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Ruling

Subject: Assessability of a government grant in respect of a natural disaster

Question 1

Is the government grant paid for the purpose of rebuilding your business premises considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the government grant paid for the purpose of rebuilding your business premises considered assessable income under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Is the government grant paid for the purpose of rebuilding your business premises considered assessable under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Relevant facts and circumstances

An unsigned copy of the Grant Agreement (the Agreement) between you and the Government was provided and forms part of the facts of this ruling.

The business premises was destroyed as a result of a natural disaster.

In the same year you commenced a similar business at a different location. The partnership took up the lease at an existing commercial premise and fitted it out to conduct business.

In response to the impact of the natural disaster the Government established the funding program to restore and improve the capacity of affected areas by enhancing economic development through encouraging private sector capital works and job creation in those areas. Eligible applicants could apply for a proportion of the funding in relation to the eligible capital expenditure to be incurred.

A Funding Program Overview (the Overview) was released by the Government. It provides that the funding must be directed towards the capital costs associated with the construction of the replacement business premises, it cannot contribute towards ongoing operating costs or salary subsidies.

In the following year an application for funding was lodged with the Government.

In that year you ceased operating the business out of the leased premises and sold it as a going concern.

Two years later construction of the new business premises commenced.

In that year, but prior to the commencement of construction, approval for funding was received and an agreement signed. The agreement required that a specified amount of expenditure be spent on the project.

Also in that year the first grant instalment was received. Subsequent instalments have/will be received as milestones stated under the agreement are met.

Milestone 1 required that the partnership provide documentation confirming that (i) there was sufficient funding to complete the project by the required date, (ii) detailed project costings were in place, (iii) applications for building and planning permits have been made, and (iv) detailed construction plans in relation to parking had been approved.

Milestone 2 required the partnership to provide the Government with a statutory declaration stating that a certain amount had been spent on the project and that work had commenced.

The new business opened over two years after the occurrence of the natural disaster.

Milestone 3 requires that (i) all equipment, materials and technology are operational and that all project stages have been completed, (ii) written confirmation be provided from council that car parking has been provided and (iii) a statutory declaration is provided stating that the agreed amount of expenditure been spent on the project.

Milestone 4 requires that audit opinion to the satisfaction of the Government be provided evidencing (i) that he agreed amount has been spent, and (ii) that four full time equivalent staff have been employed for a continuous period of three months. It also requires an inspection.

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, Subsection 20-20(3)
Income Tax Assessment Act 1997, Section 20-40
Income Tax Assessment Act 1997, Section 104-25
Income Tax Assessment Act 1997, Paragraph 118-37(2)(a)
Income Tax Assessment Act 1997, Subsection 110-45(3)

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 pertain to the ITAA 1997.

Question 1

A payment or other benefit received by a taxpayer is included in assessable income if:

· It is income according to ordinary concepts in terms of section 6-5, or

· If not ordinary income it may be included in your assessable income because it is caught under the general 'statutory income' provisions in section 6-10, as listed in section 10-5. Included in the list in section 10-5 are bounties and subsidies (section 15-10).

Ordinary Income

Section 6-5 states, in part, the following:

· 6-5(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

· 6-5(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The intent of section 6-5 is to include in assessable income those receipts which can be categorised as income according to ordinary concepts.

Although the expression 'income according to ordinary concepts' is not defined in the ITAA 1997, there is a substantial body of case law from which a number of factors have been drawn to determine whether an amount has the character of income according to ordinary concepts.

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity, even if the receipts are not directly attributable to services rendered. This view is supported by ATO Interpretative Decision report, ATO ID 2003/902 which cited the same reasoning in finding that a government grant paid in two instalments to a medical practitioner was not assessable under section 6-5.

ATO policy concerning government payments to industry (GPI) is set out in Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business. At paragraph 84, it provides that ordinary income generally falls within three categories:

· Income from providing personal services,

· Income from property, or

· Income from carrying on a business.

Application to your circumstances

The Government Grant does not constitute ordinary income.

Whilst it has been / will be paid in separate instalments it does not possess the necessary elements of periodicity, recurrence or regularity that are common to receipts of ordinary income.

Further, in terms of TR 2006/3 it does not constitute income from the provision of personal services, is not sourced from property, and has not been derived directly from your usual business activities.

Question 2

Statutory Income - a Bounty or Subsidy

Under section 6-10 some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law. These amounts are termed 'statutory income'. Subsection 6-10(1) refers to 'provisions about assessable income' and references a summary list of these provisions which is contained in section 10-5.

One of the statutory income provisions listed in section 10-5 is section 15-10, which deals with the treatment of bounties and subsidies.

Section 15-10 provides that 'assessable income includes a bounty or subsidy that:

(a) is received in relation to carrying on a business; and

(b) is not assessable as ordinary income under section 6-5.'

In relation to carrying on a business

In determining the correct treatment of the payment it needs to be considered whether the bounty or subsidy has been received 'in relation to carrying on a business.'

'In relation to'

A grant '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…' (Paragraph 100 of TR 2006/3)

In the Full Federal Court decision in First Provincial Building Society Ltd v. FC of T (1995) 128 ALR 118; (1995) 95 ATC 4145; (1995) 30 ATR 207; (1995) 56 FCR 320 (First Provincial), Hill J was discussing the antecedent of section 15-10, that is, paragraph 26(g) of the Income Tax Assessment Act 1936 (ITAA 1936). He stated that it is important to note that the former provision contained the words ' received in or in relation to carrying on of a business ... (emphasis added).' When the provision was incorporated into the ITAA 1997, it was rewritten as a bounty or subsidy 'you receive in relation to carrying on of a business.'

