Edited version of private advice

Authorisation Number: 1052152376900

Date of advice: 18 September 2023

Ruling

Subject: Grant monies from a state government funding initiative

Question 1

Are the grant monies received from a state government funding initiative assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Are the grant monies received from a state government funding initiative assessable as statutory income under section 15-10 of the ITAA 1997?

Answer

No.

Question 3

Will capital works deductions under Division 43 and depreciation deductions under Division 40 of the ITAA 1997, incurred due to grant monies being applied to a capital expenditure project, be an assessable recoupment under section 20-20 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20YY

The scheme commenced on:

1 July 20WW

Relevant facts and circumstances

The Unit Trust established by the trust deed on XX Month 20NN.

Company X is the trustee for the trust.

The Trustee owns land at property 1, where a building (Building 1) was erected and completed in Month 20XX. Since Month 20XX, a related entity has been carrying on business.

On XX Month 20WW, the Trustee was awarded a state government grant targeted to stimulate economic growth and activity after the COVID19 pandemic. Successful applicants were awarded the grant who met specific conditions.

The trustee intended to construct buildings on the land it held. Construction involved the development of two new buildings on the land. These structures are identified as Building 2 and Building 3.

Total funding received was $XXX (excluding GST). The payment was subject to the certain conditions set out in the grant agreement.

Grant payments were received in stages over the 20XX and 20YY Financial Years, contingent on achieving specified milestones as per the grant agreement.

To obtain the grant's instalment for meeting the next milestone, the trustee was required to provide the state government with invoices associated with the construction of the two buildings for the previous milestone. Additionally, the trustee contributed a specific amount towards the construction of the buildings, which was initially projected to be $XXX but exceeded this amount. Also, one of the milestones was delayed due to a shortage of labour, which resulted in the state government agreeing to amend the grant agreement.

Building 2 measures X square meters. It serves various purposes but is presently not tenanted, but instead utilized intermittently for public events.

Building 3 currently is tenanted by a business and it is rented.

The trustee engaged the services of external builders to execute the construction project. The trustee or its related entities do not possess any background, licenses or memberships connected to the building and construction industry. Building and construction business activities are not within the scope of your usual business operations.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 15-10

Income Tax Assessment Act 1997 paragraph 15-10(a)

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 20-20

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

Income Tax Assessment Act 1997 paragraph 20-20(1)(b)

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

Income Tax Assessment Act 1997 paragraph 20-20(2)(b)

Income Tax Assessment Act 1997 subsection 20-20(3)

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

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 subsection 20-35(1)

Income Tax Assessment Act 1997 subsection 20-35(2)

Income Tax Assessment Act 1997 subsection 20-35(3)

Income Tax Assessment Act 1997 subsection 20-40(1)

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

Income Tax Assessment Act 1997 section 20-45

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Subdivision 43-F

Reasons for decision

Question 1

Are the grant monies received from a state government funding initiative assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The grant monies received by the trustee will not be assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Subsection 6-5(1) of the ITAA 1997 provides that an entity's assessable income includes income according to ordinary concepts, called ordinary income. Therefore, for the grant monies to be assessable to the trustee under subsection 6-5(1), the grant monies must be considered to be ordinary income. Furthermore, the ordinary income must be derived directly or indirectly from all sources during the income year by an Australian resident.

There is no definition of 'ordinary income' in the income tax legislation. Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business provides the Commissioner's view on the taxation treatment of government payments to industry to assist entities to continue, commence or cease business, including consideration of section 6-5. Paragraph 84 in TR 2006/3 states:

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 fall into three categories:

•         income from providing personal services,

•         income from the use of property, or

•         income from carrying on a business.

Example 9 in TR 2006/3 sets out the Commissioner's view on whether Government Payment Initiatives (GPI) paid to assist research of new business opportunities is ordinary income and assessable under section 6-5. Paragraph 56 of TR 2006/3 says that payments that are preliminary to a business being established are not ordinary income and nor assessable under section 6-5.

Further, paragraph 139 of TR 2006/3 states that a payment 'to assist a new business with the purchase of a depreciating asset will not be assessable under section 6-5 as ordinary income'. Rather, the payment will be regarded as capital in nature.

