Edited version of private advice

Authorisation Number: 1051659483349

Date of advice: 15 April 2020

Ruling

Subject: Administration of government grant funds

Question 1

Is Government grant money received for charity funds assessable as income in The Company under Subdivision 20-A of the Income Tax Assessment Act 1997?

Answer

No

Question 2

Is grant money paid to charity funds recognised as an expense in The Company under Income Tax Assessment Act 1997 section 8-1?

Answer

No

Question 3

When calculating aggregated turnover to satisfy the Small business CGT concession basic conditions under ITAA 1997 section 152-10 and small business entity concessions under ITAA 1997 section 328-110, will you include government grants received as part as aggregated turnover?

Answer

No

This ruling applies for the following periods:

1 July 20XX to 30 June 20XY

Relevant facts and circumstances

The Company is a professional consulting firm that provides specialist technical and analytical expertise to international and community development programs. The Company has been engaged to manage an element of the Department of Foreign Affairs' (DFAT) aide program. This includes contracting and disbursement of funds to Non-Governmental Organisations (NGO)s.

There is a Deed of Standing Offer between the Commonwealth of Australia represented by DFAT and The Company.

The relevant clauses in this deed are summarised below:

-   The Company will administer a grant scheme under which DFAT will select Grant Recipients and The Company will pay the Grant Funds from DFAT to the Grant Recipient.

-   The Company must ensure the funds are held in a bank account in its own name which it solely controls and which is held solely for the purposes of administering the grant funds, separate from The Company's other operating accounts.

-   The Company must ensure it accounts for receipt and expenditure of grant funds separately within its accounting records, so that these funds are traceable and identifiable at all times.

-   The Company must remit any interest earned on grant funds within the Company's control to DFAT.

-   The Company will enter into an agreement with the Recipient.

-   The Company has no right to terminate agreements without consulting DFAT.

-   Grant Recipients must repay grant funds and interest for amounts that remain unspent, or which have been used for purposes other than the specified purposes.

-   The Company must notify DFAT immediately of any funds it recovers and deal with those funds as directed by DFAT.

-   DFAT will pay The Company Reimbursable Costs for the provision of the services in accordance with the Service Order.

DFAT provides details of each grant to be paid via service order. The relevant clauses in the service order are summarised below:

-   DFAT will pay The Company $X plus GST if applicable in Fees within seven (7) days receipt of a tax invoice.

-   The Fees will be paid into The Company's bank account stated in the invoice

-   The following NGOs will receive Grants Funds through this service order

(a) NGO1 will be paid Grant funds of $A plus GST.

(b) NGO2 will be paid Grant funds of $A plus GST.

-   Within seven (7) Business Days of The Company receiving from DFAT the Fees listed in this Services Order, The Company will pay the amount of those Fees to the NGOs listed

-   The Company will not levy an administrative fee against, or otherwise retain any part of, the Fees received from DFAT under this Service Order.

The Company creates a contract with the Grant Recipient outlining the requirements of the DFAT Grant. These are referred to as Grant Orders, the relevant clause in the Grant Order is summarised below:

-   The Company will pay The Recipient Grant Funds for the relevant tranche within seven (7) days of The Company receiving the funds from DFAT, and in accordance with this Grant Agreement. The Provision of the grants is subject to The Recipient issuing a valid Tax invoice.

Relevant legislative provisions

Income Tax Assessment Act 1997

subsection 6-5(4)

section 8-1

subsection 20-20(2)

subsection 20-20(3)

subsection 20-25(1)

subparagraph 152-10(1)(c)(i)

subsection 152-10(1AA)

subsection 328-110(1)

section 328-115

section 328-120

Reasons for decision

These reasons for decision accompany the Notice of private ruling for The Company.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

The government grant money received by The Company for distribution to NGOs is not an assessable recoupment under subdivision 20-A of the ITAA 1997.

Detailed reasoning

Some amounts are included in assessable income to reverse the effect of past deductions, subdivision 20-A of the ITAA 1997 deals with insurance, indemnity and other recoupment of deductible expenses. The definition of recoupment is found in subsection 20-25(1) of the ITAA 1997.

Subsection 20-20(2) of the ITAA 1997 states that an amount received as recoupment of a loss or outgoing is an assessable recoupment if:

(a) received by way of insurance or indemnity; and

(b) you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

The term "indemnity" is not defined in either of the Income Tax Assessment Acts. It therefore must take its ordinary meaning.

The term "indemnity" was considered in Denmark Community Windfarm Ltd v. Federal Commissioner of Taxation 2018 ATC 20-646 (Denmark Case). The Full Court stated at paragraph 39:

The Grant was payable in instalments on the completion of identified project milestones. In these circumstances, the amounts received by Denmark fell within the ordinary meaning of the word "indemnity", which includes, as noted by the primary judge at [50], "a sum of money paid to compensate a person for liability, loss or expense incurred by the person". The fact that the amounts were a government subsidy or rebate does not affect the position. The amounts nevertheless bear the character of compensation for a liability, loss or expense incurred.

