Edited version of your written advice

Authorisation Number: 1012622382210

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This edited version has been found to be misleading or incorrect. It does not represent the ATO's view of the relevant law.

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Ruling

Subject: Assessability of a government grant

Question 1

Will receipt of the funds by subco from a government agency be assessable to headco as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will receipt of the funds by subco from a government agency be assessable to headco as a bounty or subsidy under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Will receipt of the funds by subco from a government agency be assessable to headco as a net capital gain under section 102-5 of the ITAA 1997?

Answer

No.

Question 4

Will receipt of the funds by subco from a government agency be an assessable recoupment to headco under section 20-20 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

The scheme commenced on:

During the year ended 31 December 2012

Relevant facts and circumstances

1. Subco is an Australian resident company for income tax purposes.

2. Subco is a special purpose entity that has been incorporated with the intention that it will construct and operate a large asset.

3. The sole shareholder of subco is headco.

4. Headco and subco intend to consolidate for tax purposes with headco as the head company of the income tax consolidated group.

5. Headco will elect to form a tax consolidated group prior to subco receiving the funds and subco incurring expenditure on depreciating assets.

6. A government agency will provide initial grant funds to subco for the construction of the large asset. A funding agreement was signed between subco and the government agency to that effect.

7. Subco has not yet commenced the construction of the asset and it has only undertaken preliminary organisational activities.

8. All drawdown milestones of the funds will be tied to construction milestones.

9. Subco does not have any tangible assets or employees.

10. The funds will be paid into subco's bank account prior to the commencement of the construction of the asset but subco's access to the funds will be tied to achievement of various construction milestones. As such, the initial grant funds will be paid as a lump sum to subco but only available to fund project costs on achievement of agreed milestones.

11. On the date that the funds are paid into subco's bank account, subco will become the legal and beneficial owner of the funds.

12. The government agency is entitled to recover from subco any of the funds which have not been spent or legally committed for the purposes of undertaking the construction of the asset.

13. The funds will all be drawn down by subco during the construction phase and used to fund construction costs. No funds will be received once the asset is operational.

14. Subco cannot commence the construction before the funds are paid into the subco bank account, as it is only at this point that subco can be confident that it has enough funds to build the asset. If the funds are not received, the construction will not commence.

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 102-5

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

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 section 20-30

Reasons for decision

Question 1

Will receipt of the funds by subco from a government agency be assessable to headco as ordinary income under section 6-5 of the ITAA 1997?

Detailed reasoning

Section 6-5 of the ITAA 1997 provides:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

The characteristics of ordinary income have been developed by case law and generally fall into three categories:

● income from providing personal services

● income from property, or

● income from carrying on a business.

Taxation Ruling TR 2006/3 provides the Commissioner's view regarding the way in which certain provisions, including sections 6-5 and 15-10 of the ITAA 1997, apply to government payments to industry (GPI) to assist entities to commence, continue or cease business.

Paragraph 4 of TR 2006/3 provides guidance as to what constitutes a payment to assist with the commencement of a business:

Government payments to commence business

These include payments:

● to assist with the cost of evaluating whether to commence a business;

● to reimburse the cost of taxation advice;

● for the commencement of a business; or

● to assist with the purchase of a depreciating asset.

Paragraph 128 of TR 2006/3 outlines how a GPI will be treated for the commencement of a business:

Government payments to industry to commence or cease business are not assessable as ordinary income under section 6-5 or as a bounty or subsidy in relation to carrying on a business under section 15-10. However, the GPI may be taken into account in determining whether there is an assessable recoupment under Subdivision 20-A. If the GPI is not assessable under any of these provisions, the recipient will need to consider whether there are any CGT consequences.

Paragraph 139 of TR 2006/3 further states that:

A Government Payment to Industry (GPI) paid to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income as the GPI is capital in nature.

In accordance with paragraphs 128 and 139 of TR 2006/3, subco will receive the funds from the government agency as part of the funding agreement to assist with the construction of the asset. The funds are considered to be a GPI.

Subco has not yet commenced the construction; however, it has undertaken some preliminary organisational activities.

