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Ruling

Subject: Government Funding Payment

Question 1

Is the Government funding payment paid to assist with the acquisition of a property assessable as ordinary income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the Government funding payment paid to assist with the acquisition of a property assessable income as a bounty or subsidy pursuant to section 15-10 of the ITAA 1997?

Answer

No

Question 3

Is the Government funding payment paid to assist with the acquisition of a property a recoupment of expenditure incurred in acquiring a property for the purpose of subsection 110-45(3) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commences on:

30 May 2011

Relevant facts and circumstances

An entity proposes to acquire a property and establish it as a protected area for inclusion in a government project that is seeking to establish and maintain a system of natural reserves in Australia.

The Federal Government will pay the entity a government grant (funding payment) in order to assist the entity to acquire the property.

A condition of receiving the funding payment is that a conservation covenant that meets the standards for inclusion in the government project is registered on the land title. The conservation covenant must be entered into with a state / territory government.

A number of other conditions must also be met in order to secure the funding payment.

The entity receiving the funding payment had not commenced any business prior to receiving the government 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 20-25

Income Tax Assessment Act 1997 - Subsection 110-25(2)

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

Income Tax Assessment Act 1997 - Section 104-47

Income Tax Assessment Act 1997 - Section 104-35

Reasons for decision

Question 1

Section 6-5 of the ITAA 1997 specifically includes ordinary income (defined as income according to ordinary concepts) in the assessable income of a taxpayer.

There is no definition of income according to ordinary concepts in the income tax legislation. The characteristics of ordinary income have been developed by case law and generally fall into three categories:

· income from providing personal services;

· income from property; or

· income from carrying on a business.

Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business, discusses the Commissioners views on the assessability of government payments to industry (GPI) to assist entities to continue, commence or cease business. In determining the assessability of the payments, the ruling looks at how the following provisions apply:

Section 6-5

Section 15-10

Section 59-30

Subdivision 20-A

Subdivision 40-B.

Paragraph 85 of the Taxation Ruling TR 2006/3 sets out a number of guidelines which have been established by case law to assist in determining the nature of a receipt. Included in those guidelines are the following principles:

· the nature of a payment is determined by examining the character of the payment in the hands of the recipient;

· regard must be given to all facts, as such a broad view must be taken of a taxpayer's situation and it is necessary to consider the total situation of the taxpayer;

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

· a payment by gift or subsidy to replenish or augment the recipient's capital is not income under ordinary concepts as it is not a product or incident of the recipient's income producing activity.

Paragraph 85 of TR 2006/3 also provides that payments which have the following characteristics would generally be considered to income:

· a payment which is periodic, regular or recurring

· payment received for services rendered

· payments provided for particular revenue expenses

· payment from an isolated transaction entered into with an intention to profit.

The funding payment made to the entity has been made for the specific purpose of acquiring a capital asset. The entity was not carrying on a business at the time the funding payment was made. Consequently, the payment was not received for the purpose of continuing a business (examples of which are set out at paragraph 4 of TR 2006/3). Nor was the funding payment made for the purpose of assisting the entity to commence a business.

As part of its responsibilities for receiving the funding payment, the entity is required to ensure that the land meets certain environmental characteristics, and that it registers the approved covenant in respect of the land.

As the funding payment received by the entity is for the purchase of a capital asset and it has not been paid to the entity in respect of commencing, carrying on, or ceasing a business, it is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Relevant case law includes:

Federal Coke Co Pty Ltd v FCT (1977) 7 ATR 519; 77 ATC 4255 lump sum payment received by a company in compensation for a contract cancellation was considered to be capital in nature. It was considered that the receipts were in no sense the product of any business or income producing activity which it carried on.

Scottish Australian Mining Co Ltd v. FCT (1950) 81 CLR 188; 4 AITR 443 where a company incorporated to purchase and mine coal undertook a scheme to sell the land after mining operations ceased. It was held that the profits from the sale of the land were not assessable income and that the taxpayer was merely engaged in the realising of a capital asset. The taxpayer was not in the business of selling land.

Dickenson v FCT (1958) 98 CLR 460; 7 AITR 257; 11 ATD 415, where a lump sum payment received by the taxpayer for giving up a substantial sphere of activity which was otherwise open to him was a capital receipt.

Question 2

TR 2006/3 provides at paragraph 91 that where a GPI is not assessable as ordinary income, consideration needs to be given to whether section 15-10 of the ITAA 1997 applies.

Paragraph 92 of TR 2006/3 provides that a GPI is assessable under section 15-10 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.