If the requirements of subsection 20-20(2) of the ITAA 1997 are not met, the recoupment may still be assessable under subsection 20-20(3) of the ITAA 1997. For the purposes of satisfying subsection 20-20(3) of the ITAA 1997 to be an assessable recoupment, you must be able to deduct an amount for the loss or outgoing for the current year, or have deducted or can deduct an amount for it for an earlier income year, under a provision listed in section 20-30 of the ITAA 1997.

Application to your circumstances

The grant funds received by The Company meet the definition of recoupment of a loss or outgoing provided in subsection 20-25(1) of the ITAA 1997 as they can be considered amounts received in respect of a reimbursement.

The Grant Funds provided to NGOs by DFAT are not a liability, loss or expense incurred by The Company. These funds are an expense incurred by DFAT (see further explanation at question 2). The Company has received the funds on behalf of a third party and transfers them accordingly. These amounts do not meet the definition of indemnity, therefore subsection 20-20(2) of the ITAA 1997 does not apply.

Also subsection 20-20(3) of the ITAA 1997 will not apply as the grant funds provided to NGOs cannot be deducted by The Company under any of the provisions in section 20-30 of the ITAA 1997.

Therefore, Subdivision 20-A of the ITAA 1997 will not apply to the grant funds received for charities, these amounts are not considered to be an assessable recoupment.

Question 2

Summary

The grant funds paid by The Company to NGOs are not a deductible expense under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 8-1 of the ITAA 1997 stipulates that a deduction can be claimed against your assessable income for any loss or outgoing where it was incurred in gaining or producing your assessable income or it was necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

As a broad guide, you incur an outgoing at the time you owe a present money debt that you cannot escape. But this broad guide must be read subject to the propositions developed by the courts.

Where a principal acts through an agent, the principal is entitled to a deduction when the agent incurs the liability on the principal's behalf, rather than at the earlier time when the principal contributed money to the agent (TR 2004/5). However, expenditure is not incurred by a principal if there is insufficient evidence of an agency relationship, or if there is no evidence that a taxpayer is under a presently existing obligation to reimburse another entity for expenses paid on the taxpayer's behalf (Healy).

Butterworths Australian Legal Dictionary (1997) defines 'agency' as follows:

A relationship involving authority or capacity in one person (the agent) to create or affect legal relations between another person (the principal) and third parties: International Harvester Co of Australia Pty Ltd v. Carrigan's Hazeldene Pastoral Co (1958) 100 CLR 644; 32 ALJ 160. Whether 'agency' is constituted depends on the true nature of the agreement or the exact circumstances of the relationship between the alleged principal and agent, rather than on language adopted by the parties: Norwich Fire Insurance Society Ltd v. Brennans (Horsham) Pty Ltd [1981] VR 981. A relationship of agency is created either by the express or implied agreement of principal and agent, by the subsequent ratification by the principal of the agent's acts done on behalf of the principal, by operation of law, pursuant to statute, or by estoppel under the doctrine of apparent (or ostensible) authority.

A loss or outgoing would be incurred by the principal when the agent incurs expenditure on the principal's behalf, but not before. Whether this loss or outgoing is deductible to the principal under section 8-1 or any other provision of the ITAA 1936 or ITAA 1997 would depend on whether the requirements of the relevant provisions are satisfied. TR 2004/5 provides guidance on this matter:

49. There is little, if any, direct authority on whether or when a taxpayer can claim a deduction for moneys advanced to an agent. As a result the issue must be determined by applying general principles.

50. In AAT Case 9897 (1994) 30 ATR 1030; (1994) 95 ATC 101 Deputy President BJ McMahon said (at paragraph 23):

An outgoing is the opposite of income and connotes a movement of resources out of the taxpayer's control or dominion.

51. Money held by an agent on a principal's behalf is in the dominion of the principal. It follows that the principal incurs no outgoing until the agent incurs an outgoing on its behalf or the retailer is charged for expenses the association has incurred on its own behalf.

52. This is supported by Hill J's decision in Ogilvy & Mather Pty Ltd v. FC of T 90 ATC 4838 (Ogilvy & Mather). Although Hill J gave the dissenting judgment in this case, the majority based their decision on another issue.

53. In Ogilvy & Mather Hill J considered whether an agent was entitled to claim a deduction for liabilities it incurred on behalf of a principal. In doing so he stated that it was the principal, not the agent, who would be entitled to a deduction if one was otherwise allowable, even if the agent agreed to accept personal liability under the contract, an obligation he likened to a guarantee. His Honour said (at 4857):

In such a case, the principal, who is also bound to make the payment, has incurred a liability and assuming that the liability otherwise satisfies the criterion of sec. 51(1) is entitled to a deduction under that section. It would be strange if the agent, who has also incurred a liability, would be entitled simultaneously to a deduction of the same amount.

