Edited version of your private ruling

Authorisation Number: 1012590586368

Ruling

Subject: Grant

Question 1

Does the grant form part of the assessable income of the Fund under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Does the grant form part of the assessable income of the Fund under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Did the receipt of the grant trigger CGT event C2 under section 104-25 of the ITAA 1997?

Answer

Yes.

Question 4

Will any capital gain or loss made by the Fund in respect of the grant be disregarded under paragraph 118-37(2)(a) of the ITAA 1997?

Answer

Yes.

Question 5

Will a portion of the grant be included in the assessable income of the Fund under subsection 20-20(2) of the ITAA 1997 (assessable recoupment) to the extent that it is not ordinary income or statutory income and is used by the Fund to meet a loss or outgoing that is deductible under any provision of the ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

The Fund is an Australian resident trust.

A program was established by the Australian Government to provide monies to entities which undertook certain activities.

The program was established with funding appropriated through an Appropriation Act.

The Australian Government published a request for submissions to apply for grant monies under the program.

An initial application including a business plan was submitted on behalf of the proposed Fund.

The application was successful.

The grant was made on terms set out in the Funding Agreement between the relevant parties.

The selection criteria (in the grant application) indicated that the application will be assessed partly on what the grant monies will be used for.

The Fund's business plan states that the grant monies will be used to meet on-going costs and to undertake the activities that were relevant under the program. Should the grant not be received the Fund would not commence its activities.

Following the establishment of the Fund, but prior to receipt of the grant, neither the fund manager (in either its personal capacity or on behalf of the Fund) nor the Fund undertook any material or significant activities other than preparing preliminary documentation relating to the actual grant process and entering into various documents.

One of the conditions of the Funding Agreement was that the fund manager, supply an invoice specifying the amount of the grant monies including a description of the purpose for which the grant monies will be applied.

The money received by the Fund from the grant has been, and will be, predominantly used:

· to pay (or reimburse) annual management costs of the Fund, and start-up costs incurred to establish the Fund (including professional fees); and

· to cover any losses incurred by the Fund in relation to undertaking program relevant activities.

The Fund was not carrying on a business at the time the grant was received.

As part of the Funding Agreement, the Australian Government agreed to pay the grant monies to the trustee of the Fund upon satisfaction of the agreement's conditions and receipt of an invoice from the trustee of the Fund.

If the Fund complies with the Funding Agreement, it will not need to repay the grant to the Australian Government.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 20-35

Income Tax Assessment Act 1997 section 20-40

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 118-37(2)

Income Tax Assessment Act 1997 paragraph 118-37(2)(a)

Reasons for decision

Ordinary Income

Subsection 6-5(1) of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts, which is called ordinary income.

Relevant factors in determining whether a payment is ordinary income include whether the payment is for services rendered, such as from personal services, and the character of the payment in the hands of the recipient.

Other 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 of the grant that the Fund received is not income from personal services. The payment was not earned as the Fund had not yet commenced operations, and it was not expected or relied upon as the grant had to be applied for and the application may not have been successful. The payment also has no element of periodicity, recurrence or regularity, in the respect that it is a one off payment.

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

Whether a bounty or subsidy received in relation to carrying on a business

Section 15-10 of the ITAA 1997 provides that assessable income includes a bounty or 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.

Taxation Ruling TR 2006/3 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 bounty or subsidy received in relation to carrying on a business.

The terms 'bounty' or subsidy are not defined terms for the purposes of either the ITAA 1997 or ITAA 1936. However, the Courts in their consideration of how the terms were used in paragraph 26(g) of the ITAA 1936 (the predecessor to section 15-10 of the ITAA 1997) have provided some guidance as to their meaning which are equally relevant for section 15-10 of the ITAA 1997 (see Plant v. FCT 2004 ATC 2364; 58 ATR 1070).

In Reckitt and Colman Pty Ltd v. FCT (1974) 4 ATR 501, 74 ATC 4185 Mahoney J said that the terms 'bounty' or subsidy include a financial grant made by the State for the purpose of encouraging a particular activity in the field of trade and commerce.

A bounty or 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 there 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 bounty or 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.

A bounty or subsidy must 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.

A bounty or subsidy to commence or cease a business is not included in assessable income as a bounty or subsidy in relation to carrying on a business under section 15-10 of the ITAA 1997 (see paragraph 26 of TR 2006/3).

