O'Grady), McHugh J also said at CLR 376:

the prepositional phrase "in relation to" is indefinite. But, subject to any contrary indication derived from its context or drafting history, it requires no more than a relationship, whether direct or indirect, between two subject matters (emphasis added)

The comments by Hill J in First Provincial and McHugh J in O'Grady make it clear that all that is required for a bounty or subsidy to be received in relation to carrying on a business is that there is 'a relationship' to the carrying on of a business that is not so remote as to be insignificant. It is also clear from the use of the expression 'any relationship' by Hill J and the conclusion that the relationship may be indirect that there is no requirement that the relationship be the dominant or main relationship. The degree of the connection will be a matter of judgement on the facts of each case (see O'Grady (1989-90) 169 CLR 356 at 376).

The commencement of a business is a specific point in time. In Goodman Fielder Wattie Ltd v. Federal Commissioner of Taxation (1991) 29 FCR 376; 91 ATC 4438; (1991) 22 ATR 26 (Goodman), Hill J said that the actual date of commencement of a business is a question of fact. In Whitfords Beach Pty Ltd v. FC of T 83 ATC 4277; (1983) 14 ATR 247 (Whitfords Beach), Bowen CJ, Morling and Fitzgerald JJ said 'in order to determine when the taxpayer's relevant business commenced, it is necessary to have regard to both the taxpayer's purposes and to its activities'. A mere intention to commence a business is not enough: see Hill J in Goodman. There must also be activity.

However, the degree of activity which is requisite to the carrying on of a business varies according to the circumstances in which the relevant business is being conducted. Little activity may suffice for carrying on a business which does not call for much activity: see Inglis v. FC of T 80 ATC 4001; (1979) 10 ATR 493.

The requisite degree of activity will be established where the taxpayer's activities show that the taxpayer is committed to proceed with the implementation of its purpose to carry on a business.

The decision in Whitfords Beach illustrates this point. The Full Federal Court said that although the relevant project:

was to extend over a number of years and was to involve development in stages, there was from 20 December 1967 both a persistent intention to develop, subdivide and sell all of the deferred urban and rural land and a continuous course of conduct directed to the implementation of that intention.

Accordingly, the Full Federal Court concluded that the taxpayer's business of developing, subdividing and selling the land commenced as soon as the intention to take steps for that purpose in relation to the entire land was formed and activities directed to that end were commenced.

TR 2006/3 set out the Australian Taxation Office (ATO) view of the application of section 15-10 of the ITAA 1997 to government grants. It states that at paragraphs 103 and 139 that:

103. A government payment to industry received by an entity or made on behalf of the entity as assistance to commence a business does not satisfy the requirement of being paid in relation to carrying on a business.

…

139. A government payment to industry paid to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income as the government payment to industry is capital in nature. The government payment to industry will not be assessable under section 15-10 if it is received in relation to the commencement of a business.

In ATO ID 2010/38 it stated that:

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 .

The taxpayer's activities in completing the final stage of the construction process asset are activities that are integral to the taxpayer's business even though they are preparatory to, and not directly productive of assessable income. Accordingly, the receipt of a grant to partly fund those activities is received in relation to carrying on this business.

To make an appropriate ruling in relation to the application of taxation law to the facts of this arrangement, an examination of the original understanding or intentions of the parties was made.

While it could reasonably be argued that the penultimate document in establishing the original understandings or intentions of the parties is in fact only the deed of agreement dealing with the creation of the Scheme, a fuller examination of other documents has been made.

In considering this private ruling application the contents of the following documents were considered.

Funding Agreement between Commonwealth of Australia and you.

Are the activities in the nature of trade?

The first question that must be considered is: 'Is the activity, on the one hand, a trade, or an adventure in the nature of trade, producing a profit, or is it, on the other, a mutual arrangement which, at most, gives rise to a surplus?' (Fletcher v. ITC (1971) 3 All ER 1185).

(a) From your formation to the present

The deed of association clearly identifies that the unincorporated association administered the scheme and appointed you as trustee or agent to enter into contracts relating to the implementation maintenance or administration of the scheme. In this context there is clear evidence of an agency relationship.