The Commissioner issued an addendum to TR 2006/3 to state at paragraph 15A that a GPI paid with the intention of funding the cost of building or constructing a substantial capital asset, but contingent on the performance of the contract to build or construct the asset, will generally be assessable under section 6-5. This is because the GPI will be derived in the course of carrying on a business of building or constructing the asset.

However, in your case, it is considered that the trustee is not carrying on a business of building or constructing the commercial buildings and facilities. In particular, the trustee was not directly involved in the construction process for the commercial buildings and facilities, which was undertaken by external contractors. The trustee does not possess the necessary experience or skill to construct or build the commercial buildings and facilities.

The grants are not considered to be ordinary income. Whilst they have been paid in separate instalments, they do not possess the necessary elements of periodicity, recurrence or regularity that are common to receipts of ordinary income.

In addition, the grant received enabled the construction of commercial buildings and facilities for rent. It is not received from providing personal services, sourced from property or derived from any business activity. Support is obtained from paragraph 85 of TR 2006/3 which says, among other statements, 'a payment that is provided for a purpose which is not part of the recipient's business will not be income in nature.'

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

Question 2

Are the grant monies received from a state government funding initiative assessable as statutory income under section 15-10 of the ITAA 1997?

Summary

The grant monies received by the trustee will not be assessable as statutory income under section 15-10 of the ITAA 1997.

Detailed reasoning

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 build commercial buildings and facilities to stimulate economic growth and activity after the COVID19 pandemic. As previously stated, the trustee is not in the business of building or constructing the commercial buildings and facilities. The trustee does not possess the knowledge, experience or skills to construct buildings. The trust engaged external contractors to construct or build the commercial buildings and facilities, Therefore, the grant monies will not be received in relation to carrying on a business for the purposes of paragraph 15-10(a).

As previously established in Question 1, the grant is not considered to be assessable as ordinary income under section 6-5.

Therefore, the grant will not be assessable to the trustee as statutory income under section 15-10.

Question 3

Will capital works deductions under Division 43 and depreciation deductions under Division 40 of the ITAA 1997, incurred due to grant monies being applied to a capital expenditure project, be an assessable recoupment under section 20-20 of the ITAA 1997?

Summary

The trustee incurred capital expenditure, from which grant monies have been applied, and claim capital works deductions under Division 43 and depreciation deductions under Division 40 of the ITAA 1997. Such amounts are assessable recoupment under section 20-20 of the ITAA 1997, as the amounts received are a recoupment of a loss or outgoing by way of an indemnity. When you incur a deduction for a loss or outgoing for two or more years, your assessable income reportable in an income year is the amount of the assessable recoupment. You would apply the method statement outlined in section 20-40 to calculate the amount of the assessable income.

Detailed reasoning

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 this Subdivision.

In Questions 1 and 2 above, it has been determined that the monies received from the grant is not assessable as either ordinary income or statutory income.

Assessable recoupment by way of insurance or indemnity

Subsection 20-20(2) 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.

Subsection 20-25(1) states:

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 Explanatory Memorandum to the Tax Law Improvement Bill 1997 (amended)[1] states that the ordinary meaning of 'recoupment' encompasses any type of compensation for a loss or outgoing.

As the Trustee has received a grant to stimulate economic growth and activity after the COVID19 pandemic, it will fall within the definition of 'recoupment' as stated under subsection 20-25(1).

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.

In your case, based on the information provided, the grant monies were not received by way of insurance. It therefore needs to be determined if the grant monies were received by way of indemnity.

As 'indemnity' is not defined in either of the Income Tax Assessment Acts, it therefore takes its ordinary meaning. The term 'indemnity' was considered in Denmark Community Windfarm Ltd v. FC of T [2018] FCAFC 11 (Denmark case). The Full 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 fact that the amounts were a government subsidy or rebate did not affect that position. The amounts bore the character of compensation for a liability, loss or expense incurred, The Full Federal Court held that the government grant provided to a taxpayer to assist in the cost of acquiring and installing wind turbines was an amount received by way of indemnity, as it was compensation for expenditures incurred by the taxpayer. Consequently, the grant was held as an assessable recoupment under subsection 20-20(2).

