Edited version of your private ruling

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Ruling

Subject: Income Tax: Assessable income - Government payments to industry (GPI)

Question 1

Will 'progress payments' received under a Government payment to industry (GPI) program, in respect of eligible activities conducted in the ordinary course of your business, be included in your assessable income under section 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. Those progress payments will be included in your assessable income under section 6-5 of the ITAA 1997.

Question 2

Will 'progress payments' received under the GPI program, in respect of eligible activities undertaken in relation to the construction of an asset, be included in your assessable income under section 15-10 of the ITAA 1997?

Answer

Yes.

Question 3

Will progress payments received under the GPI program be included in your assessable income when received?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2012.

The scheme commenced on:

1 July 2011.

Relevant facts and circumstances

You are an Australian company and are part of a global group of entities who manufacture components for an industry.

You plan to redevelop your local footprint and invest in high technology plant, equipment and tools. However you require external funding in order to undertake that redevelopment.

You lodged an application with the Australian Government (the Government) for a program providing GPI, where the GPI program was implemented in support of specific Government policy objectives.

Your application contained details including that you will undertake and complete a specified project, the outcome of which aligns with the achievement of the specified Government policy objectives. Your application includes your explanation of:

· your source of funding to undertake the project

· the impact of grant funding on project outcomes

· your capacity to undertake the project

· commercialisation potential of the product.

Activity you will undertake in the course of the project includes:

· activity of a kind you already carry on in the ordinary course of your business

· the construction of an asset.

The Government granted you funding under the GPI program. The particulars of your project and the rights and obligations of each party to the GPI agreement is set out in a deed of arrangement, which is signed by each of those parties involved. That deed sets out various items, including:

· definition of terms

· general and specific terms and conditions to which each party must abide

· agreed level of funding under the program

· eligible activities for which funding will be provided

· critical dates

· reporting and review schedule

· project schedule

· expected expenditure on project activities

· evidentiary requirements

· acquittal and repayment of the grant funds.

The deed also sets out that GPI payments are made in respect of the performance of certain eligible activity, undertaken in the course of your project, in each reporting period. You will receive a GPI progress payment quarterly and in arrears.

To receive a GPI progress payment you are required to provide the Government with certain evidentiary documentation, including a tax invoice for the amount you are eligible to receive for that period.

Where the Government is satisfied you have met your obligations, according to your evidentiary documents and the tax invoice, the Government will make the GPI progress payment to you.

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 15-10

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Detailed reasoning

General discussion of the law

Section 6-5 of the ITAA 1997 includes in your assessable income those receipts that can be categorised as income according to ordinary concepts.

Section 15-10 of the ITAA 1997 provides:

15-10 Bounties and subsidies

Your assessable income includes a bounty or subsidy that:

(a) you receive in relation to carrying on a *business; and

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

Taxation Ruling TR 2006/3 sets out the Commissioner's view in relation to how certain provisions apply in respect of schemes that include bounties, subsidies, grants and rebates paid or funded by the Commonwealth or a State, Territory or local government, or government agency.

The Commissioner has described in TR 2006/3 a number of broad categories of payment, which include:

· Government payments to continue business

· Government payments to commence business

· Government payments to cease business.

TR 2006/3 describes that Government payments to continue business include payments made to an entity to, among other things:

· assist with operating costs

· assist with improving the viability, sustainability and profitability of a business adversely affected by legislative changes

· encourage business expansion

· allow restructuring to remain viable

· assist with capital costs of restructure to remain viable

· undertake research and development activities.

The Commissioner's view in TR 2006/3, in relation to the application of relevant provisions in respect of Government payments to industry (GPI), includes:

Government payments to continue business

10. A GPI to assist a business to continue operating, except where the payment is for agreeing to give up or sell part of the profit yielding structure, is included as assessable income of the recipient under section 6-5 or section 15-10.

Section 6-5

12. A GPI to assist with business operating costs or liabilities is ordinary income in the hands of the recipient and is assessable under section 6-5 in the income year in which it is derived.

15. A GPI to evaluate current business operations in relation to expanding a recipient's business is a receipt arising as a product or incident of carrying on the business. The GPI is ordinary income and assessable under section 6-5 in the income year in which it is derived.

Section 15-10

16. 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 in the income year in which it is received.

19. A GPI received to acquire or construct an asset or assist with the capital costs of restructuring, that is an activity in relation to carrying on a business, is assessable income under section 15-10. This will be the case even if eligibility for the GPI is dependent upon legislative changes having an adverse effect upon a business.

Concessional loans, Conditional Grants, advance payments or repayments

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 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.

Repayments

25. Any amount of a GPI that must be repaid in a later year for which the recipient is not able to claim a deduction is not assessable income and not exempt income under section 59-30 of the ITAA 1997.

