Edited version of private ruling

Authorisation Number: 1011637807298

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Ruling

Subject: Assessability of Government grants received under the program

Issue 1 - Funds provided to you under the program for proponents

Question 1

Will the Commonwealth funds received under the program by you that are to be provided to the proponents in accordance with that program be assessable to you as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the Commonwealth funds received under the program by you that are to be provided to the proponents in accordance with that program be assessable to you as statutory income under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Will the Commonwealth funds received under the program by you that are to be provided to the proponents in accordance with that program be assessable to you as statutory income under Subdivision 20-A of the ITAA 1997?

Answer

No.

Question 4

Will the Commonwealth funds received under the program by you that are to be provided to the proponents in accordance with that program be assessable to you as a capital gain under section 102-5 of the ITAA 1997?

Answer

No.

This ruling applies for the following period

1 July 2010 to 30 June 2011

1 July 2011 to 30 June 2012

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

The scheme commenced on

1 July 2010

Relevant facts

You are considering entering into a program with the Commonwealth Government. Under the program, you will receive funding from the Commonwealth, which you will then distribute to the proponents in accordance with a funding agreement. The aim of the program is to transfer certain rights to the Commonwealth.

The funding agreement between yourself and the Commonwealth details how the funds are to be spent along with details of the information required to be included certain contracts between you and the proponents.

The proponents are required fulfil certain obligations under the program and to transfer certain rights to the Commonwealth. You are to receive the government funding, which will fund the proponent's obligations. The funds are to be held in an account in your name which will be established solely for the purpose of accounting for and administering any funding provided by the Commonwealth under the program and this bank account must be separate from your other operational accounts.

The proponents will complete their obligations under the agreement and after its completion, the proponents will submit a claim for reimbursement of the costs incurred, from the funding held by you. For administering the funds, you will be entitled to receive an administration fee.

If the proponents have not spent their allocated funding under the agreement, the funds left will either be returned to the government or spent on extending the program subject to Commonwealth approval.

At the completion of the program no assets will be held or owned by you. All works are to be performed by the proponent and all rights are to be returned to the Commonwealth under the program will be a direct reduction in the proponent's rights.

As all monies under the program are to be spent in accordance with the funding agreement, you will not hold any assets at the conclusion of the program. Your role is to co-ordinate the program but receive government monies into your separately established bank account for the purposes of on forwarding to the proponents for the funding of the program.

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 20-25(1).

Income Tax Assessment Act 1997 Section 102-5.

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Section 104-25.

Income Tax Assessment Act 1997 Subsection 108-5(1).

Income Tax Assessment Act 1997 Section 116-20.

Income Tax Assessment Act 1997 Subsection 116-40(1)

Income Tax Assessment Act 1997 Subsection 118-37(2).

Income Tax Assessment Act 1997 Section 118-37.

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

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Issue 1 - Funds provided to you under the program for proponents

Question 1 - Section 6-5 - Income according to ordinary concepts

Summary

The funds received under the program by you that are to be applied the proponents in accordance with that program are not assessable to you as ordinary income under section 6-5 of the ITAA 1997 as you do not have a beneficial entitlement to those funds.

Detailed Reasoning

Under subsection 6-5(1) of the ITAA 1997 an amount received by a taxpayer is included in assessable income if it is income according to ordinary concepts. There are a number of principles developed by the courts that assist in determining if an amount is income according to ordinary concepts.

In Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514, Windeyer J stated at CLR 527:

'Whether or not a particular receipt is income depends upon its quality in the hands of the recipient.'

In G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (GP International Pipecoaters) the High Court stated at CLR 138; ATC 4420; ATR 7 that:

'To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence, sometimes, by the character of a right or thing disposed of in exchange for the receipt, sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business'

The regularity and periodicity of a receipt may indicate that the receipt is income. However, this is generally not a decisive consideration (see FC of T v. Dixon (1952) 86 CLR 540 at 568). Where a recipient provides consideration for a payment, the nature of that consideration is generally taken to be the nature of that payment (see (Federal Coke Co Pty Ltd v. Federal Commissioner of Taxation (1977) 34 FLR 375). However, it is possible that a receipt is not in exchange for, or in respect of, any right or thing disposed of.

