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Authorisation Number: 1012342023387

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Ruling

Subject: Income Tax - Assessable income - government incentive program

Question

Are incentive payments received by the taxpayer under a government incentive scheme assessable as a subsidy under section 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period

1 July 2012 to 30 June 2015

The scheme commenced on

1 July 2012

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Relevant facts

The company known as the Organisation was registered as a company during the current income year.

Funds have been provided by the Commonwealth for the purchase of property and construction of facilities which will provide services for the community (the Program).

This Organisation represents the only company from the group involved in the Program to be eligible and apply for the government grant.

The Organisation was granted a funding agreement because it met with the appropriate requirements for 'Milestone 1'.

The Funding Agreement states:

The Organisation must construct and fit out the project works as agreed including site preparation, modification, expansion, refurbishment, furnishing and equipment as contemplated by the project plan and budget in accordance with a milestone schedule.

The Organisation warrants that where it purchases or leases a proposed acquisition, the transfer to the Organisation will be legally effective.

During the term of the agreement, the Organisation must not dispose of the property or any part or interest in the property without prior Commonwealth written consent and all parties must enter into a deed of covenant with the Commonwealth to dispose covenants in favour of the Commonwealth to use the property and perform the designated use of the property until the expiry of the designated use period.

If on practical completion or expiry or any earlier termination of the agreement and any or all of the funds have not been spent or committed in accordance with the agreement or cannot be satisfactorily reconciled, the Commonwealth may require the Organisation to repay part of the funds, deduct that amount from other amounts receivable or require that the funds be used as directed.

Where the Organisation fails to comply with its obligations under the Program, the Commonwealth may give written notice requiring the Organisation to pay liquidated damages.

The organisation must keep proper financial records and provide implementation progress sheets (four monthly).

The Organisation must publicly acknowledge the financial and other support received from the government as specified in the funding agreement.

The Commonwealth may step in and take control of (by itself or through a nominee) part or whole of the operations including the performance or completion of the Organisation's obligations under the agreement if the Organisation is considered to have breached or is in breach of any obligation under the agreement.

The property works are to be used for their intended purpose for a designated period.

The grant will not be used towards running an existing business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-10.

Summary

The government payment received is not a subsidy in accordance with section 15-10 of the ITAA 1997.

Detailed reasoning

Section 15-10 of the ITAA 1997 provides that assessable income includes a subsidy that is received in relation to carrying on a business and that is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Relevant factors in determining whether a payment is ordinary income are determined by the character of the payment in the hands of the recipient.

Characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon

· have an element of periodicity, recurrence or regularity.

The payment is not earned, as the Organisation had not yet commenced business and it was not expected or relied upon as it was granted as a subsequence of a successful application and satisfactory completion of milestones. The payment also has no element of periodicity, recurrence or regularity.

Therefore, the character of the payment is not ordinary income under subsection 6-5(1) of the ITAA 1997.

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. The funding agreement has been provided in order to assist in this determination.

Taxation Ruling TR 2006/3 (TR 2006/3) entitled Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business sets out the Commissioner's view on circumstances in which a government payment will be considered to be a subsidy.

The term 'subsidy' is not a defined term for the purposes of either the ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936).

The Macquarie Multimedia Dictionary version 5.0.0 defines 'subsidy' as:

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

· a sum paid, often in accordance with a treaty, by one government to another, to secure some service in return.

· a grant or contribution of money.

Mahoney J in Reckitt and Colman Pty Ltd v. FCT (1974) 4 ATR 501, 74 ATC 4185 indicated that the term 'subsidy' includes a financial grant made by the State for the purpose of encouraging a particular activity in the field of trade and commerce. The payment received by the Organisation falls within the definitions provided for the word 'subsidy'.

A subsidy will be 'in relation to' carrying on a business when there is a real connection between the receipt and the carrying on of the business and the payment is directed to the income earning activity of the business.