In First Provincial, Hill J specifically discussed the relationship between the terms 'received in relation to' and 'received in'. He concluded that the scope of the term 'received in relation to' was sufficiently broad enough to also cover the meaning of the narrower 'received in' which implied a more direct connection.

'Carrying on a business' or 'commencement'

The First Provincial case demonstrates that the scope of the phrase 'in relation to carrying on a business' in section 15-10 is to be interpreted widely. Payments made towards the restructuring of business operations with a view to improving overall efficiency are generally considered to be 'in relation to carrying on a business'. (Paragraph 102 of TR 2006/3)

'Some business restructures may not be in relation to carrying on a business, for example if a business changes its structure to …'. This is decided on the merits of each case. (Paragraph 102 of TR 2006/3)

To be assessable under section 15-10 the subsidy must relate to the 'carrying on' of the business, not merely to the commencement or cessation of it. the First Provincial case illustrates that the expression 'carrying on of the business' is limited to the activities of the business which are directed towards the gaining or producing of assessable income rather than merely to the business itself. (Paragraph 101 of TR 2006/3)

Government payments 'to commence or cease business' as opposed to 'in relation to carrying on a business' are not considered to be assessable as ordinary income under section 6-5 or as a bounty or subsidy under section 15-10.' (Paragraphs 103 and 128 of TR 2006/3.)

Application to your circumstances
The Government Grant does not constitute an assessable bounty or subsidy.

The Agreement and Overview provide that the funding must contribute to the capital costs associated with rebuilding the business premises, it cannot be spent on ongoing operating costs or other non-construction type activities.

The original business ceased operation on the date of the natural disaster. A new business did not recommence until after construction of the new premises had been finalised two years later.

A similar business was operated from a leased premises at a different location for a short time during the intervening period. During this period an application for a Government Grant was lodged. This was approved after the intervening business had ceased with construction also commencing after that time. The first instalment has been received with three subsequent instalments to be received as the payment deliverables are met in accordance with the Project Particulars and Payment Terms contained within the Agreement.

We find that the grant funding was paid solely in relation to the capital costs associated with the construction of a new business premises for a new business activity. It does not relate to the former business which had ceased operating on the date of the natural disaster, nor does it relate to any ongoing operational costs associated with the newly constructed business.

We also find that the temporary undertaking of a like business activity at a different location during the period in which the funding application was lodged does not impact on this conclusion.

Therefore, because it will not be received 'in relation to carrying on' either the original business, the temporary business or the newly commenced business the funding received is not assessable under section 15-10 as a bounty or subsidy.

Question 3

Capital gains tax provisions

Section 104-25 deals with cancellation, surrender and similar endings to CGT assets - a CGT event C2. A C2 event occurs when the ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. This would occur when a taxpayer's rights under an agreement come to an end - generally at the time the taxpayer's obligations have been discharged and the taxpayer receives payment.

A capital gain occurs if the capital proceeds from the ending of the rights are more than the asset's cost base.

CGT exemption under paragraph 118-37(2)(a)

Paragraph 118-37(2)(a) provides, in part, that a capital gain may be disregarded if you make it as a result of receiving a payment as reimbursement or payment of your expenses under a scheme established by an Australian government agency or local governing body.

In relation to this paragraph, the Revised Explanatory Memorandum (EM) in relation to the Tax Laws Amendment (2006 Measures No. 3) Act 2006 provides that the requirement that 'the scheme be established under an enactment or an instrument of a legislative character would be satisfied where the scheme is established that way either expressly or by necessary implication. An enactment would include an Appropriation Act (or equivalent) having regard to associated documentation such as budget papers. An instrument of a legislative character would include regulations (and similar instruments) and local government by-laws.'

Application to your circumstances

Under the Agreement the Government will create rights in you to receive payments upon the completion of several milestones as stated. These rights will be satisfied under CGT event C2 when the Government makes the payments to you.

You will make a capital gain equal to the difference between the capital proceeds and the cost base of the rights.

CGT exemption under paragraph 118-37(2)(a)

The Guidelines recognises that funding has been made available by the Government for the purpose of encouraging private sector investment and job creation in areas affected by the natural disaster. The Program is administered by the relevant Authority with funding made available via the relevant Government Department.

We find that the Program meets the requirements of paragraph 118-37(2)(a) as outlined in the revised EM and the grant complies because it is a payment received as reimbursement or payment of expenses incurred in relation to the Program.

Therefore, any capital gain made by you from the C2 CGT event will be disregarded under paragraph 118-37(2)(a).

Recoupment reduces cost base

Although there is no capital gain at the time of receipt of the grant, there are capital gain consequences when you eventually dispose of the property. To the extent that the grant is received to fund the cost of purchasing land and buildings or for constructing or renovating buildings, it is a recoupment of those costs. This recoupment reduces the cost base of the property as per subsection 110-45(3).

Further information regarding depreciating assets

To the extent that the grant is received to fund the cost of depreciating assets it is an assessable recoupment under subsection 20-20(3) of the ITAA 1997.

If the cost of a depreciating asset acquired out of the funding is deductible under Division 40 over two or more income years, section 20-40 applies so that the total of assessable recoupments to be included in assessable income at a particular time is limited to the total amount of the loss or outgoing that can be or has been deducted at that time. Any part of an assessable recoupment that is not included in assessable income in the year of receipt because of this limit is assessable in later income years to the extent that further amounts are deductible under Division 40 for the depreciating asset in the later income years.