It is the unincorporated association that conducted the business. An examination of the facts of this case indicate that you had not been in business to the present. You merely held some assets of the scheme on behalf of the unincorporated association and had not been remunerated for holding this office. This activity does not constitute trading operations.

In Brookton Co-operative Society v. Federal Commissioner of Taxation (1981) 147 CLR 441; 81 ATC 4346; (1981) 11 ATR 880 it was confirmed that the expression "is established" in section 117(1) of the ITAA 1936 indicates that the company and its activities must be looked at year by year and not merely at the time of its incorporation. Mason J stated at 451 that: 

To my mind it is evidently correct, allowing, as it does, that the purpose for which a company is established may change in the course of time and that with the change of purpose may come a change in status as a co-operative company

The facts provided by the applicant indicated that your operations will change due to your involvement in the application for funding and it requirements under the Funding Agreement.

(b) Once you sign the funding agreement

Your activities suggest trading operations and the objective outcome of your activities include profits from a service agreement with the unincorporated association.

It is reasonable to conclude, when considering the Funding Agreement and the comments made by the applicant that the funding you receives for your own use is for the commencement of the business. Due to the costs involved you required the funding from the government for the project to upgrade the Scheme to go ahead. You were required to apply as the unincorporated association was ineligible to be an applicant for funding. Further, the applicant stated that the viability of the modernisation project is dependant on money being received from the Program program.

Thus, in these circumstances it is reasonable to consider that the grant funds are both for the commencement and operation of the business. Whether this means that the grant funds are assessable under section 15-10 of the ITAA 1997 as received in relation to the carrying on of a business depends on the ATO view detailed in TR 2006/3.

At paragraph 26 of TR 2006/3 it states that:

Government payments to industry to commence or cease a business are not assessable as ordinary income of the recipient under section 6-5 or as a bounty or subsidy in relation to carrying on a business under section 15-10. However, the GPI may give rise to an assessable recoupment under Subdivision 20-A.

Further, at paragraph 27 of TR 2006/3 it states that:

A GPI received to assist the recipient to commence business with the purchase of a depreciating asset, the cost of which is deductible under Division 40, is assessable income under the assessable recoupment provisions in Subdivision 20-A.

TR 2006/3 goes on to state at paragraph 128 of TR 2006/3:

Government payments to industry to commence or cease business are not assessable as ordinary income under section 6-5 or as a bounty or subsidy in relation to carrying on a business under section 15-10. However, the GPI may be taken into account in determining whether there is an assessable recoupment under Subdivision 20-A.

As you are receiving the grant funds to commence business and in view of the comments quoted from paragraph 27 of TR 2006/3 the grant funds will not be treated as statutory income under section 15-10 of the ITAA 1997.

Question 3

Capital gains

Paragraph 104-25(1)(b) of the ITAA 1997 states that capital gains tax (CGT) event C2 happens to an intangible asset when it is released, discharge or satisfied. It is therefore necessary to consider when an indemnity is discharged. Subsection 104-25(2) of the ITAA 1997 specifies that the time that a CGT event C2 occurs is:

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.

The full Federal Court in FC of T v. Dulux Holdings Pty Ltd 2001 ATC 4658; (2001) 48 ATR 588 (Orica) held that a chose in action was created by the contract and the due performance of the contract gave rise a deemed disposal. Accordingly, the deemed change in ownership took place not under the original contract, but on the progressive discharge of the chose in action. The Court held that subsection 160U(3) of the ITAA 1936 did not apply. However, subsection 160U(4) of the ITAA 1936 did apply to make the time of the disposal the time of each payment.

(Note: In respect of CGT event C2 paragraph 104-25(2)(a) of the ITAA 1997 is the equivalent of subsection 160U(3) of the ITAA 1936. In respect of CGT event C2 paragraph 104-25(2)(b) of the ITAA 1997 is the equivalent of subsection 160U(4) of the ITAA 1936).

The application of the principles established in Orica mean that the timing of CGT event C2 is when payments are made and not when the original contract was entered into. CGT event C2 under section 104-25 of the ITAA 1997 happens when the entitlement to receive the grant payment is satisfied.