Paragraph 101 of TR 2006/3 further provides:

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 the First Provincial Case:

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 a 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.

The above means that in order for a bounty or subsidy to be assessable under section 15-10 of the ITAA 1997, it must not be for the purpose of commencing or ceasing a business, and the payment must be for the purpose of producing assessable income from carrying on a business.

It has already been established that the entity was not carrying on a business at the time it received the funding payment. Consequently, the funding payment was not paid in respect of producing assessable income from carrying on a business and is therefore not assessable as a bounty or subsidy under section 15-10 of the ITAA 1997.

Note: Paragraph 26 of TR 2006/3 provides that where a government payment is not assessable under section 6-5 or 15-10 of the ITAA 1997, then the payment may give rise to an assessable recoupment under Subdivision 20-A of the ITAA 1997.

To constitute an assessable recoupment, an amount must, in the first instance, satisfy the definition of a recoupment under subsection 20-25(1):

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.

In relation to assessable recoupment, subsection 20-20(3) states:

20-20(3) An amount you have received as a recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:

(a) you can deduct an amount for the loss or outgoing for the current year, or

(b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year under a provision listed in section 20-30.

In this case the payment made to the entity for the purpose of acquiring land is not deductible expenditure as it was made for the purpose of acquiring a capital asset. Consequently, the funding payment received by the entity is not an assessable recoupment for the purposes of subsection 20-25(1) of the ITAA 1997.

Question 3

In order to answer this question, it is necessary to characterise the funding payment as either:

· recoupment of expenditure for the acquisition of the property (subsection 110-45(3) of the ITAA 1997, or

· capital proceeds for creating rights under the funding agreement (CGT event D1 - section 104-35 of the ITAA 1997), or

· capital proceeds for entering a conservation covenant (CGT event D4 - section 104-47 of the ITAA 1997).

Subsection 110-45(3) of the ITAA 1997 provides:

Expenditure does not form part of any element of the 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 104-35(1) of the ITAA 1997 provides:

CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity.

Example:

You enter into a contract with the purchaser of your business not to operate a similar business in the same town. The contract states that $20,000 was paid for this. You have created a contractual right in favour of the purchaser. If you breach the contract, the purchaser can enforce that right.

Subsection 104-47 of the ITAA 1997 provides:

CGT event D4 happens if you enter into a conservation covenant over land you own.

Under a funding deed, the entity creates rights in the Australian Government including the right to enforce entry into a conservation covenant and the right to have the project carried out in accordance with certain milestones.

However, it does not follow that the funding payment is capital proceeds from creating these rights. The facts indicate that the payment is to fund the purchase of the property so that it can be protected under the relevant government project.

The facts support a conclusion that the funding payment is more directly related to the acquisition of the property rather than the agreement to enter a conservation covenant.

The facts and information about the nature and purpose of the relevant government project support the characterisation of the funding payment received under the scheme as a recoupment (as defined under subsection 20-25(1) of part of the cost of acquiring the property.

Subsection 20-25(1) of the ITAA 1997 provides:

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.

The payment is characterised as a recoupment of part of the amount the entity is required to pay to acquire the property. Consequently, the same payment cannot be capital proceeds for CGT event D1 or CGT event D4.

Apart from the reimbursement of part of the acquisition cost of the property by way of the funding payment, that part of the acquisition cost would have been included in the cost base of the property (section 110-25 of the ITAA 1997). Consequently as the funding payment is not included the assessable income of the entity, the funding payment is a recoupment of part of the acquisition cost of the property and is therefore excluded from the cost base of the property by operation of subsection 110-45(3) of the ITAA 1997.

Further issues to consider

Additional information provided in relation to the Conservation Covenant. This additional information does not form part of the ruling.

Under section 104-47 of the ITAA 1997, CGT event D4 happens if a taxpayer enters into a conservation covenant over land that it owns.

It has been established that the funding payment paid by the federal government is not capital proceeds for entry into a conservation covenant for the purposes of section 104-47 of the ITAA 1997.

However, under the scheme, the entity will be required to enter into a conservation covenant with a state / territory government. Consequently, CGT event D4 under section 104-47 of the ITAA 1997 will happen if:

· the entity receives some capital proceeds for entering into the covenant, or

· the entity can deduct an amount under Division 31 for entering into the covenant

It should also be noted that where subsection 104-47(6) applies so that CGT event D4 does not happen, CGT event D1 (under section 104-35 of the ITAA 1997) happens.