Where the taxpayer is carrying on a business, the scope of the taxpayer's business and the taxpayer's purpose in engaging in a transaction are important means of determining the character of the receipt. Other matters that the Courts, over the years, have considered to be important are:

1. whether the amount is the product of any employment, services rendered, or any business (FC of T v. Harris 80 ATC 4238 at 4241; (1980) 10 ATR 869 at 873, Hayes v. FC of T (1956) 96 CLR 47 at 54);

2. whether the amount is paid to supplement or replace an amount of income or profits so as to take on the character of the substituted or supplemented amount (FC of T v. Dixon (1952) 86 CLR 540; [1952] HCA 65); and

3. in the case of an individual, whether there is an expectation of receiving an amount on a regular basis, so that the recipient is able to depend upon the amount for his or her regular expenditure (FC of T v. Dixon (1952) 86 CLR 540; [1952] HCA 65).

Factors 2 and 3 are not applicable in the present case. Factor 1 can be seen to involve similar matter to those considered in GP International Pipecoaters.

Thus, a profit or gain made in the ordinary course of the recipient's business is included in ordinary income: see and Westfield Ltd v. FC of T (1991) 28 FCR 333; [1991] FCA 86; 91 ATC 4234; (1991) 21 ATR 1398. An amount that is a receipt arising as a product or incident of carrying on the recipient's business is included in ordinary income as expressed in Taxation TR 2006/3 at paragraph 15.

Not all receipts by a taxpayer carrying on a business will be income. In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320; [1995] FCA 1101; 95 ATC 4145; (1995) 30 ATR 207 (First Provincial), Hill J, said that 'it is now well established that not all receipts by a taxpayer carrying on a business will be income'. Hill J said further (FCR 325; FCA 1101 at paragraph 18; ATC 4148-4149; ATR 211), that the words 'in the ordinary course of business' must be understood in their context, and, referring to his comments in Commissioner of Taxation v. Hyteco Hiring Pty Ltd (1992) 39 FCR 502; [1992] FCA 189; 92 ATC 4216; (1992) 23 ATR 270, that:

'it does not follow from these words, as used by the High Court in Myer, that every gain made by a taxpayer carrying on a business and which has some relationship to that business will be taxable. To so hold would be to destroy completely the distinction between capital and income.'

In G.P. International Pipecoaters (Pipecoaters), the Full High Court accepted the proposition that a gift or subsidy to replenish or augment the recipient's capital is capital in nature (and not income under ordinary concepts) because in such a case, the receipt is not a product or incident of the recipient's income producing activity (at 170 CLR 142; 90 ATC 4422; (1990) 21 ATR 10).

In First Provincial, Hill J said that the issue which has to be addressed is the relationship between the receipt and the business activities of the recipient. It will thus be relevant to consider not only the scope and nature of the recipient's business (which involves a wide survey and exact scrutiny of the recipient's activities) but also what the grant is actually for.

In Warner Music Australia Pty Ltd v. FC of T (1996) 70 FCR 197; 96 ATC 5046; (1996) 34 ATR 171, Hill J commented at FCR 210; ATC 5056; ATR 182, that

'in seeking to determine whether an amount is received in the ordinary course of carrying on a business, it will be necessary to examine in detail both the scope and nature of a taxpayer's business.'

Hill J then referred to Gibbs J's analysis in London Australia Investment Company Limited v. FC of T (1977) 138 CLR 106 at 116, citing Western Gold Mines NL v. Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740 and said 'this involves 'a wide survey and an exact scrutiny of the taxpayer's activities.'

Thus, in First Provincial, an ex gratia payment, which assisted the recipient to continue to carry on its building society activities but was not consideration (even in a practical sense) for some trading activities of that recipient, was found not to be income according to ordinary concepts as it lacked the necessary connection with the business/trading activities of the taxpayer to be characterised as a profit or gain made in the course of the company's business as a building society.

Paragraphs 11 to 15 of Taxation Ruling TR 2006/3 set out the ATO view of when section 6-5 of the ITAA 1997 will apply to government grants in specific circumstances not presently relevant.

For an amount to be included in assessable income under section 6-5 of the ITAA 1997 as income under ordinary concepts, the taxpayer must have a beneficial entitlement to it: see Taxation Determination TD 2008/9 Income tax: are amounts mistakenly paid as salary or wages to employees (or as income support payments or worker's compensation amounts to persons), to which they are not beneficially entitled, but are obliged to repay, 'ordinary income' under section 6-5 of the Income Tax Assessment Act 1997?.

