Edited version of your written advice

Authorisation Number: 1012823299552

NOTICE

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

This notice must not be taken to imply anything about:

● the binding nature of the private advice issued to the applicant

● the correctness of other edited versions.

Date of advice: 23 June 2015

Ruling

Subject: Income Tax: Government payments to industry post-consolidation

Question 1

Will the entry history rule in section 701-5 of the Income Tax Assessment Act 1997 (ITAA 1997) apply when Company B joins the Taxpayer income tax consolidated group?

Answer

Yes

Question 2

If the answer to question 1 is yes, will the effect of the entry history rule applying be that the Project funding will be assessable recoupment of the Taxpayer under Subdivision 20-A of the ITAA 1997?

Answer

Yes

Question 3

Will section 59-30 of the ITAA 1997 apply if the Taxpayer repays some or all of the Project funding?

Answer

Yes

Question 4

Will subsection 170(10AA) of the Income Tax Assessment Act 1936 (ITAA 1936) apply to allow amendment of the Taxpayer's assessments to give effect to section 59-30 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Income years commencing with the year ending 30 June 2015

The scheme commenced in:

2014

Relevant facts and circumstances

The Taxpayer is an Australian resident company and is not a prescribed dual resident.

The Taxpayer is a wholly owned subsidiary of a foreign resident company.

The Taxpayer has some or all of its taxable income taxed at the corporate rate.

Company B was incorporated in Australia for the purpose of the construction of plant (the Project).

Company B is not a prescribed dual resident as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Company B has some or all of its taxable income taxed at the corporate rate.

Company B is wholly owned by Company A.

Company A is an Australian subsidiary of a foreign resident company.

Both the Taxpayer and Company B have their central management and control located in Australia.

The Project

The Project involves the design, construction, commissioning and operation of the plant.

The expenditure incurred to construct the Project will form part of the cost of depreciating assets for purposes of Division 40 of the ITAA 1997.

Company A and a third party will construct the Project under a contract with Company B and under a guarantee from their respective parent entities. The Project will subsequently be operated by Company A pursuant to an agreement for the project term.

On completion, the Project will be owned by Company B. The product of the Project will be sold to a customer under an agreement (Supply Agreement).

Project funding

Company B will execute a funding agreement with the financier for funding (Project funding). No consideration will be provided for the Project funding.

The financier is an independent statutory authority established under an enactment of the Commonwealth of Australia.

The funding that will be provided to Company B will be part of a program initiated by the Australian Government.

The Project will not be commercially viable without the funding and construction of the Project will not commence until the Project funding is received.

Pursuant to the terms of the funding agreement, the Project funding must only be used for the purposes of the Project.

The terms of the funding agreement provide that the funding received will be deposited in a separate bank account established solely for the purposes of accounting for, and administering the Project funding received.

The funding agreement provides that some or all of the Project funding may need to be repaid if certain conditions are met.

Proposed acquisition of Company B

The Taxpayer intends to acquire Company B shortly after receipt of the Project funding.

The Taxpayer will enter into an agreement to purchase all of the shares in Company B.

The Taxpayer will choose under section 703-50 of the ITAA 1997 to form an income tax consolidated group with effect from the date that it acquired Company B, with the Taxpayer as the head company of the income tax consolidated group.

The Supply Agreement will be novated from Company A to Company B once the Project funding has been deposited in accordance with the funding agreement.

Other matters

At the time Company B receives the Project funding, it will only have undertaken very preliminary activities in contemplation of the commencement of its business.

Arrangements for the design and construction, operations and maintenance of the project will not have been executed.

Only minor consulting and corporate set up costs will have been incurred by Company B before receipt of the Project funding.

The Taxpayer will not have undertaken any activities prior to the acquisition of Company B.

