Edited version of private ruling

Authorisation Number: 1011661328860

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Ruling

Subject: Business exit assistance

1. Is any part of the business exit assistance payment assessable income under sections 6-5 or 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No.

2. Is the business exit assistance payment subject to capital gains tax (CGT)?

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The company operates a business.

There has been a significant reduction in the resources available for the company's business and the company has been offered business exit assistance.

The company has decided to take up the offer of full business exit which will entitle it to receive payments for ceasing the business and reimbursement of certain costs.

The payments for ceasing the business are calculated based on the company's past and current allocations of resources. It does not take into account the value of the plant and equipment.

The reimbursement of costs is a reimbursement of actual costs and will be paid on satisfactory review of original receipts of approved services.

Payment of the business exit assistance is subject to the company signing a Deed of Release and Indemnity.

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 104-25

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

Reasons for decision

Question 1

Summary

The exit assistance payment is not income according to ordinary concepts under section 6-5 of the ITAA 1997 or a bounty or subsidy received in relation to carrying on a business under section 15-10 of the ITAA 1997.

Detailed reasoning

Subsection 6-5(1) of the ITAA 1997 provides that assessable income includes income according to ordinary concepts (ordinary income). Ordinary income is not defined in the taxation legislation. The characteristics of ordinary income generally fall into three categories:

· income from providing personal services

· income from property, or

· income from carrying on a business.

Whether a particular receipt is ordinary income depends on the character in the hands of the recipient.

In GP International Pipecoaters Proprietary Limited v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1, the Full High Court stated:

To determine whether a receipt is of an income or of 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.

In addition, the following principles are relevant when determining the nature of a receipt:

· the question is not determined by the nature of the measure used to calculate the payment

· where a recipient provides consideration for a payment, the nature of that consideration is generally taken to be the nature of the payment

· a payment that is provided for a purpose which is not part of the recipient's business will not be income in nature

· a payment to compensate for the restriction of a person's capacity to perform services or to carry on a business may be a capital payment, and

· a compensation receipt generally takes the character of the item it replaces. Compensation for the loss of a capital asset or an enduring part of a taxpayer's profit-yielding structure will be capital in nature.

The payment of the business exit assistance is made in consideration for the company ceasing all of their business. It is a payment for the surrender of a profit-yielding structure. The surrender is neither a normal incident of the company's business nor is the payment provided for a purpose for which the business was carried on. The payment is capital in nature and is not ordinary income under section 6-5 of the ITAA 1997.

Section 15-10 of the ITAA 1997 provides that an amount is included in assessable income 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.

The terms 'bounty' and 'subsidy' are not defined in income tax legislation. Following the decisions in Squatting Investments Co Ltd v. Federal Commissioner of Taxation (1953) 86 CLR 570; (1953) 10 ATD 126; (1953) 5 AITR 496, Reckitt and Colman v. FC of T 74 ATC 4185; (1974) 4 ATR 501 and First Provincial Building Society Ltd v. Federal 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.

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. As stated by Hill J in First Provincial at FCR 333 :

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.

A bounty or subsidy must be related to 'carrying on' the business, not merely for commencing or ceasing a business. As stated by Hill J in First Provincial at FCR 332:

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

When payments are received as assistance either to cease a business or give up or sell part of a profit yielding structure, they are not received in relation to 'carrying on' a business.

The exit assistance payment is in consideration for the company ceasing all of their business. The payment is not directed at income earning activity and is not a bounty or subsidy in relation to the carrying on of a business for the purposes of section 15-10 of the ITAA 1997.

Question 2

Summary

The exit assistance payment is subject to the CGT provisions. CGT event C2 under section 104-25 of the ITAA 1997 happens when the company receives the payment. With respect to the reimbursement of costs, any capital gain is disregarded under paragraph 118-37(2)(a) of the ITAA 1997.

Detailed reasoning

A capital gain or capital loss is made if a CGT event happens. For most CGT events, the capital gain is the difference between the capital proceeds and the cost base of the CGT asset. A capital loss is made if the reduced cost base of the CGT asset is greater than the capital proceeds.

A right to seek compensation is a CGT asset under section 108-5 of the ITAA 1997. CGT event C2 under section 104-25 of the ITAA 1997 happens when the ownership of an intangible asset ends by the asset being satisfied or surrendered.

Payments for ceasing the business

The payments for ceasing the business are the capital proceeds for the satisfaction of the company's right to seek compensation. CGT event C2 happens when, pursuant to the Deed of Release and Indemnity, the company surrenders the right to seek compensation.

The cost base is determined under Divisions 110 and 112 of the ITAA 1997. It includes the costs of applying for the exit assistance payment. The market value of the right to seek compensation is not included as part of the cost base as the market valuation rules do not apply to the acquisition of the right to seek compensation.

Any capital gain cannot be reduced by the general CGT discount as the capital gain will not result from a CGT event happening to a CGT asset that was acquired by the company at least 12 months before the CGT event happened.

Any capital gain may be reduced or deferred by the small business CGT concessions if the requirements in Division 152 are satisfied.

Reimbursement of costs

The right to receive reimbursement of the costs is a CGT asset under section 108-5 of the ITAA 1997. CGT event C2 under section 104-25 of the ITAA 1997 will happen when the right to receive the reimbursement is satisfied.

The expenditure is an incidental cost incurred in relation to the relevant CGT asset. The payment by way of reimbursement is a recoupment of this expenditure. This recoupment is not assessable income.

Any capital gain is disregarded under paragraph 118-37(2)(a) of the ITAA 1997.