In Taxation Case T44 - 20 June 1986 86 ATC 366, the Board of Review considered the position of an entity which collected amounts for services provided by the taxpayer, as agent for the taxpayer. Included in the taxpayer's arguments as to why the amounts should be assessable to the (agent) entity, was that the entity had a contractual entitlement to receive the money, and was entitled to deal with the amounts it received in the course of its agency in a particular way. However, the Board found in favour of the Commissioner and held that moneys generated on account of the taxpayer, and paid to, his agent and applied in accordance with an agreement between the taxpayer and his agent constituted assessable income in the hands of the taxpayer.

A similar conclusion was reached by the Federal Court in Zobory v. FC of T (1995) 64 FCR 86; 95 ATC 4251; (1995) 30 ATR 412 in relation to amounts in which the taxpayer had no beneficial interest. At FCR 89; ATR 414; ATC 4253, Burchett J stated that:

The fundamental principle which must be the starting point for a consideration of this case is the rule that the general provisions of the Income Tax Assessment Act 1936 (Cth) are directed to income to which a taxpayer is beneficially entitled MacFarlane v. FC of T (1986) 13 FCR 456; 67 ALR 624; Countess of Bective v. FC of T (1932) 47 CLR 417; Richardson v. FC of T (1932) 48 CLR 192; Liedig v. FC of T (1994) 121 ALR 561; 94 ATC 4269 at 4276; Vegners v. FC of T 91 ATC 4213.

Application to your circumstances

A number of clauses set out the terms and conditions for the payment of funds for the proponents to you and include the use, payment and recovery of those funds.

The funding agreement provides that you will receive the payment of the funds from the Commonwealth to be applied by the proponents in accordance with the agreement. You will hold and administer the release of the funds to the proponents in accordance with the obligations of the agreement and the related guidelines.

You are required to hold the funds received for the proponents' projects in a separate bank account. This bank account must be established solely for the purposes of accounting for and administering the funds and must be separate from your other operational accounts. You are also required to keep financial accounts and records, and to keep a separate account ledger for each proponent, clearly identifying the funds received for each proponent

At the completion of the program no assets arising from the program will be held or owned by you. All works are to be completed by the proponent and all rights acquired by the Australian Government under the program will be a direct reduction in the proponent's rights.

As all monies under the program are to be spent in accordance with the funding agreement, you will not hold any assets at the conclusion of the program. Your role is to co-ordinate the program but receives government monies into its separately established bank account to be applied by the proponents in accordance with the agreement.

You are not entitled to retain any funds that are provided for the proponents and may only make payments from those funds as required under the agreement. It must strictly account for the application of the funds under the agreement and return any unused funds to the Commonwealth.

It is considered that you have no beneficial interest in the funding received from the Commonwealth under the program for payment to the proponents and therefore will not be assessable income of yours under section 6-5 of the ITAA 1997.

Question 2 - Section 15-10 - bounty or subsidy

Summary

The funds received under the program by you that are to be applied by the proponents in accordance with that program will not be assessable to you as statutory income under section 15-10 of the ITAA 1997 as you do not have a beneficial entitlement to the funds and therefore the receipt of the funds is not a bounty or subsidy received in relation to carrying on a business.

Detailed Reasoning

Section 15-10 of the ITAA 1997 provides that your assessable income includes a bounty or subsidy that:

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

(b) is not assessable as ordinary income under section 6-5.

Bounty or subsidy

The terms 'bounty' and 'subsidy' are not defined in income tax legislation. The word 'subsidy', as noted by Windeyer J in Placer Development Ltd v. Commonwealth of Australia (1939) 121 CLR 353, derives from the Latin 'subsidium' meaning 'an aid or help'. The Macquarie Dictionary 2001, rev. 3rd edn, defines subsidy as including 'a grant or contribution of money'. The ordinary meaning adopted by case law is aid provided by the Crown (government) to foster or further some undertaking or industry.

Following the decisions in The Squatting Investment Co Ltd v. Federal Commissioner of Taxation (1953) 86 CLR 570, Reckitt and Colman Pty Ltd v. Federal Commissioner of Taxation (1974) 4 ATR 501; 74 ATC 4185 and First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207 (First Provincial ), it is accepted that a 'subsidy' or 'bounty' includes payments of financial assistance by government. It would not however include amounts provided for the acquisition of a capital asset.