In your case, the trustee received a state government grant to stimulate economic growth and activity after the COVID19 pandemic. It is considered the grant monies constitute 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 second requirement in paragraph 20-20(2)(b) requires the trustee to be able to deduct an amount for the loss or outgoing for the current year, or an earlier income year, under any provision of the ITAA 1997. In the Denmark case, it was held that the fact that the taxpayer claimed deductions under a certain provision, when it could have claimed deductions for the same expense under a different provision, did not preclude the assessability of the recoupment.

Where the trustee incurs capital expenditure with the grant monies and claims depreciation deductions under Division 40 or capital works deductions under Division 43 in the current or earlier income year 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.

Assessable recoupment amounts other than an insurance or indemnity

Alternatively, the grant would be considered to be an assessable recoupment under subsection 20-20(3) if the amount was not received by way of indemnity, as Division 40 is one of the provisions listed in section 20-30.

As stated above, in your case, subsection 20-20(2) of the ITAA 1997 applies to your circumstances and not subsection 20-20(3).

If the expense is deductible in a single income tax year

Subsection 20-35(1) states your assessable income includes an assessable recoupment of a loss or outgoing if you can deduct the whole of the loss or outgoing for the current year or for an earlier income year. The operation of subsection 20-35(1) maybe affected by a balancing charge, as outlined in section 20-45.

There is a limit on the total of assessable recoupments to be included in assessable income at any time. In accordance with subsection 20-35(2), the limit is the total amount of the loss or outgoing that can be or has been deducted at that time. Therefore, the total of the amount as assessable income for the current income tax year or a previous income tax year cannot exceed the amounts of the deduction claimed as a loss or outgoing.

In circumstances where the assessable recoupment is received in advance or before the income year in which the loss or outgoing is wholly deductible in the current income tax year, an amount is reported as assessable income for the current income tax year; refer subsection 20-35(3).

If the expense is deductible over 2 or more income tax years

Subsection 20-40(1) states an amount is included in your assessable income if:

(a) you receive in the current year an assessable recoupment of a loss or outgoing for which you can deduct amounts over 2 or more income years; or

(b) you received in an earlier income year an assessable recoupment of a loss or outgoing of that kind (unless all of the recoupment has already been included in your assessable income for one or more earlier income years by this section or a previous recoupment law).

This section applies even if the recoupment was received before the first of those income years.

In your case, commercial buildings and facilities have been constructed. As set out in Subdivision 43-F of ITAA 1997, eligible construction expenditure is written-off at 2.5% over 40 years or 4% per year over 25 years, depending on when it was incurred and the use of the capital works.

Similarly, Division 40 spreads the deduction for the cost of depreciating assets over the effective life of the asset which depending on the effective life of the asset could spread the deduction over two or more years.

The amount of an assessable recoupment in respect of a deduction under Division 43, and Division 40 will also be limited to the loss or outgoing that the trust can or has deducted at a particular time.

Therefore, to the extent the grant will be applied to an outgoing that is deductible over two or more years under either Division 40 or Division 43, that portion of the grant will be assessed for tax purposes in accordance with the method statement contained in subsection 20-40(2) of the ITAA 1997.

Method Statement

In these circumstances, if an expense is deductible over 2 or more income tax years, you are to work out how much is reported in your assessable income for the current income tax year because of one or more assessable recoupments of the loss or outgoing. The method statement ensures that assessable recoupments are included:

•         only so far as they have not already been included for an earlier income tax year; and

•         only to the extent of your total deductions to date for the loss or outgoing.

The following are steps to calculating the amount to include as assessable income in an income tax year:

Table 1: Steps to calculate the amount to include as assessable income in an income tax year

The effect of the method statement is that an assessable recoupment is only included in assessable income to the extent amounts are deductible in the current year or have been deducted in earlier years in respect of the loss or outgoing. Any portion of the assessable recoupment not included in assessable income in the current year is rolled forward for inclusion in assessable income in future income years in which amounts are deductible.

If in accordance with Division 40, or another provision outside of Division 40 allows the Trust to deduct the cost of a depreciating asset in a single year of tax (refer above), then the method statement will not apply.

[1] Original Tax Law Improvement Bill 1996 as introduced into the House of Representatives.

[2] Subdivision 20-A of ITAA 1997 includes sections 20-10 to 20-65.

[3] The total deductions may be reduced if an amount has been included in your assessable income because of a balancing adjustment, refer to section 20-45 of the ITAA 1997.