Subco does not have any tangible assets or employees. Subco will only commence the construction once the funds have been received.

Subco has been established by a consortium as a special purpose vehicle specifically for the purpose of construction and operation of the asset. Subco will receive the funds as reimbursement or payment of expenses to assist with the construction of the asset.

When subco spends the funds, expenditure will form part of the cost of depreciating assets in accordance with Subdivision 40-C of the ITAA 1997. Headco intends to claim a deduction for the decline in the value of the depreciating assets in accordance with section 40-25 of the ITAA 1997.

The funds received by subco for the construction of the asset is not being awarded for the reduction in income, to assist with business operating costs or expanding the entity's business or similar purpose.

Therefore, the funds are not assessable as ordinary income under section 6-5 of the ITAA 1997 as the funds are payments to commence business.

Question 2

Will receipt of the funds by subco from a government agency be assessable to headco as a bounty or subsidy under section 15-10 of the ITAA 1997?

Detailed reasoning

Section 15-10 of the ITAA 1997 outlines whether amounts received as bounties and subsidies are included as assessable income. Section 15-10 provides the following:
Section 15-10

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.

It is therefore necessary to determine if the funds will constitute a bounty or subsidy that headco will receive in relation to carrying on a business.

The terms ‘bounty' and ‘subsidy' are not defined in the ITAA 1997. Paragraph 94 of TR 2006/3 defines a subsidy as ‘a grant or contribution of money' and an ‘aid provided by the Crown [government] to foster or further some undertaking or industry.' The funds fall within the definition of a subsidy for the purposes of section 15-10 of the ITAA 1997 because it is a contribution of money from a government agency.

For a bounty or subsidy to fall within the scope of section 15-10 of the ITAA 1997, it must be received in relation to the carrying on of a business. ATO Interpretative Decision ATO ID 2002/1084 provides guidance on this. ATO ID 2002/184 refers to First Provincial Building Society Ltd v. Federal Commissioner of Taxation (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207 (First Provincial). In First Provincial, Hill J discussed whether an amount is directly related to the producing of assessable income through the carrying on of a business:

…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.

ATO Interpretative Decision ATO ID 2010/38 provides further guidance on whether amounts regarded as bounties or subsidies are considered to be for the ‘commencement of a business'. ATO ID 2010/38 provides the following:

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 (and such commitment is demonstrated in its activities) to proceed with the implementation of the purpose to carry on a business. However, a bounty or subsidy that is received in relation to activities of an entity as it commences business is not received to commence the business if the decision to commence is not dependent upon the receipt of the bounty or subsidy.

Whether the funds are assessable under section 15-10 of the ITAA 1997 as being received in relation to the carrying on of a business depends on the factors set out in TR 2006/3.

Paragraph 26 of TR 2006/3 provides:

Government payments to industry to commence or cease a business are not assessable as ordinary income of the recipient under section 6-5 or as a bounty or subsidy in relation to carrying on a business under section 15-10. However, the GPI may give rise to an assessable recoupment under Subdivision 20-A

Paragraph 103 of TR 2006/3 provides that a GPI received by an entity or made on behalf of an entity as assistance to commence a business does not satisfy the requirement of being paid in relation to carrying on a business.

Are the funds being received in relation to carrying on a business?

In the present context, headco is a special purpose entity established for the purposes of constructing and operating the asset.

Subco does not have any tangible assets or employees. In addition, subco has not entered into any agreements which have become binding prior to the receipt of the funds from the government agency.

It is only after subco receives the funds from the government agency that it will be in a position to access the bank finance required for the business. Subco will therefore only enter into documents that impose obligations on subco (that is, commit to the construction and operation) once the funds have been deposited.

The decision to commence the construction and operation is dependent on whether the funds will be provided to subco by the government agency. In addition, subco cannot commence carrying on the business until the asset is constructed.

When the funds are spent, expenditure will form part of the cost of depreciating assets. Headco intends to claim a deduction for the decline in value of the depreciating assets in accordance with Division 40 of the ITAA 1997.