Regulation 3A(1) of Financial Management and Accountability Act 1997 (FMA Act) defines a 'grant' for the purposes of the Commonwealth Grant Guidelines (CGGs) as an arrangement for the provision of financial assistance by the Commonwealth:

a. under which public money is to be paid to a recipient other than the Commonwealth; and

b. which is intended to assist the recipient achieve its goals; and

c. which is intended to promote 1 or more of the Australian Government's policy objectives; and

d. under which the recipient is required to act in accordance with any terms or conditions specified in the arrangement.

The AGS Legal Briefing No 83 discussion on grants programs suggests that:

'……if the prime focus is the enabling of an activity which also promotes government policy objectives, it can generally be treated as grant funding."

Received in relation to carrying on a business

A bounty or subsidy will be received in relation to carrying on a business when there is a real connection between the receipt and the carrying on of the business and this connection may be direct or indirect. Taxation Ruling TR 2006/3, at paragraphs 100-101 suggests that this principle was established in First Provincial. In First Provincial, the taxpayer was carrying on a business as a building society and was required by legislation to contribute to a contingency fund to provide protection to persons who deposited moneys with permanent building societies. The contingency fund was wound up when a new national scheme for the supervision and regulation of building societies was established. The relevant legislation was amended to provide for the payment of the gross assets of the contingency fund into consolidated revenue and to pay certain amounts out of consolidated revenue to each continuing building society named in the Schedule to the amending Act. An amount of $1.92m was distributed to the taxpayer. Hill J found that although the payment lacked the necessary connection with the business activities of the applicant to constitute income in ordinary concepts, it was received in relation to carrying on a business and formed part of the taxpayer's assessable income under paragraph 26(g) of the Income Tax Assessment Act 1936 (ITAA 1936).

In applying the elements of paragraph 26(g) to the facts of that case, Hill J (at 95 ATC 4145 at 4155; (1995) 30 ATR 207 at 218) said:

'In a real sense…the payment assists the applicant to continue to carry on its building society activities and can thus be said to have been made in relation to the carrying on of its business…

In my opinion, the present is a case where there is a real relationship between the amount paid by the Queensland Government, on the one hand, and the carrying on by the applicant of its business as a building society on the other, so that the amount forms part of the applicant's assessable income under s26(g) [of the ITAA 1936].'

Paragraph 26(g) of the ITAA 1936 was rewritten as section 15-10 of the ITAA 1997. Section 15-10 of the ITAA 1997 and paragraph 26(g) of the ITAA 1936 differ in 3 aspects:

1. Section 15-10 does not include the redundant exemption for petroleum research subsidies;

2. Section 15-10 does not deem the bounty or subsidy to be part of the proceeds of the business. Those words were inserted to ensure that bounties and subsidies were treated as income from personal exertion for the purposes of the ITAA 1936. The distinction between income from personal exertion and income from property is not relevant in the ITAA 1997; and

3. Section 15-10 only applies to bounties and subsidies that are not ordinary income.

These changes do not affect the substantive application of the provision and accordingly, it is considered that the guidance provided by the Courts regarding paragraph 26(g) of the ITAA 1936 is equally relevant for section 15-10 of the ITAA 1997. This view is confirmed in Re Plant v. FCT [2004] AATA 1296; 2004 ATC 2364; (2004) 58 ATR 1070.

In relation to

The expression 'in relation to' was considered by Hill J in First Provincial. His Honour said that the expression 'in relation to', in the context of a subsidy received by a taxpayer carrying on a business, was sufficiently wide to cover a direct relationship between the receipt on the one hand and the carrying on of the taxpayer's business on the other as well as a less direct relationship. His Honour said that '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'. He referred to McHugh J in O'Grady v. Northern Queensland Company Limited (1990) 169 CLR 356 (O'Grady) who said at CLR 376 that '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' … 'the words 'in relation to' require a connection or association' … 'what connection or association will be sufficient…must be a matter of judgement on the facts of each case...as long as the connection is not so remote as to be insignificant'. Hill J echoed the comments made in O'Grady in stating that 'If the relationship were merely a remote one…[the provision] would have no operation. 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'.

