Edited version of your written advice

Authorisation Number: 1051446996466

Date of advice: 13 November 2018

Ruling

Subject: Assessable income - government grant - deductions - repairs

Question 1

Is the $X grant received for phase one of the project assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the $X grant received for phase two of the project assessable income under section 15-10 of the ITAA 1997?

Answer

Yes

Question 3

Is the entity entitled to a deduction under section 8-1 of the ITAA 1997 in relation to expenditure incurred to complete phase one of the project?

Answer

Yes

Question 4

Is the entity entitled to a (repair) deduction for the expenditure incurred in relation to the work undertaken to complete Phase Two of the project?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2017

Year ended 30 June 2018

Year ending 30 June 2019

The scheme commenced on:

1 July 2016

Relevant facts

The entity previously received funding under a government project to restore a site to enable a mixture of business operations to be carried on.

The entity has completed all the relevant requirements for that government grant.

The entity is now the legal owner of the site.

The entity has leased some of the buildings on the site and returned rental income over a number of income years in their tax returns.

The entity sought further funding under another government grant.

The entity submitted an application to secure the funding.

The entity’s application provided the following:

● The purpose of the funding was to further develop the site, and

● The funding was to cover the following development activities:

Phase One

Phase Two

The entity entered into a Grant Deed (the Deed) to secure the funding.

The Deed relevantly provided:

● The purpose of the funding was to complete the Project as specified in the entity’s application and if applicable under an updated plan

● The grant of $X (excluding GST) is payable in instalments in accordance with Item X of the Deed

● The entity must provide updated Plans and Progress Reports where applicable in respect to Instalments to be paid

● The date for the commencement and completion of the project

● The entity as the recipient of the funding is to provide a final report within XX business days from the date of completion of the project, and

● The entity must repay the Grantor any amount not used in or for the project or such part of the Grant as may be determined by the Grantor in their absolute discretion if:

● The entity does not complete the project by DD/MM/YYYY, or at a date as specified by the Grantor

● Where the Deed is terminated by the Grantor in accordance with Clause X of the Deed, or

● In the event of Default as set out in Clause X of the Deed.

A Deed of Variation was executed and the Deed was amended to extend the payment of the instalments and reporting requirements.

The entity has provided updated plans and progress reports for the project.

To receive a funding payment the entity is required to complete all of the milestones for the project and submit an invoice for payment along with evidence of expenditure and confirmation that the milestones have been completed.

At the time the entity purchased the industrial site a building on the site was damaged due to the weather conditions.

On DD/MM/YYYY work was undertaken to repair the damage to the building.

Tax invoices were issued for the repair of the damage to the building.

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 8-1

Income Tax Assessment Act 1997 section 15-10

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 paragraph 110-25(4)(b)

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 paragraph 40-880(5)(b)

Reasons for decision

Phase One Funding

Grants received by a business in relation to the carrying on of that business are generally assessable income either according to ordinary concepts under section 6-5 of the ITAA 1997, or as a bounty or subsidy under section 15-10 of the ITAA 1997.

The commencement of a business is a question of fact. In determining when a business commences there are three indicators that must be present before it can be said that a business has commenced:

● purpose, intention and decision

● acquisition of a business structure, and

● commencement of business operations.

In this case, the entity had previously applied for, and received a grant to fund the acquisition of the site. The entity had undertaken and completed various development activities to refurbish the site. Various buildings on the site have been re-furbished and leased out to various tenants. The entity has returned income from leasing in their tax returns. The entity is considered to be carrying on a business of developing the site for the purpose of earning assessable income from the rent it receives.

Taxation Ruling TR 2006/3 discusses government payments to industry to assist entities to continue, commence or cease business. Paragraph 85 of TR 2006/3 provides a summary of the guidelines which have been developed to determine the nature of a receipt.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient not the nature of the asset acquired with the payment of the grant. In GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) (1990) 170 CLR 124, the Full High Court stated at 136-7:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

The grant is received following specified activities the entity is required to perform as outlined in its application to secure the funding from the Grantor. This includes gathering legal, commercial and professional and engineering advice as outlined in Phase One of the project. As noted at paragraph 13 of TR 2006/3 where government payments to industry reimburse, assist with, or directly pay on behalf of the recipient, the costs of obtaining legal, business, accounting, financial or other professional advice in the ordinary course of business, the payment is ordinary income and is assessable income under section 6-5 of the ITAA 1997.

Therefore, the $X of the grant for Phase One of the project is included in the entity’s assessable income under section 6-5 of the ITAA 1997 when it is derived. The entity is considered to have derived the funding when it is entitled to receive it.

Phase Two Funding

For the purposes of section 15-10 of the ITAA 1997, a bounty or subsidy must be related to ‘carrying on’ a business, not merely for commencing or ceasing a business (paragraph 101 of TR 2006/3).

Paragraph 102 of TR 2006/3 clarifies that a government payment is assessable income under section 15-10 of the ITAA 1997 if it is received for the purpose of an existing business to:

● acquire or construct an asset

● assist with the capital costs of restructuring to:

● improve the manufacturing, processing, distribution, administration or other operations of the business, or

● assist the business to improve its overall efficiency.

In this case, the entity is carrying on a business and the grant paid by the Grantor is to assist with the re-construction of an asset held by the entity. Accordingly, the amount of $X for Phase Two of the project is assessable under section 15-10 of the ITAA 1997 when the entity is entitled to receive it.

Phase One Deduction

Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or is necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature.

In this case, the entity has incurred expenses in order to meet the milestones to receive the funding under the project. The expenditure arises out of the day to day activities of an ongoing business activity carried on by the entity to develop the site. Therefore, the expenditure in respect of seeking the legal, commercial, professional and engineering advice is deductible under section 8-1 of the ITAA 1997.

Phase Two Deduction

Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income producing purposes. However, subsection 25-10(3) does not allow a deduction for repairs where the expenditure is of a capital nature.

Taxation Ruling TR 97/23 explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction. The term ‘repair’ means the remedying or making good of defects in, damage to, or deterioration of property as long as the restoration is of the entirety and does not change the character of the property. The cost of repairing an income producing property is deductible.

However, TR 97/23 states that expenditure to remedy defects, damage or deterioration in existence at the date of acquisition is constituted as initial repairs and no deduction is allowable:

59. Expenditure incurred on an initial repair after property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10. This is so whether the property is purchased or obtained under lease or licence by the taxpayer. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred: but see paragraphs 63 to 66 of this Ruling in relation to dissecting or apportioning initial repair costs.

60. The main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration:

(a) existed at the time of acquisition of the property; and

(b) did not arise from the operations of the person who incurs the expenditure.

61. It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price (or lease rentals) reflected the need for repairs. We consider that the English Court of Appeal decision in Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes) [1972] 1 All ER 681 is not authority in Australia for a contrary view. An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that produce the taxpayer's assessable income. It is essentially an additional cost of acquiring the property or an improvement in the quality of the property acquired. Initial repair expenditure relates to the establishment of the profit - yielding structure. It is capital expenditure and is not deductible under section 25-10.

In this case, a review of the information provided indicates the deterioration of the building existed at the time of acquisition of the site and not as a result of operation undertaken by the entity. Therefore, the work undertaken is considered an initial repair and not deductible under section 25-10 of the ITAA 1997 as the work is capital in nature.

Where work is undertaken as part of the cost of maintaining a property such as initial repairs, these costs form part of the third element of the cost base of the property under paragraph 110-25(4)(b) of the ITAA 1997.