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, section 15-10

Income Tax Assessment Act 1997, Subdivision 20-A

Income Tax Assessment Act 1997, section 20-20

Income Tax Assessment Act 1997, subsection 20-25(1)

Income Tax Assessment Act 1997, subsection 20-30(1)

Income Tax Assessment Act 1997, Division 40

Income Tax Assessment Act 1997, section 59-30

Income Tax Assessment Act 1997, section 104-25

Income Tax Assessment Act 1997, section 108-5

Income Tax Assessment Act 1997, subsection 104-25(1)

Income Tax Assessment Act 1997, subsection 104-25(3)

Income Tax Assessment Act 1997, section 108-5

Income Tax Assessment Act 1997, section 118-37

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

Income Tax Assessment Act 1997, section 701-1

Income Tax Assessment Act 1997, section 701-5

Income Tax Assessment Act 1997, section 703-10

Income Tax Assessment Act 1997, subsection 703-15(1)

Income Tax Assessment Act 1997, subsection 703-15(2)

Income Tax Assessment Act 1997, subsection 995-1(1)

Income Tax Assessment Act 1936, section 170

Income Tax Assessment Act 1936, subsection 170(10AA)

Reasons for decision

Question 1

Summary

The entry history rules in section 701-5 of the ITAA 1997 will apply when Company B joins the Taxpayer's income tax consolidated group.

Detailed reasoning

The entry history rule under section 701-5 of the ITAA 1997 applies when an entity becomes a subsidiary member of the group. It provides that everything that happened to an entity before it became a subsidiary member of a consolidated group is taken to have happened to the head company of the group for the purpose of working out the head company's liability to income tax or tax loss position in relation to periods after the entity joined the group.

Under section 703-15 of the ITAA 1997, an entity is a member of a consolidated group or consolidatable group while the entity is the head company of the group or a subsidiary member of the group. A consolidatable group consists of a single head company and the subsidiary members of the group (section 703-10 of the ITAA 1997).

The Taxpayer will acquire all the shares in Company B shortly after the receipt of the Project funding.

The Taxpayer will qualify as a head company of a consolidatable group as it meets all the requirements of item 1 in the table in subsection 703-15(2) of the ITAA 1997. Specifically, the Taxpayer is:

● a company that has some or all of its taxable income taxed at the corporate tax rate;

● an Australian resident company, but is not a prescribed dual resident; and

● not a wholly-owned subsidiary of another Australian resident company.

Company B will qualify as a subsidiary member of a consolidatable group as it meets all the requirements of item 1 in the table in subsection 703-15(2) of the ITAA 1997, as it:

● is a company that has some or all of its taxable income taxed at the corporate tax rate;

● is an Australian resident company as it is incorporated in Australia, but is not a prescribed dual resident; and

● will be a wholly-owned subsidiary of the Taxpayer.

As the Taxpayer and Company B will form a consolidatable group with the Taxpayer as head company of that group, the entry history rule will apply when the Taxpayer makes the election to consolidate and Company B becomes a subsidiary of the income tax consolidated group.

Question 2

Summary

Pursuant to the application of the entry history rule, the Project funding will become an assessable recoupment of the Taxpayer, as head company of the income tax consolidated group, under Subdivision 20-A of the ITAA 1997.

Detailed reasoning

The entry history rule in section 701-5 of the ITAA 1997 provides that for the head company core purposes in relation to the period after an entity becomes a subsidiary member of the income tax consolidated group, everything that happened in relation to the entity before it became a subsidiary member is taken to have happened in relation to the head company.

Accordingly, the Project funding will be taken to be an assessable recoupment to the Taxpayer under Subdivision 20-A of the ITAA 1997 if the Project funding is an assessable recoupment under Subdivision 20-A for Company B.

The Project funding will be an assessable recoupment for an income year as defined in section 20-20 of the ITAA 1997 if:

● it is not ordinary income or statutory income because of a provision outside Subdivision 20-A;

● it is received as recoupment of a loss or outgoing (except by way or insurance or indemnity); and

● an amount is deductible for the loss or outgoing for the current year or for a loss or outgoing in an earlier income year under a provision listed in subsection 20-30(1) of the ITAA 1997.

The Project funding is not ordinary income

Subsection 6-5(1) of the ITAA 1997 provides that the assessable income of an entity includes income according to ordinary concepts, or ordinary income. The Project funding will not be assessable under section 6-5 unless it is ordinary income.

Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence, or cease business provides the Commissioner's view on the tax treatment of government payments to industry to assist entities to continue, commence or cease business, including section 6-5 of the ITAA 1997. TR 2006/3 applies to schemes involving grants paid or funded by the Commonwealth or State, Territory or local government.