Therefore what 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. As well the use of the expression 'any relationship' by Hill J and the conclusion that the relationship may be indirect suggest 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). However this would not extend to a receipt that had only a relationship to the business rather than carrying on a business. In First Provincial Hill J said that the words 'carrying on' of a business makes it clear that a bounty or subsidy received merely in relation to the commencement of a business (or the cessation of the business) would not be caught.

Application to your circumstances

The Commonwealth funds received under the program is a grant provided by the government to provide financial assistance to you to implement projects to improve the efficiency and productivity of certain services. Therefore the funding received under the program falls within the meaning of the terms 'bounty' or 'subsidy'.

However, as concluded in question 1, you are not the beneficial owner of the funding that you receive under the program for distribution to the proponents.

Due to this, it cannot be said that you receive the funding under the program in relation to carrying on its business in the required sense, and therefore it will not be included in assessable income as a bounty or subsidy under section 15-10 of the ITAA 1997.

Question 3 - Assessable recoupment under Subdivision 20-A

Summary

The funds received under the program by you that are to be applied by the proponents in accordance with that program will not be assessable to you as statutory income under Subdivision 20-A of the ITAA 1997 as there is no beneficial entitlement to the funds and there is no relevant deduction as required under the Subdivision.

Detailed Reasoning

Subdivision 20-A of the ITAA 1997 provides that certain amounts received in an income year may be considered to be an assessable recoupment and included in taxable income.

Subsection 20-25(1) of the ITAA 1997 provides that a recoupment of a loss or outgoing includes:

· Any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

· A grant in respect of the loss or outgoing.

In broad terms, to be an assessable recoupment section 20-20 of the ITAA 1997 requires that an amount be received as a recoupment for a loss or outgoing for which a deduction is available. It also provides that an amount is not an assessable recoupment to the extent that it is ordinary income or statutory income under a provision outside the Subdivision.

Application to your circumstances

The funding received by you under the program received is a government grant and as such is a recoupment of a loss or outgoing as defined in subsection 20-25(1) of the ITAA 1997.

In this present application, although you will receive the funding under the program, the amounts will not be included as assessable income under sections 6-5 or 15-10 of the ITAA 1997 for the reasons discussed above.

The funding under the program would be treated as an assessable recoupment in an income year to the extent that it is received as a recoupment for a loss or outgoing for which a deduction is available and it otherwise satisfied the requirements of section 20-20 of the ITAA 1997.

However, as concluded at question 4, you do not have beneficial entitlement to the funds it receives under the program for payment to the proponents. Due to this, you will not be entitled to a deduction for any of the payments made of those funds. Consequently, no amount of the funds received under the program by you for payment to the proponents will be an assessable recoupment under Subdivision 20-A of the ITAA 1997.

Question 4 - assessable as a capital gain

Summary

The Commonwealth funds received under the program by you that are to be applied by the proponents in accordance with that program will not be assessable to you as a capital gain under section 102-5 of the ITAA 1997

Detailed Reasoning

You will acquire a legal right, being the right to receive the funds under the program. This right is a CGT asset (subsection 108-5(1) of the ITAA 1997).

CGT event C2 happens when that right is satisfied by you receiving your share of the funds (subsection 104-25(1) of the ITAA 1997.

A capital gain or capital loss may arise when CGT event C2 happens if the capital proceeds are more than the assets cost base or the capital proceeds are less than the assets reduced cost base (subsection 104-25(3) of the ITAA 1997). The amount of funds you receive under the program will be the capital proceeds pertaining to the legal right that has been satisfied (paragraph 116-20(1)(a) of the ITAA 1997). 

An exemption is available if a capital gain or capital loss arises from receiving a payment as reimbursement or payment of expenses under a scheme established by an Australian government agency under an enactment or an instrument of a legislative character (paragraph 118-37(2)(a) of the ITAA 1997). 

You will receive the grant funds under the program. The funds will be received as either a reimbursement or payment of your expenses incurred in undertaking the program.  

The grant funds will be paid under a scheme established by an Australian government agency. Specifically, the program is established by the Commonwealth Government, and administered by a Government department.  

The program is established under an enactment or an instrument of a legislative character.

As all of the conditions for the exemption have been met, any capital gain or capital loss arising from CGT event C2 is disregarded under paragraph 118-37(2)(a) of the ITAA 1997.  

Therefore, no capital gain from the receipt of the funding under the program will be included in the assessable income under section 102-5 of the ITAA 1997.