Edited version of your written advice

Authorisation Number: 1013016200644

Date of advice: 19 May 2016

Ruling

Subject: Whether the government grant is assessable income

Question

Is the grant provided to the entity assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) when it is derived?

Answer

Yes.

This ruling applies for the following periods

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commenced on

1 July 2015

Relevant facts

A government body administers a fund that was established to help, encourage and support investment in the development and commercialisation of certain devices.

The entity applied for and received a grant.

Repayment of the funding may occur under certain circumstances including if the funding is not expended or if the entity's earnings reach a certain level.

The grant balance is calculated from the day the grant is provided. Annual CPI is applied to the grant.

Certain milestones must be achieved.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 59-30(1)

Reasons for decision

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

Summary

The grant is assessable income under section 6-5 when it is derived, i.e. when it is expended.

If one of the conditions is met which requires a part or the entire grant funding to be paid back to the Government (and the entity makes the payment) the entity is able to amend applicable tax return/s to take out repaid grant amounts which were included in assessable income in the previous income year/s.

Where the earnings received exceed the repayment threshold and there is an obligation to repay amounts to the Government (which includes interest), the interest component is able to be claimed as a deduction under section 8-1 as soon as there is a liability to repay the amount.

Ordinary Income

Taxation Ruling TR 2006/3 deals with government payments to industry to assist entities (including individuals) to continue, commence or cease business.

Under Paragraph 4 government payments to continue business include payments to assist with operating costs.

Paragraph 10 states a government payment to industry (GPI) to assist a business to continue operating, except where the payment is for agreeing to give up or sell part of the profit yielding structure, in included as assessable income of the recipient under section 6-5 or section 15-10.

Paragraph 12 states a GPI to assist with business operating costs or liabilities is ordinary income in the hands of the recipient and is assessable under section 6-5 in the income year in which it is derived.

In this case the grant was provided to develop and commercialise the device. The research and development has already occurred and the final product is ready. The entity will now attempt to obtain approval for the required regulatory trials and then for it to be commercialised.

The grant will be expended over a number of years to develop and commercialise the device. This suggests that the grant was provided to continue the business rather than to commence it. The funding is also not able to be used to support activities which are considered research which points towards the funds being used for an existing business.

It is clear that the grant was provided to assist the entity to continue to operate its business. The grant is therefore assessable under section 6-5 when it is derived.

The grant is not assessable as a bounty or subsidy under section 15-10 as it is assessable under section 6-5.

Derived

The question of when income is derived has been considered in a series of decisions of the Courts and it is often simply a question of whether a 'cash' or 'accruals' basis should be employed. However, in other cases the resolution of the issue is determined by applying the principles that have grown out of cases such as C of T (SA) v. Executor Trustee & Agency Co. of South Australia Ltd (Carden's case) (1938) 63 CLR 108; (1938) 5 ATD 98, Brent v. FC of T (1971) 125 CLR 418; (1971) 71 ATC 4195 (Brent's case ) and Arthur Murray (NSW) Pty Ltd v. FC of T (1965) 114 CLR 314; (1965) 14 ATD 98 (Arthur Murray).

In Brent's Case at p 420 Gibbs J stated:

It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which 'is calculated to give a substantially correct reflex of the taxpayer's true income. (The Commissioner of Taxes (South Australia) v The Executor, Trustee and Agency Company of South Australia Limited (Carden's case) (1938) 63 CLR 108 at pp 152-154)

Carden's case was also considered in Arthur Murray, where the Court considered when amounts coded as 'unearned income' for accounting purposes, were derived for tax purposes. In discussing the possibility of having to make a refund, the Court said at CLR 319:

But those circumstances nevertheless make it surely necessary, as a matter of business good sense, that the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back, even if only as damages, should the agreed quid pro quo not to be rendered in due course. The possibility of having to make sure such a payment back (we speak in course in practical terms) is an inherent characteristic of the receipt itself. In our opinion it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company.

