Edited version of private advice

Authorisation Number: 1052150092054

Date of advice: 1 August 2023

Ruling

Subject: Assessable income and government grants

Question 1

Will the grant received by SubCo constitute ordinary income for HeadCo, as the head of a consolidated group, under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the grant received by SubCo constitute assessable income for HeadCo, as the head of a consolidated group, under section 15-10 of ITAA 1997?

Answer

No.

Question 3

If the answers to Questions 1 and 2 is no, will the grant received by SubCo constitute assessable income for HeadCo, as the head of a consolidated group, under the assessable recoupment provision in Subdivision 20-A of the ITAA 1997 where an amount received is a recoupment of a loss or outgoing that is deductible under a provision listed in section 20-30 of the ITAA 1997?

Answer

As the answers to Question 1 was yes, this question was not answered.

This ruling applies for the following periods:

Year ended 30 June 2022

Year ended 30 June 2023

Year ended 30 June 2024

Year ended 30 June 2025

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

1.         HeadCo is the head company of a tax consolidated group and SubCo is one of its wholly-owned subsidiaries.

2.         HeadCo was incorporated in Australia under the Corporation Act 2001.

3.         The wholly-owned subsidiaries of HeadCo operate a number of businesses in a city of Australia. The entities that are members of the tax consolidated group are collectively referred to hereafter as the Consolidated Group.

4.         A subsidiary member of the Consolidated Group purchased vacant land in the city of Australia in which it operates its businesses.

5.         The land was purchased to be used in part for its existing businesses, and the other part of the land set aside for possible sale.

6.         At around the same time the land was purchased, a Federal Government Department opened applications for a grant scheme. The scheme of the Grant had several purposes, include a purpose that allowed existing businesses to enter new markets.

7.         The Consolidated Group decided to pursue the possibility of applying for the grant and develop and use the land to undertake new specific business activities on that part of the land.

8.         The Consolidated Group conducted an economic and financial analysis and determined that undertaking these new specific business activities was commercially viable, but the decision to proceed would be dependent on approval of the grant.

9.         None of the existing specific business activities of the Consolidated Group would be conducted from the part of the land that would be developed if the grant was received.

10.      The Consolidated Group applied for the grant and received approval.

11.      The final grant agreement contained a number of milestone in respect of the contract phase of the redevelopment of the land which included the construction of building as well as the construction and/or acquisition of tangible depreciating assets to be used to undertake the specific business activities on that part of the land.

12.      The construction on the land of the buildings and the construction and/or acquisition of tangible depreciating assets which will be used to undertake the Consolidated Group's existing specific business activities will occur at some point in an income year after the year ended 30 June 2025.

13.      The grant agreement includes the following:

(a)       A description of the project being undertaken.

(b)       An overall project scope and description is.

(c)       A description of the activities to be undertaken including start and completion sates for the activities.

(d)       A list of eligible activities that can be conducted.

(e)       A list of milestones includes a description of each milestone, a due date for each milestone and the amounts to be paid in respect of each milestone.

(f)        The grantee agrees to undertake all the activities and is fully responsible for the Activities and for ensuring the performance of all its obligations under the agreement:

(g)       The grantee agrees to spend the Grant for the purpose of performing the Activities and otherwise in accordance with the agreement.

(h)       The grantee will provide an independently audited report verifying that the grant has been spent in accordance with the agreement.

(i)        If any amount of the grant has been spent other than in accordance with the agreement, the grantee may be required to repay that amount to the Commonwealth, or the ineligible expenditure may be recovered by other means specified.

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 Section 20-30

Income Tax Assessment Act 1997 Section 701-1

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise indicated.

Issue 1

Question 1

Will the grant received by SubCo constitute ordinary income for HeadCo under section 6-5?

Summary

The grant received by SubCo is assessable to HeadCo as ordinary income under section 6-5.

Detailed reasoning

Section 6-5 and ordinary income

14.      Section 6-5 provides:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

15.      Taxation Ruling TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business (TR 2006/3) provides the Commissioner's view regarding the way in which certain provisions, including sections 6-5 and 15-10 of the ITAA 1997, apply to government payments to industry (GPI) to assist entities to commence, continue or cease business.

