Edited version of private advice

Authorisation Number: 1052082966961

Date of advice: 22 March 2023

Ruling

Subject: Grant received by way of novation

Question 1

Is the Grant received by way of novation the assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the Grant received by way of novation by the Trustee assessable under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Is the Grant received by way of novation by the Trustee an assessable recoupment under Subdivision 20-A of the ITAA 1997?

Answer

Yes. The Grant is an assessable recoupment to the extent that the Grant is applied towards expenditure for which Division 40 and Division 43 of the ITAA 1997 would apply.

Question 4

On the basis that Question 3 is applicable, where expenditure in relation to the Grant is deductible over two, or more, years, will section 20-40 of the ITAA 1997 operate such that the amount of the assessable recoupment in a particular year will equal the total amount of deduction claimed in that year in accordance with the method statement under subsection 20-40(2) of the ITAA 1997?

Answer

Yes.

Question 5

Is the Trustee entitled to add the cost of construction of the Assets to the capital gains tax (CGT) cost base of the land under section 110-25 of the ITAA 1997?

Answer

Yes.

Question 6

In the event of disposal, will the Trustee be required to reduce the cost base of the Assets by the amount of the Grant received that has not been included in assessable income in accordance with subsection 110-45(3) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 20xx - 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

1.      Company A successfully obtained a grant from a state government (Grant) for the purpose of constructing assets (Assets).

2.      A Grant Agreement was entered into by which the state government will contribute a percentage of the total costs of the construction of the Assets (Project) and payments are to be made to Company A by instalments upon completion of certain milestones.

3.      The Project will involve the design, construction and operation of the Assets.

4.      The Assets will be constructed on land owned by a related party.

5.      Company A will select a builder by tender. Once construction is completed the Assets will be leased.

6.      Before a builder is selected and construction commences Company A proposes to carry out a restructure (Restructure).

7.      The Restructure contains the following steps:

a.      a trust is to be created for the purpose of undertaking the Project (Trust),

b.      a Novation Deed is to be entered into between the state government and Company A and the trustee of the Trust (Trustee) for the Grant to be novated to the Trustee on the same terms and conditions,

c.       The Trustee will acquire the land from the related party for the Asset to be constructed on,

d.      The Trustee will assume responsibility for delivering the Project and operating the Assets upon completion of construction

8.      Neither Company A nor the Trustee has experience or skills in constructing the Assets.

9.      The Novation Deed has not been executed and construction has not commenced.

10.   The undertaking of the Project by the Trustee is contingent on the Grant Agreement being novated to the Trustee as the deed of novation between the parties has not been entered into.

11.   Other than establishment costs, the Trustee has not incurred any expenses nor acquired any assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-10

Income Tax Assessment Act 1997 Subdivision 20-A

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

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 20-30

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

Income Tax Assessment Act 1997 section 20-40

Income Tax Assessment Act 1997 subsection 20-40(2)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-45

Income Tax Assessment Act 1997 subsection 110-45(2)

Income Tax Assessment Act 1997 subsection 110-45(3)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated

Question 1

Subsection 6-5(1) provides that an entity's assessable income includes income according to ordinary concepts, called ordinary income. The ordinary income must be derived directly or indirectly from all sources during the income year by an Australian resident.

Paragraph 84 in TR 2006/3 states that the characteristics of ordinary income have been developed by case law and generally fall into three categories:

(a)       income from providing personal services,

(b)       income from the use of property, or

(c)           income from carrying on a business.

The Grant received by the Trustee is not income from providing personal services, nor income from the use of property. For it to be assessable under section 6-5 it must be income from carrying on a business

In this case, it is not considered that the Trustee is carrying on a business of building or construction, nor does it have the necessary skills and experience in doing so. The construction process for the Assets will be undertaken by an external builder and the Trustee will only have general oversight over the construction.

The Grant is made to the Trustee for the purpose of assisting the Trustee with the costs of constructing the asset to stimulate economic activities and enhance local employment opportunities. Whilst it will be paid in separate instalments it does not possess the necessary elements of periodicity, recurrence or regularity that are common to receipts of ordinary income.

Therefore, the Grant will not be assessable as ordinary income under subsection 6-5(1).

Question 2

Section 15-10 states:

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.

Paragraph 100 of TR 2006/3 states that a bounty or subsidy will be 'in relation to' carrying on a business when there is a real connection between the payment and the business. The term 'in relation to' includes within its scope payments that have a direct or indirect connection to the business.

Paragraph 101 of TR 2006/3 provides that a bounty or subsidy must be related to 'carrying on' the business and not merely for commencing or ceasing a business.

