Edited version of your private ruling

Authorisation Number: 1012584664244

Ruling

Subject: Grant payments

Question 1

Is the grant assessable as ordinary income?

Answer

No.

Question 2

Is the grant assessable as a capital gain under the capital gains tax (CGT) provisions?

Answer

Yes.

Question 3

Do you satisfy the basic conditions for the CGT small business concessions?

Answer

Yes.

Question 4

Are you eligible for the CGT small business 15 year exemption?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

You successfully applied for a government exit grant.

You agreed to various conditions under the deed.

You have received some of the grant amount and will receive more grant payments on completion of various milestones and conditions.

If the conditions are not met, you may be required to repay all or some of the grant.

Your business has been operating for many years.

The relevant individuals are under 55 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 15-10

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 subsection 108-5

Income Tax Assessment Act 1997 Division 152

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income form rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· are earned,

· are expected,

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

The grant payments do 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.

The grant does not constitute income from the provision of personal services and is not sourced from property. It is also not derived directly from any usual business activities. That is, the payment is not a normal incident of your business, nor is it paid for a purpose for which the business was carried on. The payment is for exiting an industry and is capital in nature. Therefore the grant is not regarded as ordinary assessable income under section 6-5 of the ITAA 1997.

Statutory income

Bounties and subsidies

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997. The list includes bounties and subsidies, which are included in assessable income by virtue of the section 15-10 of the ITAA 1997.

Section 15-10 of the ITAA 1997 provides that 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 of the ITAA 1997.

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 Taxation Ruling TR 2006/3).

The words 'received in relation to carrying on a business' require a relationship between the payment and the carrying on of the business. The payment is not received in relation to carrying on your business as the payment is for exiting your business. As such, the payments are not assessable under section 15-10 of the ITAA 1997.

Capital gains tax (CGT) provisions

Under section 102-5 of the ITAA 1997, assessable income includes a net capital gain.

A capital gain or capital loss may arise if a CGT event happens to a CGT asset. Section 108-5 of the ITAA 1997 states that a CGT asset is any kind of property, or a legal or equitable right that is not property.

The Grant Deed is regarded as a contractual right and is a CGT asset.

Under section 104-35 of the ITAA 1997, CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. Subsection 104-35(2) of the ITAA 1997 states that the time of the event is when you enter into the contract or create the other right.

In this case, a contractual right was created when an agreement was entered into under which grant payments are made upon the completion of specified milestones and the provision of reports as stated in the Deed. The grant payments are received in return for not operating the business for a period of time. CGT event D1 happened when the agreement was signed.

Any capital gain that results from a CGT event may be reduced or disregarded under the CGT small business concessions.

To qualify for the small business concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions.

The basic conditions in Subdivision 152-A of the ITAA 1997 (as relevant to this case) are:

· the small business entity test and

· the active asset test.

Small business entity

You will be a small business entity if you are an individual, partnership, company or trust that is carrying on a business and has an aggregated turnover of less than $2 million.

In this case, the information provided is that you are a small business entity.

Active asset test

The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied if:

· you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

· you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the test period.

The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases.

A CGT asset is an active asset if it is owned by you and is:

· used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or

· an intangible asset that is inherently connected with a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or another entity that is connected with you, carries on; for example, goodwill.

CGT event D1

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) of the ITAA 1997 do not apply. Instead it is a basic condition under subsection 152-12 of the ITAA 1997 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.

Application to your circumstances

In this case, you are a small business entity. As discussed above, CGT event D1 happened upon the signing of the Grant Deed. We consider that the right created in relation to the restrictive covenant, which triggered CGT event D1, will be inherently connected to the goodwill of the business.

Goodwill is an intangible asset that is inherently connected with the business that has carried on for many years. Therefore, the goodwill will satisfy the active asset test.

As the right created that triggers the CGT event is inherently connected with the goodwill of the business, which is an active asset, the basic conditions have been satisfied.

Once the basic conditions have been satisfied, there are four concessions available, some of which have additional conditions that must also be met. These concessions are:

a) The small business 15-year exemption

This concession provides a total exemption of a capital gain if you have continuously owned the CGT asset for at least 15 years and the relevant individual is 55 years old, or older, and retiring, or is permanently incapacitated. As the relevant individuals are under 55 years of age, they are not eligible to apply this concession.

b) The small business 50% active asset reduction

This concession provides a 50% reduction of a capital gain. The small business 50% active asset reduction applies automatically if the basic conditions are satisfied, unless you choose for it not to apply.

c) The small business retirement exemption

This concession provides an exemption of capital gains up to a lifetime limit of $500,000. If you are under 55 years old just before you make the choice, the amount must be paid into a complying superannuation fund or a retirement savings account (RSA).

d) The small business rollover

This concession allows you to defer a capital gain from the disposal of a business asset for a minimum of two years. If you acquire a replacement asset or make a capital improvement to an existing asset, you can defer the capital gain for longer, until the asset is disposed of or its use changes in particular ways. Either will cause the deferred capital gain to crystallise. This means you would make a capital gain equal to the deferred gain at the time of the disposal or change in use, in addition to any capital gain made on the disposal of the replacement or capital improved asset.