16.      It should be noted that as detailed in the first dot point of paragraph 5 of TR 2006/3 does not discuss when a business is considered to have commenced, as that is a question of fact.

17.      Paragraph 15A of TR 2006/3 provides:

GPI paid with the intention of funding the cost of building or constructing a substantial capital asset, but contingent on the performance of a contract to build or construct the asset, will generally be assessable under section 6-5 because the GPI will be derived in the course of carrying on a business of building or constructing the asset. While this will generally be the case where the entity is a company, it will be a question of scale and degree for other entities. The building or construction of the asset may alternatively be outside the course of business yet be the result of a transaction entered into with the purpose of making a profit.

18.      SubCo is a subsidiary member of the consolidated group headed by HeadCo. A key tenet of the consolidation regime is that members of a consolidated group are treated as a single entity (being the head company) for income tax purposes (refer to section 701-1).

19.      A consequence of the single entity rule is that subsidiary members of the consolidated group are taken to be parts of the head company, rather than separate entities, while they are members of the consolidated group and their actions and transactions undertaken are imputed to the company.

20.      Consequently, the actions and transactions of the subsidiary members, including SubCo, are deemed to have been actions and transactions undertaken by the head company, HeadCo. Thus, the business carried on by HeadCo includes the businesses conducted by each subsidiary member (to the extent any action or transaction is not disregarded as intra group).

21.      As discussed in paragraph 15A of TR 2006/3 and as HeadCo is a company, it will generally be the case that a GPI paid to a company with the intention of funding the cost of building or constructing a substantial capital asset contingent on the performance of a contract to build or construct the asset will be assessable income. However, the question of fact needs to be resolved to determine that the view expressed in paragraph 15A of TR 2006/3 does apply in each particular case.

22.      Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? (TR 2019/1) discusses carrying on a business in a general sense versus carrying on a particular business:

15. There are two categories of legislative provisions and cases where the question is whether a company carries on a business. The first category is concerned with whether a company carries on a business in a general sense - irrespective of what is the actual business.

16. The second category is concerned with whether a company 'carries on a particular business'. These cases and provisions turn on the scope or nature of the business that is carried on by an entity. For example, the scope of the business carried on is relevant to whether a gain made on a transaction is income or capital in nature.^[10] Those cases that consider provisions falling in the second category do not address the broader question of whether a business is carried on by the company in the general sense.

17. The provisions this Ruling deals with are concerned with the first category: whether a company carries on a business in a general sense.

[10]

Section 6-5 of the ITAA 1997. London Australia; AGC Investments; GP International Pipecoaters.

23.      That is, in identifying the assessable income of a taxpayer for the purpose of section 6-5, this provision turns on the scope or nature of the particular business that is carried on by the taxpayer.

24.      The question then is whether the Grant is ordinary income in relation to the business carried on by HeadCo, or capital in nature.

Ordinary income or capital in nature

25.      In determining whether an amount is ordinary income or capital in nature, the characteristics of ordinary income have been developed by case law and generally fall into three categories:

•          income from providing personal services;

•          income from property; or

•          income from carrying on a business.

26.      Other characteristics of income that have evolved from case law include receipts that:

•          are earned;

•          are expected;

•          are relied upon; and

•          have an element of periodicity, recurrence or regularity.

27.      In determining whether a receipt is ordinary income and not capital in nature, the authorities establish that it is necessary to conduct "a wide survey and an exact scrutiny of the taxpayer's activities": Commissioner of Taxation v Stone (2005) 222 CLR 289 at [19]; Federal Commissioner of Taxation v Montgomery (1999) 198 CLR 639 at 663 [69]; both citing Western Gold Mines NL v Commissioner of Taxation (WA) (1938) 59 CLR 729 at 740 per Dixon and Evatt JJ.

This 'wide survey' is particularly important where the sale of the asset is by a taxpayer conducting a business. Jacobs J noted in London Australia:

The identification and characterization of the business carried on by the taxpayer is the essential task.

