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Ruling

Subject: Assessability of an 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

Is an A1 capital gains tax (CGT) event under section 104-10 of the ITAA 1997 the appropriate CGT event to be applied in relation to the receipt of the ECEG?

Answer

Yes.

Question 4

Does section 152-12 of the ITAA 1997 apply to the ECEG?

Answer

No, because the relevant CGT event is not D1.
Question 5

For the purposes of section 152-40 of the ITAA 1997 will the capital gain pertaining to the ECEG satisfy the meaning of active asset?

Answer

Yes, provided the farm business assets that were sold also met the section 152-40 meaning of active asset.

Question 6

For the purposes of section 152-35 of the ITAA 1997 will the capital gain pertaining to the ECEG satisfy the active asset test?

Answer

Yes, provided the farm business assets that were sold also met the section 152-35 active asset test.

Question 7

Should the ECEG be returned in the year ended 30 June 2011?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Relevant facts and circumstances

You operated a farm as a sole trader for over 15 years.

With a view to accessing the ECEG funding the farming property was sold under a contract which settled in the year ending 30 June 2011.

In the year ended 30 June 2011, but after the farming property was sold, an application was submitted to Centrelink in relation to the ECEG.

An ECEG was approved and received in the year ended 30 June 2012.

The ECEG is a one-off payment of up to $150,000 for farmers who sold their farm enterprise (based on date of settlement) and lodged an ECEG application by 10 August 2011.

The conditions of the ECEG are such that an applicant is necessarily required to sell their farmland and not become an owner or operator of an agricultural enterprise again within five years.

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 104-10

Income Tax Assessment Act 1997, subsection 104-10(3)

Income Tax Assessment Act 1997, section 104-35

Income Tax Assessment Act 1997, section 152-12

Income Tax Assessment Act 1997, section 152-35

Income Tax Assessment Act 1997, paragraph 152-40

Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(i)

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 recipient's 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 made a commitment to sell your farming business and paid in relation to the disposal of your farming assets and your commitment not to carry on a business of primary production 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 primary production business 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 received subsequent to you having committed to the sale of your business and associated property, and paid in relation to the disposal of your farming assets and the imposition of a restrictive covenant in which you are precluded from owning or operating a farming business again for a period of five years.

Therefore, the ECEG 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.

Question 3

CGT event A1 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.

Taxation Ruling TR 1999/16 addresses capital gains and the goodwill of a business. At paragraph 33 it provides that a restrictive covenant is inextricably linked to the value of any goodwill disposed of. If during the disposal of a business a specific part of the sale proceeds is not allocated to the covenant, then for the purposes of Part 3-1 we will treat the giving of the covenant as being ancillary to the disposal of the goodwill of the business and no part of the proceeds will be attributed to the grant of the restrictive covenant.

Application to your circumstance
As you entered into the agreement and owned the farm assets in your own right, as a sole trader, the grant represents capital proceeds for both the sale of the farm assets and the agreement not to commence another farming enterprise for five years.

However, in accordance with the direction provided in paragraph 33 of TR 1999/16, we have determined that because no identifiable part of the ECEG was paid specifically in relation to the restrictive covenant it is reasonable to allocate the entire exit grant to the sale of the farm assets.

Given that the relevant CGT event in relation to the sale of those assets is A1 it follows that the appropriate CGT event pertaining to the receipt of the ECEG is also A1.

The grant should be apportioned across the farm assets on a reasonable basis. The relative market values of the assets at the time of their sale would generally represent a reasonable basis upon which to apportion the capital proceeds from the ECEG.

Question 4

Section 152-12 only applies when the appropriate CGT event is D1.

Application to your circumstance
As we have established that the whole of the proceeds in relation to the ECEG will constitute an A1 CGT event section 152-12 is not applicable.

Question 5

Section 152-40 addresses the meaning of active asset. Subparagraph 152-40(1)(a)(i) provides that 'A CGT asset is an active asset at a time if, at that time…you own the asset…and it is used, or held ready for use, in the course of carrying on a business that is carried on by…you'.

Application to your circumstance
We have established that the relevant asset/s for the purposes of section 152-40 were the farm and associated assets. We have also established that the farming business was carried on by you in a sole trader capacity.

Provided the farming assets that were disposed of upon the cessation of the business and prior to the receipt of the ECEG met the meaning of active asset definition then it follows that the ECEG will also meet the requirements of section 152-40.

If some of the farm business assets over which the ECEG is apportioned were not active assets then the extent to which the ECEG will satisfy the meaning of active asset will be reflective of this apportionment.

Question 6

Section 152-35 addresses the active asset test. In part, it provides that 'A CGT asset satisfies the active asset test if…you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7½ years during the period' that 'begins when you acquired the asset, and…ends at the earlier of…the CGT event, and…if the business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.'

Application to your circumstance
Again, provided the farm assets that were disposed of upon the cessation of the business all satisfied the active asset test then the proceeds in relation to the ECEG will also meet this condition.

Question 7

Subsection 104-10(3) provides that the time of the event is when you enter into the contract for the disposal.

Application to your circumstance
As previously explained, despite a D1 CGT event happening at the time of the ECEG contract we have determined that for a sole trader the ECEG reasonably constitutes additional proceeds in relation to the sale of the farm assets. Therefore, the applicable CGT event is A1.

It follows that the time of the A1 CGT event will be the date of the contract for disposal. This occurred in the year ended 30 June 2011.