54. So, if an agent incurs a liability on a principal's behalf and that liability satisfies the other criterion in section 8-1 of the ITAA 1997 (equivalent to subsection 51(1) of the ITAA 1936), the principal, not the agent, is entitled to a deduction in respect of that liability. The corollary of this is that the principal is not entitled to a deduction before then.

Application to your circumstances

By entering into a contract with The Company, DFAT has created an agreement with The Company to pay grants to the NGOs, The Company then acts to contract the NGO on behalf of DFAT. Subsequently, DFAT ratifies The Company's acts by paying the grant funds into The Company's bank account, which The Company distributes to the NGO on DFATs behalf. This displays the necessary elements of agency.

The grant funds transferred to The Company from DFAT are not beneficially held by The Company. In paying amounts to NGOs, The Company have no control over how much is transferred, who it is transferred to nor when the transfer will take place. As expressed in AAT case 9897 an outgoing is movement of resources out of the taxpayers control or dominion. The Company did not have control of the funds and the funds are considered to be in the dominion of DFAT, not The Company. As a result, The Company has not incurred an outgoing when paying the grant funds to the NGO and cannot claim a deduction for these amounts under section 8-1 of the ITAA 1997. The expenses for the grant funds are considered to be incurred by DFAT, not by The Company in accordance with the principles laid out in TR 2004/5.

Question 3

Summary

The Government Grant funds received by The Company, which are paid to NGOs, are excluded from aggregated turnover in determining eligibility to meet the basic conditions for small business relief under Division 152.

Detailed reasoning

Subdivision 152-A of the ITAA 1997 provides the basic conditions for small business relief under Division 152 of the ITAA 1997. In determining whether an entity meets the criteria to satisfy the basic conditions, subparagraph 152-10(1)(c)(i) of the ITAA 1997 determines that you may meet the criteria if you are a CGT small business entity for the income year. According to subsection 152-10(1AA) of the ITAA 1997, to qualify as a CGT small business entity you must be considered a small business entity.

Division 328 of the ITAA 1997 provides for the meaning of a small business entity relevant for the entity to access various tax concessions available in the tax legislation. In determining whether an entity meets the criteria necessary to satisfy the definition of a small business entity, subsection 328-110(1) of the ITAA 1997 provides that consideration of the entity's aggregate turnover is required.

The meaning of the term 'aggregate turnover' is provided in section 328-115 ITAA 1997, which broadly is the sum of the relevant annual turnovers. Section 328-120 of the ITAA 1997 provides for the meaning of 'annual turnover'. The general rule under subsection 328-120(1) is that the annual turnover of an entity for an income year will be the total ordinary income the entity derives in the ordinary course of carrying on its business. Consequently, in order to establish whether an entity is a small business entity it is necessary to consider what constitutes the entity's ordinary income such that its annual turnover for the relevant income year can be established.

The legislation does not provide guidance on the meaning of 'ordinary income' however, guidance as to its meaning can be found in case law. For instance, in Scott v. Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215, Jordan CJ held that the meaning of 'income' was to be determined according to 'ordinary concept and usages' at 219 as follows:

'The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts: A.-G. for British Columbia v. Ostrum ([1904] AC 144 at 147); Lambe v. Inland Revenue Commissioners ([1934] 1 KB 178 at 182-3).'

Subsection 6-5(4) of the ITAA 1997 explains that an entity has derived an amount of ordinary income if they are taken to have receive the amount as soon as it is applied or dealt with in any way on their behalf or as directed. An entity, acting on behalf of another does not have an equitable interest in those funds according to ordinary concepts.

Application to your circumstances

The Company's relationship with DFAT is effectively that of an intermediary between the Australian Government and the NGOs in receipt of grant funds. The intermediary has no beneficial interest in the Grant Funds but merely serves as a conduit for the passing on of the Funds for the government to the NGO. As a result, The Company does not take on any of the associated risks and does not incur associated costs. DFAT pays the costs associated via the Reimbursement Costs that The Company invoices.

Although The Company may hold legal title to the Grant Funds in its bank account prior to forwarding relevant amounts to the NGOs, The Company does not have an equitable interest in these funds. Rather, the equitable owners of the funds are the NGOs.

Consequently, the gross amounts received from Grant Funds are not considered to be income according to ordinary concepts and should not be included in determining The Company's annual turnover for the purposes of subsection 328-120(1) ITAA 1997. This will consequently exclude the Grant Funds from aggregated turnover in determining eligibility to meet the basic conditions for small business relief under Division 152. The Company is required to include amounts representing the fees it charges to DFAT to administer the grants when determining its annual turnover.