The Project funding is not a concessional loan

The government payments to industry (GPIs) that are covered by TR 2006/3 do not include concessional loans. These are described in paragraph 22 of TR 2006/3 as:

Financial assistance provided by government by way of a loan provided at a concessional rate of interest is not a GPI. The difference between the normal market rate of interest and the concessional rate of interest is also not a GPI.

An essential feature of a loan is a definitive obligation to repay the principal on entering of the agreement. ATO ID 2010/147 Income tax: Bounties and subsidies - whether a repayable government payment a ‘bounty or subsidy' considered whether a government payment which was subject to repayment on the occurrence of certain subsequent events was a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997. In considering this question, it was necessary to consider the issue of whether the government payment was a loan. ATO ID 2010/147 concluded that a government payment would not be characterised as a loan (which would not be a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997) where a definite obligation to repay the principal sum is absent on entering the agreement. Where the provision of the government payment is subject to a contingent liability that may result in repayment in limited circumstances that may or may not ever eventuate, the obligation to repay the funding will not exist at the time the funding agreement is entered into.

Company B does not have a definitive obligation to repay the principal when it is received. Under the funding agreement, the obligation to repay any amount of the Project funding only arises if certain conditions are met.

Therefore, Company B only has a contingent obligation to repay the Project funding and it is not a concessional loan.

The Project funding is a government payment to industry to commence business as contemplated by TR 2006/3

Paragraph 26 of TR 2006/3 provides that government payments to commence or cease a business are not assessable as ordinary income of the recipient under section 6-5 of the ITAA 1997. Government payments to commence business contemplated by TR 2006/3 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.

The Project funding will only be used for the purposes of the Project. The Project will not be commercially viable without the Project funding and the Project will not proceed until the Project funding is received.

These factors indicate that the Project funding is a government payment to commence business as discussed in TR 2006/3. Applying the guidance in TR 2006/3, the Project funding will not be assessable as ordinary income of the recipient under section 6-5 of the ITAA 1997.

The Project funding is not statutory income outside of Subdivision 20-A

Section 15-10 of the ITAA 1997 provides:

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.

In order for the Project funding to be assessable under section 15-10 of the ITAA 1997 it must be:

● a bounty or subsidy;

● received in relation to carrying on a business; and

● not assessable as ordinary income under section 6-5 of the ITAA 1997

For the reasons already outlined above, the Project funding is not assessable as ordinary income under section 6-5 of the ITAA 1997.

The Project funding is a subsidy

The terms 'bounty' or 'subsidy' are not defined terms for the purposes of either the ITAA 1997 or the ITAA 1936 and their ordinary meanings should be applied. 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 guidance as to their meaning which is relevant for section 15-10 of the ITAA 1997 (see Plant v. FCT 2004 ATC 2364).

In Reckitt and Colman PTY LTD v. FCT (1974) 4 ATR 501; 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. In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 30 ATR 207, Hill J referred to Jowitt's Dictionary of English Law's observation that the word subsidy generally means 'financial assistance granted by the Crown' and said that 'This is the meaning which the word truly has in the present context'.

As the Project funding is provided under a federal government scheme, it is a ‘subsidy' for the purposes of section 15-10 of the ITAA 1997.

The Project funding is not received in the relation to carrying on a business

Paragraph 101 of TR 2006/3 distinguishes between a bounty or subsidy that is related to carrying on a business and one which is merely for commencing or ceasing a business. The latter is not considered to be in relation to carrying on a business. In First Provincial Building Society v Federal Commissioner of Taxation 56 FCR 320 at 333, Hill J stated in the context of former subsection 26(g) of the ITAA 1936:

…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 a 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 the business itself.

Applied in the present circumstances, the Project funding would not be received in relation to carrying on a business. When it is received, the requisite relationship with the ‘carrying on' of the business will not exist. The Project is not commercially viable without the receipt of the funding and the Project will not proceed without its receipt. The Project funding is an amount received in relation to the commencement of a business and not the ‘carrying on' of the business.

The Project funding is, therefore not ordinary income or statutory income outside of Subdivision 20-A of the ITAA 1997.