Therefore, as the funds will not be received in relation to ‘carrying on a business', the funds will not be assessable to headco under section 15-10 of the ITAA 1997 as a bounty or subsidy.

Question 3

Will receipt of the funds by subco from a government agency be assessable to headco as a net capital gain under section 102-5 of the ITAA 1997?

Detailed reasoning

Section 102-5 of the ITAA 1997 includes a net capital gain made for the income year in the assessable income of an entity. A capital gain or capital loss is made if a capital gains tax (CGT) event happens to a CGT asset.

Subsection 108-5(1) of the ITAA 1997 defines a CGT asset to be any kind of property, or a legal or equitable right that is not property. The entry into the funding agreement gives rise to a legal right to headco on the basis that it has a right to enforce the contract and receive funds under the terms and conditions of the funding agreement.

Paragraph 118-37(2)(a) of the ITAA 1997 provides for an exemption where certain conditions are met. Specifically, paragraph 118-37(2)(a) provides the following:

A *capital gain or *capital loss is disregarded if you make it as a result of receiving a payment or property as reimbursement or payment of your expenses, or receiving or using a voucher or certificate, under:

(a) a scheme established by an *Australian government agency, a *local governing body or a *foreign government agency under an enactment or an instrument of a legislative character…

In the present context, the government agency is a body corporate that was established under the relevant legislation.

Under the funding agreement, the government agency will provide funds to subco for the construction of the asset.

The government agency will transfer the funds to subco's bank account in accordance with the funding agreement. Subco is only permitted to drawdown on the funds following the successful completion of individual construction milestones.

The government agency is entitled to recover from subco any of the funds that have not been spent or legally committed for the purposes of undertaking the construction.

The funds that are being provided by the government agency will meet the exemption on the basis of the following:

● pursuant to the terms of the funding agreement, the funds will be provided to subco to assist with the costs associated with undertaking the construction of the asset. As such, the funds represent a reimbursement of expenses to be incurred by subco

● the government agency is an authority in accordance with the definition of Australian government agency in subsection 995-1(1) of the ITAA 1997.

Therefore, any capital gain or capital loss made by headco in relation to the funds will be disregarded in accordance with paragraph 118-37(2)(a) of the ITAA 1997.

Question 4

Will receipt of the funds by subco from a government agency be an assessable recoupment to headco under section 20-20 of the ITAA 1997?

Detailed reasoning

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

Subsection 20-20(3) of the ITAA 1997 provides that an amount will be an assessable recoupment where the following conditions are met:

An amount you have received as *recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:

(a) you received the amount for the loss or outgoing for the current year; or

(b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

under a provision listed in section 20-30.

Subsection 20-25(1) of the ITAA 1997 provides:

20-25(1) Recoupment of a loss or outgoing includes:

(a) any kind or recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

(b) a grant in respect of the loss or outgoing.

Item 1.9 in the table in subsection 20-30(1) of the ITAA 1997 includes capital allowances under Division 40 of the ITAA 1997 as deductions for which recoupments are assessable.

Paragraph 27 of TR 2006/3 provides:

A GPI received to assist the recipient to commence business with the purchase of a depreciating asset, the cost of which is deductible under Division 40, is assessable income under the assessable recoupment provisions in Subdivision 20-A.

In the present context, the government agency will transfer the funds to the nominated bank account of subco. Subco will periodically drawdown on the funds after the successful completion of construction milestones. In effect, the funds compensate subco for the outgoing to construct the asset. The funds are therefore a recoupment amount for the purposes of subsection 20-25(1) of the ITAA 1997.

When the funds are spent, expenditure will form part of the cost of depreciating assets. Headco, as head company of the proposed income tax consolidated group, will be entitled to claim a deduction for the decline in value of the depreciating assets in accordance with Division 40 of the ITAA 1997.

As the funds are not assessable as ordinary income or assessable under a provision outside of Subdivision 20-A of the ITAA 1997 and headco will be entitled to claim a capital allowance deduction for the depreciating assets, the funds are an assessable recoupment for the purposes of section 20-20 of the ITAA 1997.