For that reason it is not surprising to find, as the parties in the present case agree is fact, that according to established accountancy and commercial principles in the community, the books of a business either selling goods or providing services are so kept with respect to amounts received in advance of goods being sold or of the services being provided that the amounts are not entered to the credit of any revenue account until the sale takes place or the services are rendered: in the meantime they are credited to what is in effect a suspense account, and their transfer to an income account takes place only when the discharge of the obligations for which they are a prepayment justifies their being treated as having finally acquired the character of income.

The grant agreement in this case provides in certain circumstances for a refund of grant funds to the government body. However, it is considered that the funds used to provide services have 'come home' to the taxpayer when expended. In terms of the quid pro quo referred to in the quote from Arthur Murray above, the quid pro quo occurs when the grant monies have been spent for the intended purpose. At that point, the taxpayer has done everything necessary to earn the income. The fact that the grant agreement provides for a possibility, if certain events occur, that an amount expended may need to be refunded, is not sufficient to say that the point of derivation of the income is deferred.

The circumstances here can be distinguished from the situation in Case 22/94 94 ATC 225; AAT Case 9472 (1994) 28 ATR 1155. In that case it was decided that the true nature of the arrangement under which the relevant funds were provided was a conditional loan. As such the funds provided were not recognised as income until they ceased to be conditionally repayable. In arriving at this decision the Tribunal took into account the fact that the grantor and the grantee had both treated the amount received as a loan in their books of account.

However this is not the situation here. There is no evidence which supports the conclusion the payments were intended to be or had the features of a loan (see further below for a more detailed discussion).

The proper accounting treatment is to treat the grant funds as derived at the time the funding is expended. This treatment gives a true reflex of the entity's income.

Accordingly, the grant funds are derived by the entity for the purposes of section 6-5 in the income year in which the funding is expended.

Loan

If the entity's earnings reach a certain threshold it is obliged to pay back the funding with interest. The question about whether the funding is considered a loan will now be addressed.

Paragraph 22 of TR 2006/3 states 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.

In Case 5/94 94 ATC 130; AAT Case 9221 (1993) 27 ATR 1117 at 1125, it was said:

the term loan is not defined in the Act, but is defined in Chitty on Contracts, 1989, 26th ed, at para 3574:

Definition of loan. A contract of loan of money is a contract whereby one person lends or agrees to lend a sum of money to another, in consideration of the promise expressed or implied to repay that sum on demand, or at a fixed or determinable future time, or conditionally upon an event which is bound to happen, with or without interest. In many circumstances, the question whether a particular transaction is, in law a loan or not will be immaterial, since the transaction will take effect according to the intention of the parties, however the contract may be classified...

This definition indicates that a loan should possess the following elements:

• a person lends or agrees to lend money to another

• in consideration of a promise to repay that sum

• the repayment is at a fixed or determinable future time or conditionally upon an event which is bound to happen

• the repayment can be made with or without interest, and

• an equivalent amount will be repaid.

Based on the above analysis, it is clear that a loan involves an obligation on the borrower to repay the principal with or without interest whereas a grant, a bounty or a subsidy does not impose an obligation on the recipient to repay the amount received.

In this case, the funding provided to the entity is not a loan because it doesn't have all the elements of a loan as outlined above. The agreement states the funding is a grant and any repayment is conditional on particular events that may or may not occur that is, there is no certainty that repayment will be required.

Repayment of Grant funding

Subsection 59-30(1) states 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.

If the entity is required to, and actually pays back any of the grant funding to the Government and it has included the amount as assessable income in a previous income year, it is able to amend the applicable previous tax return/s to reduce its assessable income in that year by the repaid amount.

Repayment of Grant funding - interest

Under section 8-1 you can deduct from your assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income unless it is capital or private in nature.

Interest is accruing on the grant amount. It only needs to be paid to the Government along with a repayment of the grant funding if earnings exceed the repayment threshold. If in the future the entity is obligated to repay the grant funding because the earnings threshold is reached, it is entitled to claim a deduction under section 8-1 for the interest associated with the amount paid back.