Nature of receipt

In TR 2006/3 the Commissioner explains that 'ordinary income' includes income according to ordinary concepts. Income according to ordinary concepts is not defined in the taxation 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.

Further, Case law has established the following guidelines to assist in determining the nature of a receipt:

· 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

· it is necessary to apply 'a business conception to the facts of the case'

· the test in determining if a payment is income or capital is an objective test

· the question is not decided by determining whether the expenditure by the payer is revenue or capital in nature

· the question is not decided by determining whether any expenditure the recipient is required to make is revenue or capital in nature

· the question is not decided by determining the nature of the measure used to calculate the payment

· where a recipient provides consideration for a payment, the nature of that consideration is generally taken to be the nature of the payment

· a payment that is provided for a purpose which is not part of the recipient's business will not be income in nature

· periodicity, regularity or recurrence may show a payment to be income

· a payment paid in consideration for the performance of services is generally income

· calculation of a payment by reference to expected profits made, or not made by the recipient but that would ordinarily have been expected to have been made, is a factor supporting a conclusion of income

· a payment provided for a particular revenue expense is a factor supporting a conclusion of income

· a payment from an isolated transaction entered into with an intention to profit may still be income

· a payment in a lump sum does not require a conclusion that the payment is capital

· 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

· a payment for the sterilisation of a capital asset of a business is a capital receipt

· a payment for surrender of part of the profit earning structure is a capital receipt.

A GPI that is ordinary income is assessable under subsection 6-5(1) of the ITAA 1997 in the income year of derivation.

However, in GP International Pipecoaters Pty Ltd (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (GP International Pipecoaters) the High Court commented on the characterisation of a subsidy that is intended to assist the recipient with capital costs, saying that such receipts would be capital in nature. The court stated at CLR 124; ATC 4422; ATR 10 that:

…it is necessary to consider the taxpayer's submission that the cases show that a receipt of moneys intended by payer and payee to recoup a recipient's capital expenditure is a receipt of a capital nature. That proposition can be accepted when the amount is received by way of gift or subsidy to replenish or augment the payee's capital, for in such a case the receipt cannot fairly be said to be a product or incident of the payee's income-producing activity.

Bounty or subsidy

In TR 2006/3 the Commissioner also discusses that payments of financial assistance by government are commonly referred to as 'bounties', 'subsidies' or 'grants'. As bounty, subsidy and grant are not defined terms, the ordinary meaning of these terms applies. TR 2006/3 explains that:

94. 'Subsidy' is defined as: 1. a direct pecuniary aid furnished by a government to a private industrial undertaking, a cultural organisation, or the like; 2. a sum paid, often in accordance with a treaty, by one government to another, to secure some service in return; 3. a grant or contribution of money'. The ordinary meaning adopted by case law is an 'aid provided by the Crown [government] to foster or further some undertaking or industry'.

95. 'Bounty' is defined to include 'a premium or reward, especially one offered by a government'. When 'bounty' and 'subsidy' are positioned together the compound term is interpreted as describing financial assistance given to assist business.

96. 'Grant' is defined to include 'that which is granted, as a privilege or right, a sum of money, as for a student's maintenance, or a tract of land'. A reference to 'bounty or subsidy' includes a grant that encourages business or trade and also a grant to address a detrimental effect on a business or trade.

Importantly, TR 2006/3 explains that not all government grants are bounties or subsidies for the purposes of section 15-10 of the ITAA 1997. It is essential to determine what the grant is actually for. The question as to the nature and quality of any payment must be determined by reference to the agreement or the terms which created in the recipient the right to the government grant. Any factors used to calculate the amount of payment are of marginal, if any, assistance in determining what the payment is for.

TR 2006/3 also explains that some legislation provides that payments are deemed to be a subsidy for the purposes of section 15-10 of the ITAA 1997. For example, a payment such as an energy grant or a cleaner fuel grant, that is a 'grant' or 'benefit' under section 8 of the Products Grants and Benefits Administration Act 2000 (PGBAA 2000) is taken to be a subsidy for the purposes of section 15-10. However, if such a payment is received as ordinary income, it is assessable under section 6-5 rather than section 15-10.

In relation to carrying on a business

In TR 2006/3, the Commissioner explains that 'Business' is defined in section 995-1 of the ITAA 1997 as 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. Taxation Ruling TR 97/11 provides further guidance on whether an activity carried on by a taxpayer amounts to a business.

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 to' includes within its scope payments that have a direct or indirect connection to the business. As stated by Hill J in First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320; (1995) 128 ALR 118; (1995) 30 ATR 207; (1995) 95 ATC 4145 (First Provincial):

The words 'in relation to' are words of wide import. They are capable of referring to any relationship between two subject matters in the present case the receipt of the bounty or subsidy, on the one hand, and the carrying on of the business, on the other, the degree of connection will be 'a matter of judgment on the facts of each case'. What is necessary, at the least, in the present context is that there be a real connection...the relationship need not be direct, it may also be indirect.