28.      In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation(1990) 170 CLR 124; (1990) 64 ALJR 392; (1990) 93 ALR 193; (1990) 21 ATR 1; 90 ATC 4413; [1990] HCA 25 (G.P. International Pipecoaters) the High Court commented on the characterisation of a subsidy that is intended to assist the recipient with capital costs, saying that such receipts may be capital in nature in certain circumstances. The court stated at CLR 124; ATC 4422; ATR 10 that:

...it is necessary to consider the taxpayer's submission that the cases show that a receipt of moneys intended by payer and payee to recoup a recipient's capital expenditure is a receipt of a capital nature. That proposition can be accepted when the amount is received by way of gift or subsidy to replenish or augment the payee's capital, for in such a case the receipt cannot fairly be said to be a product or incident of the payee's income-producing activity.

29.      The Full High Court also stated in the G.P. International Pipecoaters case[1]:

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 for which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

30.      The grant monies received and to be received by SubCo are tied to the completion of specified milestones in constructing, and the ultimate completion of construction of, the specific assets ultimately to be used in carrying out its business, and those Grant monies are therefore relied upon.

31.      The grant instalments arguably have periodicity (being scheduled to be paid approximately every six months, bar the final instalment), and thus recurrence and regularity. However, looking to the grant agreement itself (the scope of the transaction and the reason for which the money is received), the amount received is ultimately payable on the performance of a contract to be completed in the course of carrying on the business commenced earlier. It has the character of income in the hands of the SubCo, and thus HeadCo, because the grant is conditional on the completion of construction of certain assets, and regardless of the fact that those assets constructed will be held on capital account.

32.      Accordingly, the grant is assessable income under section 6-5 of HeadCo.

Ordinary income and profit-making intent

33.      While periodicity, recurrence and regularity are influential factors (as above), they are of diminished value when generated in the context of carrying on a business. The unanimous decision of the High Court in Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199 at 215 in discussing periodicity, regularity and recurrence stated:

...valuable though these considerations may be in categorizing receipts as income or capital in conventional situations, their significance is diminished when the receipt in question is generated in the course of carrying on a business, especially if it should transpire that the receipt is generated as a profit component of a profit-making scheme. If the profit be made in the course of carrying on a business that in itself is a fact of telling significance.

34.      Example 8A in TR 2006/3 (paragraphs 54A to 54C) describe a situation where a special purpose vehicle (SPV) is created to receive a GPI in instalments to construct a renewable energy plant. After construction it will use the plant in the course of an electricity generation business or to lease to a related party for the same purpose. It was considered that in such a situation the GPI instalments were derived in the course of a business of constructing the plant and therefore assessable as ordinary income, as income received from an isolated transaction with a profit making purpose, or as a subsidy under section 15-10.

35.      This example examined a SPV created to undertake construction of a renewable energy plant which the SPV would use or lease to a related party after construction is completed. As a newly created entity it had no history of business activities as an entity its own right.

36.      The creation of a SPV is not the reason the conclusion in the example was reached but the example illustrates that a newly created entity can be carrying on a business from the construction of an asset that it will eventually use to generate income.

37.      In this case we are not looking at a newly created entity, we are looking at an established company with a history of activities which under the single entity rule would disregard the intra group dealings so that any lease to a group member is disregarded.

38.      Thus, and alternatively, the Grant would be assessable under section 6-5 as an amount derived from an isolated transaction entered into with a profit-making intention.

Commencement of particular business

39.      The taxpayer has asserted that the business had not commenced and that the grant was being provided to commence this business and that is to be taken into account in determining whether the grant is assessable income.

40.      In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320, Justice Hill provided:

...the relationship must be to the "carrying on" of the business. These words may perhaps be understood in opposition to a relationship with the actual business itself. They would make it clear, for example, that a bounty received, merely in relation to the commencement of a business or the cessation of the business, would not be caught. The expression "carrying on of the business" looks, in my opinion, to the activities of that business which are directed towards the gaining or producing of assessable income, rather than merely to the business itself.