The purpose of the Grant is to allow the Trustee to construct assets to encourage economic activities the area. The Trustee will acquire the land and engage external contractors to construct the Assets, as the Trustee is not in the business of building construction and does not possess such experience or skills. The Grant will contribute to the creation of a new business entity for a specific purpose.

The Grant is not received in relation to carrying on a business for the purposes of paragraph 15-10(a).

Therefore, the Grant will not be assessable to the Trustee under section 15-10.

Question 3

Subsection 20-20(1) states that an amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside Subdivision 20-A.

As stated above the Grant is not assessable as either ordinary income or statutory income.

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

(a) you received the amount 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.

Subsection 20-25(1) states that:

Recoupment of a loss or outgoing includes:

(a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

(b) a grant in respect of the loss or outgoing.

The Trustee will incur an outgoing on constructing the Assets and the Grant is made available to offset part of the cost of construction. The Grant is, therefore, a 'recoupment'.

For the purposes of subsection 20-20(2), for the recoupment to be an assessable recoupment, the grant monies have to be received by way of insurance or indemnity.

The Grant in this case is not received by way of insurance.

The term 'indemnity' was considered in Denmark Community Windfarm Ltd v. FC of T 2018 ATC 20-646. The Federal Court held that the meaning of the word 'indemnity' included 'a sum of money paid to compensate a person for liability, loss or expense incurred by the person' or 'compensation for damage or loss sustained' and 'something paid by way of such compensation'. The court held that the Grant, being a portion of the Eligible Project costs to construct two wind turbines, was received by the taxpayer as compensation for an 'expense' incurred by it and so fell within the meaning of the word 'indemnity'.

In the present case, the Grant is a portion of the total cost of the Project and is received to compensate the Trustee for the expenditure it will incur in relation to constructing the Asset. It is considered that the Grant constitutes compensation for loss or expenses incurred by the Trustee and therefore received by way of 'indemnity for the purposes of paragraph 20-20(1)(b).

The Grant will be applied towards expenditure to which Division 40 and Division 43 would apply.

Where the Trustee incurs capital expenditure with the Grant and claims deductions under Division 40 and Division 43 in the current or earlier income year it will result in the second requirement in paragraph 20-20(2)(b) being satisfied.

As both requirements in subsection 20-20(2) have been satisfied means that the amounts received from the Grant is an assessable recoupment.

Question 4

Section 20-40 sets out the amount to be included in assessable income where the assessable recoupment relates to a loss or outgoing that is deductible over several income years.

Section 20-40 applies where a taxpayer receives an assessable recoupment of a loss or outgoing that is deductible over several income years in either of the following situations:

(a)              the assessable recoupment was received in the current year; or

(b)        the assessable recoupment was received in an earlier income year and there remains a part of the recoupment that has not yet been included in your assessable income by section 20-40 or by a previous recoupment law.

Where section 20-40 applies, the amount to be included in your assessable income for the current year is worked out in accordance with the method statement in subsection 20-40(2).

Both Division 43 and Division 40 allow for deductions to be spread over a period of two or more years. When the provisions within these Divisions apply to the Trustee to spread the deduction over two or more years the method statement under subsection 20-40(2) will apply when calculating the amount of assessable recoupment that will arise in respect of these deductions.

Questions 5

Section 110-25 sets out the five elements of the cost base of a CGT asset. The most relevant element of the cost base to the costs of the Assets is the fourth element.

Subsection 110-25(5) states that the fourth element is capital expenditure incurred:

(a) the purpose or the expected effect of which is to increase or preserve the asset's value; or

(b) that relates to installing or moving the asset.

Any capital expenditure incurred by the Trustee with the purpose or the expected effect of which is to increase or preserve the Assets value will form part of the cost base of the land under subsection 110-25(5). The cost of construction of the Assets will form part of the CGT cost base of the land.

Questions 6

Upon disposal of the Assets, the Trustee will reduce the cost base of the Assets by the amount of the Grant received that has not been included in assessable income.

Expenditure does not form part of any element of the cost base or reduced cost base to the extent of any amount received as 'recoupment' of it, except so far as the amount is included in the taxpayer's assessable income (subsections 110-45(3) and 110-55(6)).

The Grant in this case is a recoupment for the purpose of subsection 20-25(1). Except in so far as any amount of the Grant has been included in assessable income, the Grant amount would form part of the CGT asset's cost base (or reduced cost base) in calculating any capital gain under section 110-45(3) or capital loss under section 110-55(6).