In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320; [1995] FCA 1101; 95 ATC 4145; (1995) 30 ATR 207 (First Provincial), the Full Federal Court held that, as the payment assisted the taxpayer to continue to carry on the taxpayer's business activities, it was made in relation to the carrying on of its business, although it lacked the necessary connection with the taxpayer's business activities to constitute ordinary income.

The comments by Hill J in First Provincial make it clear that all that is required for a subsidy to be received in relation to carrying on a business is that there is 'a relationship' to the carrying on of a business that is not so remote as to be insignificant. It is also clear from the use of the expression 'any relationship' by Hill J and the conclusion that the relationship may be indirect that there is no requirement that the relationship be the dominant or main relationship. The degree of the connection will be a matter of judgement on the facts of each case.

The payment received by the Organisation has sufficient relevance to the business to be carried on that it is considered to be 'in relation to' the business.

In order to be assessable income in terms of section 15-10 of the ITAA 1997 a subsidy must also be related to the 'carrying on' of the business and not merely for commencing or ceasing a business. In looking at the meaning of the phrase 'in relation to carrying on a business' Hill J stated in First Provincial that:

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 the 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.

In accordance with paragraph 26 of TR 2006/3, government payments to industry to commence or cease a business are not assessable as ordinary income of the recipient under section 6-5 of the ITAA 1997 or as a subsidy in relation to carrying on a business under section 15-10 of the ITAA 1997.

A subsidy is received to 'commence a business' if the subsidy is to enable the recipient to reach the necessary point where the recipient is committed to proceed with the implementation of its purpose to carry on a business. However, a subsidy that is received in relation to the activities of an entity as it commences its business is not received to commence the business if the decision to commence is not dependent upon the receipt of the subsidy. If there is a real connection, whether direct or indirect, between the subsidy and the carrying on of a business, it would be received in relation to carrying on a business.

Thus, a grant that is received in relation to an activity that is integral to carrying on a business (such as the acquisition of an asset that is necessary for the business) is received in relation to carrying on a business even though the activity may be carried out soon after the business commences and is preparatory to and not directly productive of assessable income.

In the present case, funding has been granted as the result of the Organisation meeting requirements for Milestone 1 under the funding agreement to establish a capital asset. The application of funds in order to procure a capital asset does not preclude the application of section 15-10 of the ITAA 1997. As determined in First Provincial, the amount paid lacked the necessary connection with the taxpayer's business activities to constitute income according to ordinary concepts however the law was intended to include as assessable income items which might or might not be of an income nature. Therefore a payment received on capital account may be an assessable subsidy.

It is significant that the Organisation was not carrying on a business at the time the funding payment was applied for or granted. Consequently, the payment was not received for the purpose of carrying on or continuing a business. The Organisation applied for the government funding for the construction of a new facility. The Organisation will own the land and buildings as well as conducting the business.

The funding will not be used in relation to:

· increasing the efficiency of an existing business

· the actual carrying on of the business activity or

· any other type of business activity.

The commencement of the business was dependent upon the approval and receipt of the grant. The grant was to assist the Organisation to reach the necessary point to proceed with the implementation of its purpose to carry on a business. Accordingly, the grant monies were received to commence a business. To be considered assessable under section 15-10 of the ITAA 1997, the receipt must be in relation to the carrying on of a business. As summed up in paragraphs 103 and 128 of TR 2006/3, government payments 'to commence or cease business' as distinguished from those received 'in relation to carrying on a business' are not considered to be assessable as a subsidy under section 15-10 of the ITAA 1997.

Therefore the payment received by the Organisation is not included in the assessable income of the Organisation as it does not qualify as a subsidy for the purposes of section 15-10 of the ITAA 1997.

Further issues for you to consider

As the government payment is not considered assessable in terms of section 6-5 of the ITAA 1997 or section 15-10 of the ITAA 1997 the Organisation will need to consider whether there are any capital gains tax consequences in relation to the payment received.