41.      This is considered in ATO ID 2010/38 (Withdrawn) Income Tax: Bounty and subsidies: financial assistance received in commencing a business - whether received 'to commence a business' (ATO ID 2010/38).[2] ATO ID 2010/38 provides:

However, a bounty or subsidy that is received in relation to activities of an entity as it commences its business is not received to commence the business if the decision to commence is not dependent upon the receipt of the bounty or subsidy. If there is a real connection, whether direct or indirect, between the bounty or subsidy and the carrying on of a business, it would be received in relation to carrying on a business.

Thus, a grant that is received in relation to an activity that is integral to carrying on a business (such as the acquisition of an asset that is necessary for the business) is received in relation to carrying on a business even though the activity may be carried out soon after the business commences and is preparatory to and not directly productive of assessable income.

In the present case, the grant was not to assist the taxpayer to reach the necessary point where it could be said that the taxpayer was committed (and such commitment was demonstrated in its activities) to proceed with the implementation of its purpose to carry on a business. The taxpayer was incorporated for the specific purpose of undertaking a project that included the design, procurement, construction and operation of an infrastructure asset and assumed responsibility for delivering the project through its activities soon after its incorporation. It is considered that the taxpayer commenced carrying on the business of delivering the project from that point in time. While the receipt of the grant was important and assisted the taxpayer to carry on its business, the commencement of its business was not dependent upon the receipt of the grant. Accordingly, the receipt of the grant is not received to commence a business.

42.      The grant agreement limits eligible expenditure to expenditure on the activities, the funding is made to facilitate the construction of the facilities. The amount received by SubCo from government agency is conditional on the performance of the specified activities under the grant agreement, and not to allow SubCol to commence business.

43.      Thus, HeadCo is carrying on the at the time that SubCo entered into the grant agreement, or at an earlier time.

44.      Accordingly, the grant would be included in the assessable income of under section 6-5.

45.      Alternatively, and on the same basis as set out above, and consistent with example 8A of TR 2006/3, the grant would be assessable under section 6-5 as an amount derived from an isolated transaction entered into with a profit-making intention.

Question 2

Will the grant received by SubCo constitute assessable income for HeadCo, as the head of a consolidated group, under section 15-10 of ITAA 1997?

Summary

The grant received by SubCo are not assessable to HeadCo as statutory income under section 15-10 because it is assessable as ordinary income under section 6-5.

Detailed reasoning

46.      Section 15-10 of the ITAA 1997 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.

47.      'Subsidy' is not defined in the taxation laws and instead takes its ordinary meaning. A subsidy is defined in The Macquarie Dictionary online to mean:

•          a grant by a government to a company, organisation or individual, for which it receives nothing in return;

•          a sum paid, often in accordance with a treaty, by one government to another, to secure some service in return; and

•          any grant or contribution of money towards the cost of some purchase or endeavour.

48.      Windeyer J described a subsidy in Placer Development Ltd v. Cth (1969) 121 CLR 353 at 373 as:

...aid provided by the Crown [government] to foster or further some undertaking or industry

49.      The grant is a Federal government initiative.

50.      The grant falls within the definition of a subsidy, being aid the Consolidated Group's existing business to diversity into new business activities. As outlined above, the grant will be received in relation to carrying on a business but will be assessable as ordinary income under section 6-5.

51.      Therefore, the grant will not be assessable under section 15-10 of the ITAA 1997.

Question 3

If the answers to Questions 1 and 2 is no, will the grant received by SubCo constitute assessable income for HeadCo, as the head of a consolidated group, under the assessable recoupment provision in Subdivision 20-A of the ITAA 1997 where an amount received is a recoupment of a loss or outgoing that is deductible under a provision listed in section 20-30 of the ITAA 1997?

Summary

As the answers to Question 1 was yes, this question was not answered.

[1] 21 ATR 1 at 7.

[2] While this ATO ID has been withdrawn, it was done so because it was a straight interpretation of the law and not because it was incorrect or does not represent the ATO view.