Edited version of your written advice

Authorisation Number: 1013127957947

Date of advice: 24 November 2016

Ruling

Subject: Assessability of a government grant

Question 1

Is the receipt of the government grant assessable as ordinary income or ordinary income?

Answer

No

Question 2

Is the receipt of the government grant assessable under the capital gains tax provisions?

Answer

No

Question 3

Are you required to account for any assessable recoupment under Subdivision 20-A of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period(s)

Year ended 30 June 20YY

Year ending 30 June 20ZZ

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You have signed a funding agreement having successfully applied for a government grant for the establishment of a new business.

The grant funding available is subject to a number of conditions outlined in the funding agreement, with that amount to be matched by a contribution by the grantee.

Applicants are required to fund at least 2/3 of the project cost, with the grant being a maximum 1/3 of the project costs.

You are an Australian company. At the time of being awarded the grant and entering into the funding agreement you had not traded and were not conducting a business.

The purpose of the grant is to establish a new business.

You have provided a copy of the Funding Agreement.

The Activity will lead to the employment of X full time equivalent (FTE) staff.

The Grant will be paid over two financial years, subject to the terms of this Agreement.

A final payment of up to 20% of the Grant will be withheld until the end of the project reporting obligations have been met.

Record Keeping

The Grantee agrees to maintain the following records:

(a) Identify the receipt and expenditure of the Grant [and any other Contributions] separately within the Grantee's accounts and records so that at all times the Grant is identifiable; and

(b) Keep financial accounts and records relating to the Activity so as to enable all receipts and payments related to the Activity to be identified and reported;

Equipment and assets

The Grantee agrees to obtain the relevant prior written approval to use the Grant to purchase any equipment or asset for more than $X,XXX (including GST), apart from those listed in the Budget.

The Grantee agrees to maintain a register of all equipment and assets purchased for $X,XXX (including GST) or more with the Grant in the form specified and to provide the register to the relevant body upon request.

The Grantee agrees that the proceeds of any equipment and assets purchased with the Grant disposed of during the Activity must be treated as part of the Grant and used for the purposes of the 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 15-10

Income Tax Assessment act 1997 Subdivision 20-A

Income Tax Assessment act 1997 Section 104-25

Income Tax Assessment act 1997 Section 108-5

Reasons for decision

Ordinary Income/bounty or subsidy

A grant can be assessed under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income; 'ordinary income' includes income according to ordinary concepts. Income according to ordinary concepts is not defined in the taxation legislation. The characteristics of ordinary income have been developed by case law and generally falls into three categories:

● Income from providing personal services;

● Income from property; or

● Income from carrying on a business.

Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business provides the ATO view on the income tax implications of government payments to industry to assist entities to continue, commence or cease business.

Paragraph 26 of TR 2006/3 states:

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.

You have stated that the company was recently registered and at the time of being awarded the grant and entering into the funding agreement you had not traded and were not conducting a business. The funding is for building infrastructure and acquisition of depreciable assets to commence the business.

The payment received is not income according to ordinary concepts. It is not a bounty or subsidy that is received in relation to carrying on a business. The receipt is not assessable income under section 15-10 of the ITAA 1997.

Assessable recoupment

Paragraph 27 of TR 2006/3 states:

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.

Under section 20-20 of Subdivision 20-A, a receipt is an assessable recoupment if:

● it is not income under ordinary concepts or otherwise assessable;

● it is received as recoupment of a loss or outgoing (as defined by section 20-25; and

● the taxpayer has deducted or can deduct an amount for a loss or outgoing in the current year or an earlier year under a provision listed in section 20-30.

A payment under the Relevant Funding Agreement made for the purchase of a depreciating asset, for which deductions for decline in value are available under Division 40 of the ITAA 1997, is assessable income under the assessable recoupment provisions in Subdivision 20-A.

At the time of receiving the payment under the funding agreement a deduction for decline in value would be potentially available under Division 40 of the ITAA 1997. A decision on whether to calculate the depreciation under Division 40 or Subdivision 328-D will not be made until the income tax return is to be lodged.

Class Ruling CR 2007/65 which covered the income tax treatment of payments in relation to assist fishing community recipients to commence a business addressed this issue at paragraphs 49 to 51.

Under Division 40, a taxpayer 'can deduct' an amount for the cost of a depreciating asset that they hold based on the decline in value of the asset. The deduction is reduced to the extent that the depreciating asset is used for other than a taxable purpose. Division 40 applies to most depreciating assets, including plant, and is a provision listed in section 20-30. Depreciating assets that are excluded from the scope of Division 40 are listed in section 40-45 and include: depreciating assets for which deductions are available under specific film provisions; depreciating assets that are capital works; and cars where the cents per kilometre method for calculating car expenses. For the amount of depreciation to be calculated under Subdivision 328 the asset has to be depreciable under Division 40 (section 328-175 of ITAA 1997).

Section 20-35 provides that the assessable recoupment is included in assessable income if the whole amount of the loss or outgoing can be deducted for the current year or in an earlier income year. The total amount assessed cannot exceed the amount of loss or outgoing. If the recoupment is received before the income year of the deduction then the assessable recoupment is included in assessable income in the year in which the loss or outgoing is deductible.

Where the loss or outgoing is deductible under Division 40 over two or more income years, section 20-40 applies so that the total assessable recoupments to be included in assessable income is limited to the total amount of the loss or outgoing that can be or has been deducted at that time. Any part of an assessable recoupment that is not included in assessable income in the year of receipt, because of this limit, is assessable in later income years to the extent that further amounts are deductible under Division 40 for the depreciating asset in the later income years.

Generally a small business entity can choose to calculate deductions and balancing adjustments for depreciating assets under Subdivision 328-D instead of Division 40. With certain exceptions, this choice is available for all depreciating assets that the taxpayer holds and started to use, or had installed ready to use, for a taxable purpose during or before the income year in question. However, assets that would not otherwise be depreciable under Division 40 are not deductible under the small business concessions in Subdivision 328-D.

It is considered that section 20-20 would apply to the payment received under this Relevant Funding Agreement to commence a business to the extent that it is used to purchase depreciable assets.

The amount of the payment that is a recoupment, is based on the evidence provided by the 'accounting records' (clause G3) and the 'Equipment and assets register' (clause G7) required under the Funding Agreement, which will be a reasonable estimate of the amount of grant monies actually spent on depreciable assets.

Capital gains tax

A payment received under the funding agreement to commence a business is subject to capital gains tax (CGT) provisions in Part 3-1 and 3-3.

CGT event C2 under section 104-25 happens to the entitlement to receive the funding when the entitlement is satisfied.

However any capital gain or capital loss made as a result of a payment under the funding agreement to commence a business is disregarded under paragraph 118-37(2)(a).

To the extent that an amount paid under the funding agreement to commence a business relates to the acquisition of a new CGT asset that is not a depreciating asset, the expenditure is excluded from the cost base (or reduced cost base) of the new CGT asset under subsection 110-45(3) or Subsection 110-55(6).

Where the payment relates to a new asset that is a depreciating asset, the expenditure is not excluded from the CGT cost base (or reduced cost base) of the new asset under subsection 110-45(3) or subsection 110-55(6) to the extent to which it is an assessable recoupment under Subdivision 20-A.