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Ruling

Subject: Government grant

Question 1

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

Answer

No.

Question 2

Do the capital gains tax (CGT) provisions apply to the grant?

Answer

Yes.

Question 3

Should the grant be apportioned on a reasonable basis between CGT events A1 and D1 under sections 104-10 and 104-35 of the ITAA 1997 respectively?

Answer

Yes.

Question 4

For the purposes of 152-12 of the ITAA 1997, will the portion of the capital gain pertaining to the D1 event satisfy the meaning of active asset?

Answer

Yes.

Question 5

If, as a result of the reasonable apportionment some amount is assigned to CGT event A1 should this amount be returned in the year in which the original business assets were sold (year ended 30 June 2011)?

Answer

Yes.

Question 6

If, as a result of the reasonable apportionment some amount is assigned to CGT event D1 should this amount be returned in the year in which the grant was received (year ended 30 June 2012)?

Answer

Yes.

Question 7

Will the capital gain in relation to the grant be split on a 50/50 basis between both business partners?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Two individuals operated a business as a partnership.

The partnership is a small business entity.

With a view to accessing a Government grant, the property was sold under a contract which settled in the year ended 30 June 2011.

The property satisfied the active asset test.

In the year ended 30 June 2011, an application was submitted to the Government by one of the individuals (on behalf of the partnership) for the payment of the grant.

The grant was approved and payment was made to the individual in the year ended 30 June 2012.

The grant is a one-off payment.

A condition of the payment is that the owner cannot become an owner or operator of an enterprise again within X years. This restriction applies to both partners.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5,

Income Tax Assessment Act 1997 section 15-10,

Income Tax Assessment Act 1997 section 104-35,

Income Tax Assessment Act 1997 section 108-5,

Income Tax Assessment Act 1997 section 115-25(3),

Income Tax Assessment Act 1997 section 152-10,

Income Tax Assessment Act 1997 section 152-12,

Income Tax Assessment Act 1997 section 152-35,

Income Tax Assessment Act 1997 section 152-40,

Income Tax Assessment Act 1997 subdivision 152-D,

Income Tax Assessment Act 1997 subdivision 152-305, and

Income Tax Assessment Act 1997 section 960-100(1).

Reasons for decision

Note: Unless otherwise stated, all subsequent legislative references are to the ITAA 1997.

Question 1

Subsection 6-5(1) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of ordinary income in income tax legislation, it is necessary to apply principles developed by the courts to the facts of a particular case.

A generally decisive consideration is whether the payment is the product in a real sense of any employment, services or business carried on by the recipient. A payment that is provided for a purpose which is not part of the recipient's business will not constitute ordinary income.

In your case, the receipt of the grant is neither a normal incident of your business nor provided in relation to the purpose for which your business was carried on. The receipt was a direct result of your having sold your land and associated property, and agreeing not to carry on a business within X years of the payment date.

It follows that the grant does not constitute ordinary assessable income under section 6-5.

Question 2

The property is a CGT asset in terms of section 108-5.

In accordance with the eligibility requirements, the grant was made directly in relation to the disposal of the underlying CGT assets to which it relates. In your case that is the property. Therefore, it is treated as part of the capital proceeds for the disposal of this asset.

As you entered into a restrictive covenant not to operate a business for X years it follows that CGT event A1, and also possibly CGT event D1 happened when the grant was paid to you. As such, this amount is to be included in your assessable income as a capital gain under Division 104.

Question 3

CGT event D1 happens under section 104-35 'if you create a contractual right or other legal or equitable right in another entity.'

Under subsection 960-100(1), an entity is defined as any of the following:

(a) an individual;

(b) a body corporate;

(c) a body politic;

(d) a partnership;

(e) any other unincorporated association or body of persons;

(f) a trust;

(g) a superannuation fund.

The Commonwealth is an entity for the purpose of CGT event D1.

CGT event A1 happens under section 104-10 'if you dispose of a CGT asset'.

A contractual right was created when an agreement was entered into with the Commonwealth under which a grant was received in return for not becoming involved in an enterprise for at least X years. A D1 CGT event happened upon the signing of this agreement.

However, it is also reasonable to conclude that where the partners who received the grant also owned the assets of the business that were sold then some portion of the grant may relate to that original disposal. Under those circumstances part of the capital proceeds may pertain to the original A1 CGT event.

Depending on your circumstances, it is appropriate that any capital gain in relation to the grant may be apportioned on a reasonable basis between CGT events D1 and A1.

Question 4

According to the Advanced guide to capital gains tax concessions for small business 2010-11, to qualify for the small business CGT concessions, you must satisfy several conditions that are common to all concessions. Theses are called the basic conditions.

The basic conditions require the entity to satisfy the maximum net asset value test or be considered a small business entity for the income year. To be a small business entity you must have an aggregated turnover of less than $2 million. The basic conditions also include the active asset test. A CGT asset is an active asset at a given time if, at the time you own it and it is used (or held ready for use) in the course of carrying on a business by you, a small business CGT affiliate of yours or an entity connected with you.

There are special conditions for the active asset test if CGT event D1 occurs. The standard conditions in paragraphs 152-10(1)(a) and (b) do not apply, instead it is a basic condition under subsection 152-12 that the right you create that triggers the CGT event must be inherently connected with a CGT asset of yours that satisfies the active asset test.

In your case, the partnership was a small business entity and as discussed above, CGT event D1 happened upon the signing of the agreement. The property sold in the 2009-10 financial year satisfied the active asset test. Therefore, the right created is considered inherently connected with a CGT asset of yours that satisfies the active asset test.

Question 5

For A1 CGT events subsection 104-10(3) provides that the time of the event is when you enter into the contract for the disposal.

In this case, the property was sold under a contract executed in the year ended 30 June 2011. It follows that any capital gain apportioned to CGT event A1 and the original disposal will be included in the year ended 30 June 2011.

Question 6

For D1 CGT events subsection 104-35(2) provides that the time of the event is when you enter into the contract or create the other right.

In this case, the right was created when you received approval in relation to the grant. This occurred during the year ended 30 June 2012.

It follows that any capital gain apportioned to CGT event D1 in relation to the restrictive covenant will be included in the year ended 30 June 2012.

Question 7

CGT event D1 happens under section 104-35 'if you create a contractual right or other legal or equitable right in another entity.'

In this case, the restrictive covenant is created between the Commonwealth and both individuals. It follows that the 'you' referred to in subsection 104-35(1) is a reference to both parties.

Therefore, the grant should be split on a 50/50 basis between both individuals.

If you determine that some or all of the grant is received in relation to the D1 CGT event then it happens equally to both parties.

If you determine that some or all of the grant is received in relation to the A1 CGT event connected to the original disposal then it too happens equally to both parties on the basis that they owned the partnership assets equally.