Edited version of private ruling

Authorisation Number: 1011799349691

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Ruling

Subject: Exceptional Circumstances Exit Grant

Question 1

Is the Exceptional Circumstances Exit Grant (ECEG) assessed as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the ECEG assessed as a bounty or subsidy under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Does capital gains tax (CGT) event A1 under section 104-10 of the ITAA 1997 happen upon receipt of the ECEG?

Answer

No.

Question 4

Does CGT event D1 under section 104-35 of the ITAA 1997 happen upon receipt of the ECEG?

Answer

Yes.

Question 5

Will a capital gain in relation to the ECEG be assessed to the grant recipient only?

Answer

Yes.

Question 6

Will a capital gain in relation to the ECEG be assessed in the year of receipt, being the year ended 30 June 2010?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2010

Relevant facts and circumstances

The ECEG is an Australian Government package that is administered on the government's behalf by Centrelink. It is payable to business operators who's enterprise is located in an Exceptional Circumstances designated area and, having met certain eligibility criteria, sell their enterprise and undertake not to become an owner or operator of an enterprise again within a period of five years. The Exit Grant is subject to an assets test.

The grant recipient operated an enterprise up until a given point in time. These operations were undertaken on land owned jointly by the grant recipient and their spouse. Prior to the year in question, they contracted to sell the property and business. Settlement of this contract occurred in the following financial year.

Under the terms of the Government package, the grant recipient became eligible to apply for the Exit Grant following settlement of the sale of the business enterprise. The grant recipient duly applied for and was granted an Exit Grant.

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 104-10

Income Tax Assessment Act 1997, section 108-5

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

Note: Unless otherwise stated, all subsequent legislative references are to the ITAA 1997.

Question 1

Subsection 6-5(1) 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.

In accordance with Taxation Ruling TR 2006/3, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

A generally decisive consideration is whether the payment is the product in a real sense of any employment, services or business carried on by the recipient. A payment that is provided for a purpose which is not part of the recipients business will not constitute ordinary income.

Application to your circumstance

The receipt of your ECEG is neither a normal incident of your business nor provided in relation to the purpose for which your business was carried on. The receipt was derived subsequent to you having sold your business and associated property, and paid because you agreed not to carry on a like business within five years of the payment date.

A compensation receipt generally takes the character of the item it replaces. Accordingly, because an amount received subsequent to the disposal of your business and property and in relation to the imposition of a restrictive covenant would be capital in nature, so to is the compensation amount paid to you.

It follows that the ECEG does not constitute ordinary assessable income under section 6-5.

Question 2

Section 15-10 provides that an amount is included in assessable income if it is a bounty or subsidy received in relation to carrying on a business which is not already caught as ordinary income under section 6-5.

The terms bounty and subsidy are not defined in income tax legislation. The ordinary meaning adopted by case law is an aid provided by the Crown (government) to foster or further some undertaking or industry. It is now well accepted that a subsidy or bounty includes a financial grant made by a government.

In accordance with TR 2006/3, 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' includes within its scope payments that have a direct or indirect connection to the business. However, a bounty or subsidy must be related to carrying on the business not merely for commencing or ceasing a business.

Therefore, Government payments to industry received by an entity as assistance either to cease a business or give or sell part of the profit yielding structure of the business are not in relation to the carrying on of the business.

Application to your circumstance

The receipt of your ECEG is neither a normal incident of your business nor provided in relation to the purpose for which your business was carried on. The receipt was subsequent to you having sold your business and associated property and paid in relation to a restrictive covenant in which you are precluded from owning or operating a like business again for a period of five years.

Therefore, it is not a bounty or subsidy in relation to the carrying on of a business for the purposes of section 15-10. Accordingly, no part of the total receipts constitutes assessable income under section 15-10.

Questions 3 & 4

CGT event A 1 happens under section 104-10 if you dispose of a CGT asset by affecting a change of ownership from you to another entity, whether because of some act or event or by operation of law.'

CGT event D1 happens under section 104-35 when a contractual or other legal or equitable right is created in favour of another entity.

The Commonwealth is an entity for the purpose of CGT event D1.

Application to your circumstance

The facts of your case do not support the conclusion that an A1 CGT event happened.

A contractual right is created when you enter into the agreement with the Commonwealth not to be involved in a like enterprise for at least five years. As you agree not to return to a like enterprise for a period of five years, the grant is for entering into a restrictive covenant.

The restrictive covenant is a separate asset from the business enterprise. It is considered that a CGT event D1 and not A1 is relevant to the restrictive covenant.

Under subsection 104-35(2) you will make a capital gain if the capital proceeds from creating the restrictive covenant are more than the incidental costs you incurred in relation to it. You will make a capital loss if the capital proceeds are less than the incidental costs you incurred in relation to it.

Question 5

Again, the legislation provides that a D1 event happens 'if you create a contractual or other legal or equitable right in favour of another entity' (emphasis added).

Application to your circumstance

In this instance the restrictive covenant is created between the Commonwealth and the grant recipient only. It follows that the 'you' referred to in subsection 104-35(1) is a reference to the grant recipient only.

The grant was made to the grant recipient and it is only the grant recipient who is required to advise the Commonwealth if he becomes an owner or operator of a like enterprise again within five years. Further, the amount of the grant would be recoverable as a debt to the Commonwealth from the grant recipient.

It follows that a capital gain in relation to the ECEG will be assessed to the grant recipient only.

Question 6

Under subsection 104-35(2) the 'time of the event is when you enter into the contract or create the other right.'

Application to your circumstance

You advise that the application, approval, receipt of the grant and corresponding agreement with the Commonwealth involving the five year restrictive covenant all occurred during the one financial year.

It follows that the D1 capital gain is assessed to the grant recipient at that time.

Further issues for you to consider

CGT discount

A capital gain from a CGT event D1 is not a discount capital gain in accordance with subsection 115-25(3).

Small business CGT concessions

As the grant cannot be paid until after the business and property have been sold it follows that the right which is created upon the signing of the agreement with the Commonwealth is not an asset 'inherently connected with a business that is carried on…' as is the requirement under the meaning of active asset definition in section 152-40. The business and associated property were both disposed of prior to the grant being received.

It follows that because this basic condition cannot be satisfied, the grant recipient cannot access the small business CGT concessions under Division 152 in relation to this particular payment.