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Ruling

Subject: Derivation of Government Grant

Question 1

Are instalments paid to a trustee from the Commonwealth upon the terms and conditions of a Grant derived at the time of receipt for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The trustee has applied for a private ruling seeking to determine at what point a grant, paid in instalments by the Commonwealth, is derived according to section 6-5 of the ITAA 1997. The grant is a government payment to industry (GPI).

The agreement entered into between the trustee and the Commonwealth (the Agreement) sets out that that the funding is to be used for an expansion project. The trustee has agreed to perform the project in accordance with the terms and conditions of the Agreement.

The key elements of the Agreement for the purposes of this Ruling are:

· the funding is to be paid in instalments, based on project milestones being met

· the trustee must manage and govern the application of the funding towards the carrying out of the project

· under the Agreement, upon completion of the project the trustee enters a five year period known as the Designated Use Period and must continue to use their facility and property for its designated use

· failure to use the facility and property for its designated use throughout the five year period will result in the trustee being obliged to repay an amount calculated according to a specific formula.

Relevant legislative provisions

Income Tax Assessment Act 1997 s6-5

Income Tax Assessment Act 1997 ss6-5(2)

Reasons for decision

Under subsection 6-5(2) of the ITAA 1997, assessable income includes ordinary income derived during the income year.

Therefore, an amount (including an amount which has been received), will not be included in assessable income for an income year, unless it has been derived during that year.

In Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418; 71 ATC 4195; (1971) 2 ATR 563, the High Court said at CLR 420, ATC 4200, ATR 570:

It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which 'is calculated to give a substantially correct reflex of the taxpayer's true income'. (Commissioner of Taxes (South Australia) v Executor, Trustee and Agency Company of South Australia Limited (Carden's Case) (1938) 63 CLR 108, at pp 152-154).

This reflects the view taken by the High Court in Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673 ( Arthur Murray ).

In Case U7 87 ATC 127; Tribunal Case 20 (1986) 18 ATR 3120 a company received, at the discretion of the grantor, an 'advance' of grant monies to which it would become entitled upon expenditure on the agreed research and development (R&D) activities. These monies were repayable if this expenditure was not made, or was less than the amount advanced. The issue before the AAT was whether the company should be taxed on the whole of the grant monies received during that year, or only so much of it as had been directed towards the conduct of the R&D activities. The AAT referred to the decision in Arthur Murray and considered that there was a close analogy between the company's situation and that of a prepayment under a contract for future services, notwithstanding that the company was not held to be contracting to render future services to the Commonwealth. The AAT considered that the company in the year in question had not done all that was required of it to earn the full amount prepaid to it.

Taxation Ruling TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business discusses at paragraphs 23 and 24, government payments made in advance of the performance of obligations:

Conditional grants

23. Government financial assistance to business is sometimes provided on terms where the amount must be repaid unless the recipient meets agreed conditions within a specified period. The grant becomes unconditional when the recipient satisfies the required conditions of the agreement with the funding authority. It is at this time that a GPI [Government payment to industry] is taken to be received, not at the time the conditional grant was paid.

Advance payments

24. An assessable GPI that is an advance payment is derived by the recipient to the extent that the recipient has done everything necessary to be entitled to retain the amount received. An overpaid amount to which the recipient is not entitled and that must be repaid is not derived by the recipient.

The essence of these paragraphs is that government payments made in advance of performance of the obligations in return for which agreement to make the payments has been given, in situations where legal restrictions attach to the use of those payments, and where repayment of the monies will occur, should the obligations not be performed, or the restrictions breached, do not constitute income derived at the time of receipt. It is only at the later time, when obligations begin to be performed, and restrictions or conditions lift, and the recipient has done all required of it in order to retain the monies received, that it can be said that it will have begun to derive the amounts in question as income.

In this case, under the Agreement, the funding provided has hallmarks of being both conditional and advance payments.

They are advance payments in the sense that they are received by the trustee upon completion of various milestones. Under the Agreement these funds are required to be repaid if they are not then spent as stipulated under the terms of the Agreement.

The funds are conditional in the sense that they must be repaid in part or in full at anytime during the Designated Use Period if the trustee does not satisfy the conditions set out in the Agreement.

Since the government grant is conditional it is concluded that the instalments under the Agreement are not derived as income on receipt. As per paragraph 23 of TR 2006/3 the grant is taken to be received at the time that the required conditions of the Agreement are satisfied.

In basic terms the Agreement requires the trustee to use the Property and the Works for their 'designated use'. The Designated Use Period lasts five years from the 'Practical Completion of the Works'. During this period the trustee will be required to repay, in part or in full, an amount of the grant if it fails to use the Property for its designated use.

Consequently 20% of the grant monies are taken to be received by the trustee on each anniversary of the commencement of the Designated Use Period. It is at these five annual intervals that 20% of the grant is assessable income of the trustee derived in accordance with section 6-5 of the ITAA 1997.