Edited version of your private ruling

Authorisation Number: 1012460051910

Ruling

Subject: Government grant

Question 1

Will the government funding paid under the grants program constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the government funding paid under the grants program constitute assessable income under section 15-10 of the ITAA 1997?

Answer

No

Question 3

Will the government funding paid under the grants program constitute assessable income under subdivision 20-A of the ITAA 1997?

Answer

Yes, in part, to the extent that the funding is expended on and deductions are claimed in respect of any of the items listed in the table in section 20-30 of the ITAA 1997.

Question 4

Will the government funding paid under the grants program constitute assessable income under Part 3.1 of the ITAA 1997?

Answer

No

This ruling applies for the following periods

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2012

Relevant facts and circumstances

Company X acts as Trustee of Trust Y.

In this capacity, it holds a property.

This property is leased to a related party, Entity Z.

The property is used as a business premises.

Trust Y does not carry on a business, but simply acts as an investment entity.

Entity Z lodged an application with a government department funding under the grants program. The Funding Agreement (the Agreement) was entered into during the relevant year.

The funding requested for under the grants program was for infrastructure works at the property.

The Agreement provides for instalment payments based upon certain milestones being achieved.

A revised project proposal was approved which a Deed of Novation and Variation (the Deed) novating the Agreement to Trust Y.

The capital works will consist of construction costs, furniture and fittings, equipment and information and communication technology costs.

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 20-25

Income Tax Assessment Act 1997 Section 20-40

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

General - effect of novation of contract

Entity Z entered into the Agreement to obtain funding for infrastructure works at the property. The Agreement was modified and included the Deed which provided for the novation of the Agreement such that Trust Y became a party to the Agreement.

Based on the implementation of the Deed we accept that Trust Y has assumed all rights, responsibilities and obligations under the Agreement. This ruling has been prepared on this basis.

Question 1 - ordinary income

Section 6-5 of the ITAA 1997 states, in part, the following:

6-5(1) Your assessable income includes income according to ordinary concepts which is called ordinary income.

6-5(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The intent of section 6-5 of the ITAA 1997 is to include in assessable income those receipts which can be categorised as income according to ordinary concepts.

Although the expression 'income from 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 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 of the ITAA 1997.

ATO policy concerning government payments to industry is set out in Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business. At paragraph 84, 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 funding received under the Agreement 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.

Furthermore, 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 any existing business activity.

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 '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.

One of the statutory income provisions listed is section 15-10 of the ITAA 1997, which deals with the treatment of bounties and subsidies.

Section 15-10 of the ITAA 1997 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 a payment it needs to be considered whether the bounty or subsidy has been received 'in relation to carrying on a business.'

'In relation to'

A grant '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...' (paragraph 100 of TR 2006/3).

In the Full Federal court decision in First Provincial Building Society Ltd v. FC of T (1995) 128 ALR 118; (1995) 95 ARC 4145; (1995) 30 ATR 207' (1995) 56 FCR 320 (First Provincial), Hill J was discussing the antecedent of section 15-10, that is, paragraph 26(g) of the Income Tax Assessment Act 1936. He stated that it is important to note that the former provision contained the words 'received in or in relation to carrying on of a business ... (emphasis added).' When the provision was incorporated into the ITAA 1997, it was rewritten as a bounty or subsidy 'you receive in relation to carrying on of a business.'

In First Provincial, Hill J specifically discussed the relationship between the terms 'received in relation to' and 'received in'. He concluded that the scope of the term 'received in relation to' was sufficiently broad enough to also cover the meaning of the narrower 'received in' which implied a more direct connection.

'Carrying on a business' or 'commencement'

The First Provincial case demonstrates that the scope of the phrase 'in relation to carrying on a business' in section 15-10 of the ITAA 1997 is to be interpreted widely. Payments made towards the restructuring of business operations with a view to improving overall efficiency are generally considered to be 'in relation to carrying on a business' (Paragraph 102 of TR 2006/3).

'Some business restructures may not be in relation to carrying on a business, for example if a business changes its structure to facilitate a new activity ...' (emphasis added). This is decided on the merits of each case (paragraph 102 of TR 2006/3).

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 First Provincial case illustrates that 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).

Government payments 'to commence or cease business' as opposed to 'in relation to carrying on a business' are not considered to be assessable as ordinary income under section 6-5 of the ITAA 1997 or as a bounty or subsidy under section 15-10 of ITAA 1997 (paragraphs 103 and 128 of TR 2006/3).

Application to your circumstances

The money received under the Agreement 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.

Entity Z applied for the government funding. The Agreement was novated to Trust Y which owns the land and building from which a business, conducted by a related entity, operates

Trust Y does not carry on a business but simply acts as an investment entity.

With regard to the use of the funding, we find that it was not used in relation to increasing the efficiency of an existing business or the actual carrying on of a business activity.

As Trust Y is not carrying on a business any receipts in relation to the funding are on capital account and are not assessed under section 15-10 of the ITAA 1997 as bounties or subsidies.

Question 3 - recoupment

Recoupment is a defined term and has the meaning given by subsection 20-25(1) of the ITAA 1997. Under paragraph 20-25(1)(b) of the ITAA 1997, a recoupment of a loss or outgoing includes a grant in respect of the loss or outgoing.

If the cost of a depreciating asset is deductible under Division 40 of the ITAA 1997 over two or more income years, section 20-40 of the ITAA 1997 applies so that the total of assessable recoupments to be included in assessable income at a particular time is limited to the total amount of the loss or outgoing that can be or has been deducted at that time. Any part of an assessable recoupment that is not included in the assessable income in the year of receipt because of this limit is assessable in later income years to the extent that further amounts are deductible under Division 40 of the ITAA 1997 for the depreciating asset in the later income years.

Application to your circumstances

The money received under the Agreement will be spent partly on furniture and fittings and equipment associated with the facility.

To the extent that the money is used to fund the cost of depreciating assets, such as necessary equipment and furniture, it is an assessable recoupment under subsection 20-20(3) of the ITAA 1997.

Question 4 - capital gains tax (CGT) provisions

Section 104-25 of the ITAA 1997 deals with the cancellation, surrender and similar endings to CGT assets, CGT event C2. A C2 event occurs when the ownership of an intangible 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.

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 governing by-laws.'

Application to your circumstances

Under the Program the government department created rights in Trust Y to receive payments upon the completion of several milestones as stated in the Agreement. These rights will be satisfied under CGT event C2 when the government entity makes payments to Trust Y.

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

However, we find that the grants program meets the requirements of paragraph 118-37(2)(a) of the ITAA 1997 as outlined in the revised EM and the funding complies because it is a payment received as a reimbursement or payment of expenses incurred in relation to the grants program.

Therefore, any capital gain made by Trust Y from the C2 CGT event will be disregarded under paragraph 118-37(2)(a) of the ITAA 1997.