A bounty or subsidy is received to 'commence a business' if the bounty or 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 bounty or subsidy that is received in relation to 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 bounty or subsidy.

In the present case, the commencement of the Fund's business was dependent upon the approval and receipt of the grant. The grant was to assist the Fund to reach the necessary point where it could be said that it was committed to proceed with the implementation of its purpose to carry on a business.

Accordingly, the grant monies were received to commence a business and are therefore not assessable as a bounty or subsidy received in relation to carrying on a business under section 15-10 of the ITAA 1997.

Capital gains tax

An entitlement to receive grant monies under the program is a CGT asset under subsection 108-5(1) of the ITAA 1997 that is acquired when the applicant signs the agreement.

CGT event C2 happens under section 104-25 of the ITAA 1997 when a recipient's entitlement to receive the grant is satisfied. The time of the CGT event under subsection 104-25(2) of the ITAA 1997 is when the payment is made.

However, paragraph 118-37(2)(a) of the ITAA 1997 provides a CGT exemption for a capital gain that results from receiving a payment as reimbursement or payment of expenses or anticipated expenses under a scheme established by an Australian government agency under an enactment.

The Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 3) Act 2006 which amended subsection 118-37(2) of the ITAA 1997 stated at paragraph 5.23 that: 'An enactment would include an Appropriation Act'.

The program was established by the Australian Government with funding appropriated through an Appropriation Act and the grant was received by the Fund under the scheme for the purpose of paying for its losses and outgoings.

Therefore, the CGT exemption provided by paragraph 118-37(2)(a) of the ITAA 1997 applies in this case.

Whether an assessable recoupment

Under Subdivision 20-A of the ITAA 1997 certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Under subsection 20-20(2) of the ITAA 1997, an amount received as recoupment of a loss or outgoing is an assessable recoupment if:

(a) you received the amount by way of insurance or indemnity; and

(b) you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for the loss or outgoing for an earlier income year under any provision of this Act (this includes both the ITAA 1997 and ITAA 1936).

Sections 20-35 and 20-40 of the ITAA 1997 discuss when and how much is included in assessable income if the recoupment is received before the income year of the deduction and if the expense is deductible over two or more income years, respectively.

For the recoupment of the loss or outgoing to be an assessable recoupment under subsection 20-20(2) of the ITAA 1997, the amount the taxpayer receives must be by way of insurance or indemnity. It is clear in this case that the recoupment will not be received by way of insurance.

Indemnity is not a defined term and therefore must be given its ordinary meaning. The Macquarie Dictionary, [Multimedia], version 5.0.0, 1/10/01, definition of indemnity includes compensation for damage or loss sustained.

The issue of whether an amount is received by way of indemnity for the purposes of the predecessor provision to subsection 20-20(2) of the ITAA 1997 (paragraph 26(j) of the ITAA 1936) has been considered in a number of cases including: Federal Commissioner of Taxation v. Wade (1951) 84 CLR 105; (1951) 9 ATD 337; 5 AITR 214; Robert v. Collier's Bulk Liquid Transport Pty Ltd (1959) VR 280; Goldsbrough Mort & Co Ltd v FC of T (1976) 76 ATC 4343, 6 ATR 580; and Commercial Banking Company of Sydney Limited v. FC of T 83 ATC 4208 (1983); 14 ATR 142.

These cases make it clear that an amount received by way of indemnity is not restricted to amounts received under a contract of indemnity. This was made clear by Hunt J. in Commercial Banking who, referring to the decision in Goldsbrough, stated

... his Honour was correct in ruling that the expression "by way of... indemnity" should not be construed narrowly in the sense of "pursuant to a contract of indemnity".

The cases also make it clear that an amount received 'by way of indemnity' would include a receipt pursuant to an antecedent obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good or compensate for a loss which arises after the obligation comes into existence.

Therefore, the phrase 'by way of indemnity' broadens the range of receipts to be considered an assessable recoupment under subsection 20-20(2) of the ITAA 1997 to include receipts other than amounts received under a contract of indemnity.

The grant partially compensates the Fund for losses and outgoings to commence and operate its business. That being so the grant is an amount received by way of indemnity.

Therefore a portion of the grant will be included in the assessable income of the Fund under subsection 20-20(2) of the ITAA 1997 to the extent that it is used by the Fund to meet a loss or outgoing that is deductible under any provision of the ITAA 1997 or ITAA 1936.