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Ruling

Subject: Assessable income

Question 1

Is the grant assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the grant assessable under section 15-10 of the ITAA 1997?

Answer

No

Question 3

Is the grant assessable under Subdivision 20-A of the ITAA 1997?

Answer

No, provided the funding is not expended on and deductions are not claimed in respect of any of the items listed in the table in section 20-30 of the ITAA 1997.

Question 4

Is the grant assessable under the capital gains tax provisions?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2013

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

You own property that is leased to a separate entity. This separate entity carries out a business on the property. You are not in anyway involved in their business activities and act as a lessor only.

You own X properties that are leased to the separate entity. You do not own any other properties.

You are not carrying on any other business activities.

You made an application for a grant (the grant) in relation to a government initiative.

You intend to undertake the construction of additions to the existing buildings on the property. The grant will contribute to the funding of these works.

The Guidelines
A complete copy of the guidelines relating to the grant and issued by the government agency responsible for administering the grant (the Guidelines) forms part of the facts of this ruling.

The Agreement
A copy of the Funding Agreement (the Agreement) between you and the Commonwealth of Australia forms part of the facts of this ruling.

The agreement provides the following:

· In relation to the property, you must have tenure by way of fee simple, lease or another form of legally binding tenure which enables you to undertake the project and comply with the obligations under the Agreement.

· That you use the property for the designated use over the designated use period which is X years.

· If the funds are not spent in accordance with the Agreement the Commonwealth may, by written notice to you, direct you to repay the funds, deduct amounts from future payments to you or require that you use all or part of the funds identified as the Commonwealth sees fit.

· The budget attached to the agreement provides that the grant will be used for building and site preparation works only. The trust will source funds from alternative sources to fund expenses relating to the internal fixtures and furniture, essential equipment and information technology.

· The grant will be paid in instalments in accordance with the milestone schedule. The maximum amount payable will be $X.

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 20-30

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)

Reasons for decision

Question 1 - Ordinary income

Subsection 6-5(2) 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 is 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. At paragraph 84 of TR 2006/3, 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 grant does not constitute ordinary income. Whilst it 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.

Accordingly, the grant is not assessable under section 6-5 of the ITAA 1997.

Question 2 - Statutory Income - a Bounty or Subsidy

Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law. These amounts are referred to as 'statutory income'. Subsection 6-10(1) of the ITAA 1997 refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5 of the ITAA 1997.

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.'

Taxation Ruling TR 97/11 provides the Commissioner's views on what constitutes 'the carrying on of a business'. At paragraph 13 the following indicators are outlined:

· whether the activity has a significant commercial purpose or character...

· whether the taxpayer has more than just an intention to engage in business...

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity...

· whether there is repetition and regularity of the activity...

· whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business...

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit...

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit...

· the size, scale and permanency of the activity..., and

· whether the activity is better described as a hobby, a form of recreation or a sporting activity...

In considering these indicators against the facts of each case the Commissioner recognises that no one indicator is conclusive. The determination of the question is generally the result of a process of weighing all the relevant indicators.

To be assessable under section 15-10 of the ITAA 1997 the subsidy must relate to the 'carrying on' of the business, not merely to the commencement or cessation of it. 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)

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

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.

You own the property and have applied for government funding to extend the facility that is on the property. You will not be operating a business. This will be conducted by a separate entity.

Your only activity will be to act in the capacity of lessor in relation to the property and to derive periodical rental payments from the entity that will be operating the business. Further, you will not be involved in any other income earning activities outside of the leasing of this facility.

With regard to the use of the funding, we find that it is not used in relation to:

· increasing the efficiency of an existing business

· the actual carrying on of a business activity

· the carrying on of a rental property business, or

· any other type of business activity.

Taking into account the indicators in TR 97/11, as the extent of your activities as a lessor will be aligned more readily with the type of activities generally undertaken by an investor, it is clear that you will not be carrying on a business in this regard.

As you will not be carrying on the business or a business of leasing properties, any receipts in relation to the funding will not be assessed under section 15-10 of the ITAA 1997 as a bounty or subsidy.

Question 3 - Assessable recoupment

For an amount to be considered an assessable recoupment subsection 20-20(3) of the ITAA 1997 requires that the expenditure be incurred and then a corresponding deduction be claimed under one of the provisions listed in the table provided under section 20-30 of the ITAA 1997.

Capital works expenditure claimed under Division 43 of the ITAA 1997 is not listed in that table. Accordingly, if the expenditure is in relation to capital works only then the assessable recoupment provisions do not apply.

To the extent that a government grant is received to fund the cost of depreciating assets, such as medical equipment, it is an assessable recoupment under subsection 20-20(3).

Application to your circumstances

You have advised that, on the whole, the grant is intended to be used on building works expenditure. These types of expenses would fall under the capital works provisions contained in Division 43 of the ITAA 1997. Accordingly the assessable recoupment provisions will not apply to this case.

However, where any portion of the funds are used and a deduction is claimed in respect of any of the items listed under section 20-30 of the ITAA 1997, that portion will be considered an assessable recoupment under subsection 20-20(3) of the ITAA 1997.

Question 4 - Capital gains tax
Section 104-25 of the ITAA 1997 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) of the ITAA 1997 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 agency creates rights in you to receive payments upon the completion of several milestones as stated in the Agreement. These rights will be satisfied under CGT event C2 payments are made to you.

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

Funding in relation to the Program was announced by the Australian Government in the 20xx-xx budget. The Guidelines make reference to this Program and provide that the government has made a commitment to build on the initial funding. The Commonwealth administers the Program via a government agency.

We find that the Program meets the requirements of paragraph 118-37(2)(a) of the ITAA 1997 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 the trust from the C2 CGT event will be disregarded under paragraph 118-37(2)(a) of the ITAA 1997.

Note: Cost base reduction
Although there is no capital gain at the time of receipt of the grant, there will be capital gains 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) of the ITAA 1997.