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Ruling

Subject: Owners reimbursement costs

Question 1

Will the full amount of the owner reimbursement costs (ORC) payment be included in your assessable income?

Answer

Yes

Question 2

Will the full amount of the ORC payment be treated as income derived from primary production?

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You are a primary producer who derives income from two primary production activities. One activity is the harvesting of a product.

During the 2010/11 financial year most of your product trees were destroyed by the Department of Primary Industries (DPI)I as part of a program to eradicate a disease.

As a result of the eradication, you received an ORC payment which was paid under the Guidelines for owner reimbursement costs under the plant pest deed (the Guidelines). The payment was made during the 2011/12 financial year.

The Guidelines state that the main objective in providing ORC is to provide incentives for growers to report suspicious pests or pathogens under the basic principle of no one being worse off or better off as a result of reporting a suspected exotic pest incursion.

Your ORC payment comprises of the following components:

· loss of profit from current crop

· costs from tree destruction to harvest

· replacement of capital costs

· loss of profit over fallow period

· tree replanting costs

· loss of profit during non-bearing period.

The loss of profit from current crop amount was based on your average revenue from the sale of your product and adjusted for CPI changes.

The costs from tree destruction to harvest amount is an estimate of the costs you would have incurred between the time the trees were destroyed to when they would have been harvested.

The replacement of capital costs amount is the cost to purchase and install tree guards for the replacement trees.

A fallow (non-growing) period for your land applies. This means you are unable to plant new trees until a future year. The loss of profit over fallow period amount represents the loss of the expected profit during the fallow period. This amount was discounted and then adjusted upwards in line with CPI changes.

The tree replacement costs amount represents the cost of purchasing and planting trees including starter fertiliser and labour.

The replacement trees are assumed to take a number of years to reach maturity. The loss of profit during non-bearing period amount is an estimate of the profits you would have made from the sale of your product during those years had the old trees not been destroyed.

You have continued your other primary production activity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 6-10
Income Tax Assessment Act 1997 Section 10-5
Income Tax Assessment Act 1997 Section 15-10
Income Tax Assessment Act 1997 Section 393-5
Taxation Administration Act 1953 Schedule 1 Subsection 357-110(1)

Reasons for decision

Issue 1

Summary

The full amount of ORC forms part of your assessable income as the net amount received for loss of profits is considered to be ordinary income and the amounts received for tree replanting and capital costs are assessable subsidies.

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

Assessable income also includes amounts that are not ordinary income but are made assessable by a specific provision of the taxation legislation. These amounts are called statutory income. A summary of the provisions are listed in section 10-5 of the ITAA 1997.

You received an ORC payment as a result of your product trees being destroyed. The ORC consisted of the following components:

· loss of profit from current crop, over fallow period and during non-bearing period

· costs from tree destruction to harvest

· replacement of capital costs and tree replanting costs.

Each of the above component groupings will be examined separately.

Loss of profits

An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments that substitute for income have been held by the courts to be income under ordinary concepts even when paid as a lump sum.

Proceeds from carrying on a business are income according to ordinary concepts and are included in assessable income.

The Commissioner considers the amounts received for loss of profits from the current crop, over the fallow and non-bearing periods to be compensation which replaces lost business income. As such they are assessable under section 6-5 of the ITAA 1997.

Costs from tree destruction to harvest

The loss of profit from the current crop amount does not include the cost of harvesting the crop which would have been incurred had the trees not been destroyed.

In determining the total ORC to be paid the DPI have deducted the harvesting costs and paid the net amount to you.

The loss of profit from current crop amount is also reduced by the expected harvesting costs. Only the net amount is included in your assessable income.

Replacement of capital costs and tree replanting costs

Taxation Ruling TR 2006/3 provides the Commissioner's opinion on the assessability of bounties, subsidies, grants and rebates paid or funded by the Commonwealth or a State, Territory or local government, or government agency. This type of payment is referred to in the ruling as a government payment to industry (GPI).

A GPI that assists a business to carry on its activities and is:

· a bounty or subsidy

· capital in nature, and

· received in relation to carrying on a business

· is assessable under section 15-10 of the ITAA 1997 in the income year in which it is received.

The Macquarie Dictionary (2^nd edition) defines 'subsidy' as:

A direct pecuniary aid furnished by a government to a private industrial undertaking, a cultural organisation, or the like.

The courts have also considered the term 'subsidy' and it is now accepted that a 'subsidy' includes a financial grant made by a government.

You have received a payment from the government, via the DPI, which includes components for the cost of replanting trees and tree guards. These components of the payment are considered to be subsidies as they are financial grants made by a government.

The cost of purchasing and planting new trees is a capital cost as the trees are assets to your business. As is the cost of replacement tree guards (the capital costs component of the ORC).

You received the payments as a result of carrying on a product growing business.

As the payments for the replanting of the trees and the capital costs meets the requirements of section 15-10 of the ITAA 1997, these amounts are included in your assessable income.

Issue 2

Summary

The full ORC payment is considered to be taxable income derived from primary production as the payment resulted from you carrying on a primary production business. It will be included in calculating your taxable primary production income.

Detailed reasoning

Section 392-80 of the ITAA 1997 tells you how to work out your primary production income.

Taxable primary production income for a financial year is determined by:

· comparing your assessable primary production income for the financial year with your primary production deductions for the income year

· if your assessable primary production income is larger than your primary production deductions, your taxable primary production income is the difference between them

· if your primary production deductions are larger than (or equal to) your assessable primary production income, your taxable primary production income is nil.

Your assessable primary production income for a financial year is the amount of your assessable income for the financial year that was derived from, or resulted from, you carrying on a primary production business.

The components of the ORC payment which relate to the loss of current and future year profits are primary production income as they resulted from your carrying on a primary production business.

TR 2006/3 states that an assessable GPI that is derived from, or results from, carrying on a primary production business is primary production income. Thus, the components of the ORC payment which relate to the capital and tree replanting costs are also primary production income.

The full amount of the ORC payment is considered to be primary production income and is used to calculate your taxable income derived from primary production.