Edited version of private advice

Authorisation Number: 1012633209917

Ruling

Subject: Income - grants

Question 1

Is the grant paid by the Government to assist in funding capital works to upgrade and expand your business assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the grant assessable under section 15-10 of the ITAA 1997?

Answer

Yes.

Question 3

Is the grant assessable under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

• your application for private ruling which we received; and

• further information provided in your email.

The company, ('You') operated a wholesaling business.

You applied for and were successful in obtaining capital funding in the form of a grant from a Government Department (the grant).

The program provided for capital funding under funding provided by the State Government to assist you to in a project to upgrade and expand your existing business to support value adding product activity via the two stages.

Your application stated that you were specifically seeking support towards the second stage, which related to capital works on the existing building.

The total cost of the upgrade/expansion was estimated at a certain amount with the total funding for the activity providing part of this amount.

You received 'capital' funding payments in two instalments. The majority of the funds were received at the time of the final approval of the project plan by the State Government and a smaller portion of the funds on the completion of the project.

The funding was received by you for the commencement of a value added activity, operating in your existing company structure and applied towards capital works that were essential to the commencement of the new business activity.

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 Section 104-25

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

Income Tax Assessment Act 1997 Subsection 110-45(3)

Further issues for you to consider

Does Part IVA apply to this ruling?

No

Reasons for decision

Note, unless otherwise stated all subsequent legislative references in this ruling pertain to the ITAA 1997.

Summary

We have determined that, as there is a fundamental connection between the receipt of the payments and the carrying on of your existing business, the payment is considered to be a subsidy and is required to be brought to account as assessable income.

Question 1

A payment or other benefit received by a taxpayer is included in assessable income if:

• It is income according to ordinary concepts in terms of section 6-5, or

• If not ordinary income it may be included in your assessable income because it is caught under the general 'statutory income' provisions in section 6-10, as listed in section 10-5. Included in the list in section 10-5 are bounties and subsidies (section 15-10).

Ordinary Income

Section 6-5 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 is to include in assessable income those receipts which can be categorised as income according to ordinary concepts.

Although the expression 'income according to 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 report, 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.

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 grant does not constitute ordinary income.

Whilst it will be paid in two instalments it does not possess the necessary elements of periodicity, recurrence or regularity that are common to receipts of ordinary income.

Further, 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 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) refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5.

One of the statutory income provisions listed in section 10-5 is section 15-10, which deals with the treatment of bounties and subsidies.

Section 15-10 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 the 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 ATC 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 (ITAA 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 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 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 or as a bounty or subsidy under section 15-10.' (Paragraphs 103 and 128 of TR 2006/3.)

Application to your circumstances

To be considered assessable under section 15-10 the receipt must be in relation to the carrying on of a business.

In your case, you carry on an existing wholesaling business which, due to the grant opportunity, allowed you to introduce a value-added activity to increase sales. Rather than a new facility or business venture, we consider that it added value to your existing business. The new activity is conducted under the same business structure and the same roof as the existing business. You submit that there was no necessity to form a new structure in respect of this 'new business venture'.

Although you have argued you were dependent on this funding in order to proceed with the activity, we find that as your funding proposal specifically sought assistance to fund capital works on the existing building, the relationship between the new works and the existing business cannot be denied.

As there is a fundamental connection between the payments to fund the capital works and your existing business, the payment is considered to be an assessable bounty or subsidy and is required to be brought to account as assessable income under section 15-10.

Question 3

Capital gains tax provisions

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

CGT exemption under paragraph 118-37(2)(a)

Paragraph 118-37(2)(a) 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 government by-laws.'

Application to your circumstances

Under the Program the Government Department created rights in the company to receive payments upon the completion of milestones as stated in the Agreement. These rights were satisfied under CGT event C2 when the payments were made.

You 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 Program meets the requirements of paragraph 118-37(2)(a) as outlined in the revised EM and the grant complies because it is a payment received as reimbursement or payment of expenses incurred in relation to the Program.

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

Cost Base Reduction

Although there is no capital gain at the time, there are capital gain consequences when the property is eventually disposed of. To the extent that the grant is received to fund the cost of purchasing land and buildings or for constructing or renovating buildings, it is a recoupment of those costs. This recoupment reduces the cost base of the property as per subsection 110-45(3).