The Project funding is a recoupment of a loss or outgoing

The term ‘recoupment of a loss or outgoing' is defined in subsection 20-25(1) of the ITAA 1997 as including a grant in respect of the loss or outgoing. This definition is sufficiently broad to cover the Project funding which is a government grant provided for the purposes of the Project.

An amount is deductible for the loss or outgoing under section 20-30

Section 20-30 of ITAA 1997 includes a table showing deductions under the ITAA 1997 for which recoupments are assessable. Item 1.9 of the table concerning capital allowances under Division 40 of the ITAA 1997 is relevant to Company B's circumstances.

The expenditure Company B will incur to construct the Project will form part of the cost of depreciating assets. Company B will be entitled to claim a deduction for the decline in value of those depreciating assets under Division 40 of the ITAA 1997.

This is supported by paragraph 27 of TR 2006/3 which provides that 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 of the ITAA 1997, is assessable income under the assessable recoupment provisions in Subdivision 20-A of the ITAA 1997.

The Project funding is an assessable recoupment

As the Project funding is not otherwise ordinary or statutory income outside of Subdivision 20-A of the ITAA 1997, and is a recoupment of an outgoing which is deductible under section 20-30 of the ITAA 1997, it is an assessable recoupment under Subdivision 20-A of the ITAA 1997.

As the Project funding is an assessable recoupment to Company B at the time it receives the funding, the Project funding will, pursuant to the entry history rule, be taken to be an assessable recoupment under Subdivision 20-A of the ITAA 1997 to the Taxpayer, as head company of the income tax consolidated group.

Question 3

Summary

Section 59-30 of the ITAA 1997 will apply if Company B repays some or all of the Project funding as the Taxpayer will not be able to deduct the repayment for any income year.

Detailed reasoning

Under the single entity rule in section 701-1 of the ITAA 1997, a subsidiary member of a consolidated group is taken to be part of the head company for head company core purposes and entity core purposes. Head company core purposes include working out the head company's income tax liability or loss. This means that the treatment of an amount as non-assessable non-exempt income for Company B under section 59-30 of the ITAA 1997 is treated as being an amount of non-assessable non-exempt income for the Taxpayer.

Subsection 59-30 of the ITAA 1997 provides that:

59-30(1) An amount you receive is not assessable income and is not *exempt income for an income year if:

(a) you must repay it; and

(b) you repay it in a later income year; and

(c) you cannot deduct the repayment for any income year.

Under the funding agreement, Company B has an obligation to repay some or all of the Project funding when certain conditions are met.

If Company B repays some or all of the Project funding, it will not be able to claim a deduction for the repayment in any income year.

As the requirements of section 59-30 of the ITAA 1997 have been met, section 59-30 will apply if Company B repays some or all of the Project funding. As Company B is treated as part of the Taxpayer for the purposes of working out the Taxpayer's assessable income, the amount to which section 59-30 applies will be treated as non-assessable income non-exempt income in the hands of the Taxpayer.

Question 4

Summary

Subsection 170(10AA) of the ITAA 1936 will apply to allow amendment of Taxpayer's assessments to give effect to section 59-30 of the ITAA 1997.

Detailed reasoning

Section 170 of the ITAA 1936 provides the circumstances under which an assessment may be amended. Subsection 170(10AA) lists provisions of the ITAA 1997 for which assessments may be amended at any time in order to give effect to the listed provisions. Of relevance in the current circumstances is item 22, which lists section 59-30 of the ITAA 1997.

As noted above, section 59-30 of the ITAA 1997 will apply if Company B repays all or part of the Project funding.

The applicability of subsection 170(10AA) of the ITAA 1936 in such circumstances is confirmed by paragraph 122 of TR 2006/3 which provides that:

[s]ection 170(10AA) of the ITAA 1936 allows an amendment of an assessment at any time to give effect to section 59-30.

As explained above, Company B will be treated as part of the Taxpayer for the purpose of working out the Taxpayer's income tax liability or tax loss under the single entity rule. Therefore, subsection 170(10AA) of the ITAA 1936 will apply to allow an amendment of the Taxpayer's assessments to give effect to section 59-30 of the ITAA 1997.