Paragraph 118-37(2)(a) of the ITAA 1997 provides a CGT exemption by disregarding a capital gain or capital loss that results from receipt of a payment as reimbursement or payment of expenses under a scheme established under legislation by an Australian government agency. Class Ruling CR 2008/40 clarifies that this includes anticipated expenses at paragraph 109:

109. Paragraph 118-37(2)(a) provides a CGT exemption by disregarding a capital gain or loss that results from the receipt of a payment as a reimbursement or payment of expenses (or anticipated expenses), under a scheme established by an Australian government agency.

The grant payments will be paid under such a scheme. The first grant funding payment will be paid on signing of the Funding Agreement.

Funding for your own use that has not been legally and irrevocably committed for expenditure in accordance with the Funding Agreement may be required to be refunded to the Commonwealth. Subsequent payments will not be made until the Commonwealth receives:

· an acquittal showing that any previous payments made under the Program Funding have been fully expended

· progress reports as identified in the Funding Agreement, and

· confirmation of completion of specific milestones

Therefore, any capital gain or capital loss made as a result of the grant payments for your own use is disregarded under paragraph 118-37(2)(a) of the ITAA 1997.

Question 4

Assessable recoupment

Subdivision 20-A of the ITAA 1997 includes certain amounts in a taxpayer's assessable income to the extent that those amounts constitute an assessable recoupment as defined in section 20-20 and section 20-25 of the ITAA 1997.

Under Subdivision 20-A of the ITAA 1997 an amount will be considered to be an assessable recoupment if:

· the amount is not specifically excluded from Subdivision 20-A pursuant to section 20-20(1) of the ITAA 1997

· the amount constitutes a recoupment as defined in section 20-25 of the ITAA 1997, and

· the amount is a recoupment of a loss or outgoing pursuant to section 20-20(2) of the ITAA 1997.

To constitute an assessable recoupment, an amount must, in the first instance, satisfy the definition of a recoupment under section 20-25 of the ITAA 1997.

An assessable recoupment is defined within section 20-25 of the ITAA 1997 which states as follows:

Section 20-25 What is recoupment?

20-25(1)

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.

It is noted at paragraph 137 of TR 2006/3:

136. The assessable recoupment provisions in Subdivision 20-A need to be considered where a GPI is received as recoupment of certain deductible losses or outgoings and is not otherwise assessable. The provisions in Subdivision 20-A may apply even if the entity is not in business.

137. An amount is an assessable recoupment under these provisions to the extent it is:

· not income under ordinary concepts or otherwise assessable; and

· received either:

o by way of insurance or indemnity as recoupment of a deductible loss or outgoing, or

o as recoupment (other than by way of insurance or indemnity) of a deductible loss or outgoing that is listed in the table in section 20-30.

The items listed in section 20-30 include deductions for bad debts, rates or taxes, research and development activity expenditure, tax related expenses and capital allowances.

138. For the purposes of Subdivision 20-A, recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, recovery, refund, insurance or indemnity. It also includes a grant in respect of a loss or outgoing. In addition, you are taken to receive an amount as recoupment of a loss or outgoing if another entity pays the amount for you in respect of a loss or outgoing you incur.

Reimbursement for purchase of a depreciating asset

139. A GPI paid to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income as the GPI is capital in nature. The GPI will not be assessable under section 15-10 if it is received in relation to the commencement of a business.

140. The business will be able to claim deductions for the decline in value of the depreciating asset under the capital allowances provisions in Division 40. Capital allowances deductible under Division 40 is an item in the table of section 20-30. As such, to the extent that the GPI is a recoupment of the cost of the 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.

An amount received by way of indemnity is not restricted to payments received under a contract of indemnity. The cases also make it clear that an amount received by way of indemnity would include a receipt pursuant to an antecedent obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good or compensate for a loss which arises after the obligation comes into existence.

Amounts received by you under the Funding Agreement will be received by way of indemnity because they are receipts pursuant to an antecedent obligation by virtue of a contract.

Commonwealth funds received under the Program by you for your own benefit will be an assessable recoupment under section 20-20(2) of the ITAA 1997 to the extent that you have or can deduct an amount for it under any provision of the ITAA 1936 or ITAA 1997.