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 First Provincial:

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.

Goods and Services Tax

Section 195-1 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) defines that 'tax invoice'

has the meaning given by subsections 29-70(1) and 48-57(1), and includes a document that the Commissioner treats as a tax invoice under subsection 29-70(1B). However, it does not include a document that does not comply with the requirements of section 54-50 (if applicable).

Subsection 29-70(3) of the GST Act states that:

A recipient created tax invoice is a *tax invoice belonging to a class of tax invoices that the Commissioner has determined in writing may be issued by the *recipient of a *taxable supply

Section 195-1 of the GST Act defines that a 'recipient, in relation to a supply, means the entity to which the supply was made'.

Application of the law

Progress payments in relation to activity in the ordinary course of your business

You applied for funding under the GPI program, which was granted and consequently you signed the deed on or after 1 July 2011.

The grant is paid in respect of the conduct of eligible activity, which is defined within the general conditions and includes activities of a kind you already carry on in the ordinary course of your business.

Progress payments are made quarterly and in arrears, corresponding to the reporting requirements and reporting periods set out under the deed.

With regard to the principles in the First Provincial case, it is considered that the part of the grant received in relation to those activities of a kind you already carry on in the ordinary course of your business, is subsidising the ordinary costs of carrying on your business.

In consideration of the facts, you are granted a sum of money by the Government to further your existing business activities. Therefore, in applying the ordinary meaning of the term, the grant you receive is a subsidy.

Consistent with the Commissioner's view in TR 2006/3, that a GPI is to assist with business operating costs or liabilities is ordinary income, the GPI progress payments received in respect of those eligible activities of a kind you already carry on in the ordinary course of your business is income according to ordinary concepts. Those progress payments will be included in your assessable income under section 6-5 of the ITAA 1997.

For an amount to be included in assessable income under section 15-10 of the ITAA 1997 the amount must be a bounty or subsidy received in relation to carrying on a business and is not assessable under section 6-5 of the ITAA 1997.

Therefore, progress payments received under the GPI program in respect of those eligible activities undertaken in relation to activities of a kind you already carry on in the ordinary course of your business is not included in your assessable income under section 15-10 of the ITAA 1997.

Question 2

Application of the law

Progress payments in relation to the construction of an asset

Drawing on the principles of GP International Pipecoaters case, as you receive part of the grant in respect of eligible activities undertaken in relation to the construction of an asset, that part of the grant is considered to be a receipt that is capital in nature.

As it has been determined that the progress payments received in respect of eligible activities undertaken in relation to construction of an asset are capital in nature, the payment is not ordinary income, therefore is not included in assessable income under section 6-5 of the ITAA 1997.

Consistent with the Commissioner's view in TR 2006/3, that a GPI received to acquire or construct an asset that is an activity in relation to carrying on a business is assessable income under section 15-10 of the ITAA 1997, progress payments received under the GPI program, in respect of eligible activities conducted in relation to the construction of an asset, is included in your assessable income under section 15-10 of the ITAA 1997.

Question 3

Detailed reasoning

General discussion of the law

Derivation and Timing of derivation of a GPI

In TR 2006/3 the Commissioner explained that 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.

TR 2006/3 discusses that the term 'derive' is defined in subsection 995-1(1) of the ITAA 1997 as having a meaning affected by subsection 6-5(4) of the ITAA 1997. Under subsection 6-5(4) of the ITAA 1997 a recipient is taken to have derived an amount as soon as it is applied or dealt with in any way on their behalf or as they direct. Therefore, if a grant is ordinary income and is paid on behalf of the recipient directly to a supplier in respect of an expense the recipient incurred, it is derived at the time it is so paid to the supplier.

Further, if a grant would be assessable as statutory income apart from the fact that the recipient has not received it, subsection 6-10(3) of the ITAA 1997 provides that the amount becomes assessable as soon as it is applied or dealt with in any way on the recipient's behalf or as directed by the recipient. Therefore, if a grant would be assessable under section 15-10 and is paid on behalf of the recipient directly to a supplier in respect of an expense the recipient incurred, it becomes assessable to the recipient at the time it is so paid to the supplier.

The Commissioner highlights in TR 2006/3 that no Australian judicial decisions precisely cover the timing of derivation of government funding by way of grant or subsidy. However in Brent v. Federal Commissioner of Taxation (1971) 125 CLR 418; (1971) 45 ALJR 557; (1971) 2 ATR 563; (1971) 71 ATC 4195; [1971] HCA 48 (Brent), the High Court said:

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. (The Commissioner of Taxes (South Australia) v. The Executor, Trustee and Agency Company of South Australia Limited (Carden's case ) (1938) 63 CLR 108 at pp 152-154).

In Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 314; (1965) 39 ALJR 262; (1965) 14 ATD 98 (Arthur Murray) the High Court affirmed the proposition that in relation to the question of when income should be judged to have been derived, it was appropriate to have regard to the application of ordinary business and commercial principles.

This proposition was applied most recently by the Full Federal Court in BHP Billiton Petroleum (Bass Strait) Pty Ltd v Commissioner of Taxation [2002] FCAFC 433; (2002) 2002 ATC 5169; (2002) 51 ATR 520; (2002) 126 FCR 119 (BHP Billiton) where regard was had to expert accounting evidence concerning recognising income in relation to the amounts in question. However, in BHP Billiton the Court cited the caution expressed in Arthur Murray when they quoted from that case:

A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinctions it implies. What ultimately matters is the concept; book-keeping methods are but evidence of the concept.

Barwick CJ and Kitto and Taylor JJ also said in Arthur Murray:

As Dixon J observed in Carden's Case : 'Speaking generally, in the assessment of income the object is to discover what gains have during the period of account come home to the taxpayer in a realized or immediately realizable form.

The above passages were made in relation to subsection 25(1) of the ITAA 1936. However, section 6-5 expresses the same ideas as in subsection 25(1) of the ITAA 1936, and these passages can be accepted as having equal relevance to the operation of section 6-5 of the ITAA 1997.

The reference by the High Court in Arthur Murray to the significance of an amount not being income unless it had been earned occurred again in the following passage, which contains the major part of their reasons why in that case, the prepaid fees in relation to dancing lessons not yet delivered, should not be treated as income derived at that time. The Court said:

Thus, in determining whether in such a case actual receipt had to be added to earning in order to find income, uncertainty of receipt, inherent in the circumstances of the earning appeared to his Honour to be decisive. Likewise, as it seems to us, in determining whether actual earning has to be added to receipt in order to find income, the answer must be given in the light of the necessity for earning which is inherent in the circumstances of the receipt

The closest authority to government funding by way of grant or subsidy is the decision of the Administrative Appeals Tribunal (AAT) in Case U7 (AAT Case 20) (1986) 87 ATC 127; (1986) 18 ATR 3120 (Case U7). That case concerned a company which had applied for a grant from the Commonwealth under the former Industrial Research and Development Incentives Act 1976. It had received, at the discretion of the paying agency, an 'advance' of grant monies it would become entitled to on making certain expenditure on (agreed) research and development (R&D) activities. These monies were repayable if this expenditure was not made, or made for less than the amount prepaid.

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.

However, in the current case the payments are only made in arrears after the company has certified that it has done the work for which the grant is paid. Therefore it is considered that Case U7 is not applicable.

The Commissioner has applied the view outlined in TR 2006/3 in respect of other circumstances involving the receipt of a Government grant under an agreement and the determination of when an amount is derived. In particular, ATO Interpretative Decision ATO ID 2006/122 involves the issue of whether instalments are derived at the time of receipt.

The Commissioner explains in ATO ID 2006/122 that, with reference to paragraphs 23 and 24 of TR 2006/3, 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, it will have begun to derive the relevant amount as income.

However, ATO ID 2006 122 concerned payments in advance with the activities yet to be performed and therefore can be distinguished from this case, where payments are made in arrears for activities already performed.

Application of the law

Derivation of the progress payment

You must satisfy certain aspects of the conditions of the deed in order to receive the relevant GPI progress payment.

Where you do not meet all conditions of the deed relevant to the making of progress payments, or are in breach of the deed, the Government may request repayment of an amount in advance or in excess of funds due, to the extent that those conditions were not satisfied or that relates to the breach.

However, upon submission to the Government of those reports required under the deed and a tax invoice for the relevant amount, you declare and evidence the extent to which you have fulfilled all requirements under the deed necessary to receive a GPI progress payment.

No circumstances currently exist to cause a payment, or part there-of, to remain conditional under the terms of the deed. The mere possibility of an event arising that would cause a GPI progress payment to become conditional, is not sufficient to prevent you from deriving the amount at the time it is received.

In consideration of the facts and drawing on principles applied in Arthur Murray, it is at the time of receiving the GPI progress payment that the amount has 'come home' to you and is therefore derived.

Further, consistent with the Commissioner's view on conditional grants in TR 2006/3, a GPI is taken to be received at the time the recipient satisfies the required conditions of the agreement. In your circumstances, those conditions have been satisfied at the time the progress payment is received.

Therefore, GPI progress payments received under the GPI program are included in your assessable income when received.