Private ruling: Government grant
Published: December 2013
Ruling period: Year ended 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Will funding paid in relation to the construction of new facilities be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will funding paid in relation to the construction of new facilities be assessable under section 15-10 of the ITAA 1997? | A2: No. | Q3: Will funding paid in relation to the construction of new facilities give rise to a capital gains tax (CGT) event? | A3: Yes. | Q4: Will any capital gain or capital loss be disregarded under subdivision 118-A of the ITAA 1997? | A4: Yes. | Q5: Will the cost base and reduced cost base of the CGT asset constructed be reduced to the extent of the grant monies received as a recoupment of expenditure under section 110-45(3) or section 110-55(6) of the ITAA 1997? | A5: Yes.

Relevant facts and circumstances: A company entered into a funding agreement (agreement) with a Government department to improve a facility. Under the Agreement, funds were payable in multiple instalments. The funding was received over the relevant financial years. The facility is leased to Company B. An individual is the legal owner of the facilities and its only activity is to act as lessor in relation to the property. The individual and B have distinct and separate roles with regard to the types of activities they undertake in relation to the business. The individual derives passive rental income from the facility and does not derive any business income. Company B operates a business. The grant monies were deposited into Company B's bank account. The individual will claim any capital allowances and capital works deductions in relation to the new facilities. The individual contends that it authorised Company B to act as its agent when it entered into the agreement with the department and is therefore the beneficial recipient of the funding. If not for the department's administrative requirements, it would be reasonable to conclude that the individual would have lodged the application for funding on its own behalf.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 15-10 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 104-35 | Income Tax Assessment Act 1997 section 104-155 | Income Tax Assessment Act 1997 paragraph 118-37(2)(a) | Income Tax Assessment Act 1997 subsection 110-45(3)

Reasons for decision: Summary: Before we can consider whether or not the individual has derived assessable income, we must consider whether Company B was acting as an agent for the individual. Under an 'agent agreement' an entity (the agent) may receive a payment from a third party on behalf of another entity (the principal). The relationship of the principal and the agent may arise from agreement or deed (express or implied), by operation of law or retrospectively by the principal's ratification of the acts done by the agent. The question of whether receipts or gains constitute assessable income in the hands of an agent need only be addressed if those receipts or gains are derived beneficially by that agent. Therefore, an agent who receives an amount which is required to be applied or dealt with on behalf of a principal entity, or as the principal directs, will not need to consider whether they derived any assessable income. This question will fall to the principal. In this case we consider that Company B was acting as an agent for the individual. Therefore, we need to consider whether the individual has derived assessable income. | Detailed Reasoning - Ordinary income: Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Ordinary income is income according to ordinary concepts. Although the expression 'income according to ordinary concepts' is not defined in the ITAA 1997, there is a substantial body of case law from which a number of factors have been drawn to determine whether an amount has the character of income according to ordinary concepts. A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity, even if the receipts are not directly attributable to services rendered. This view is supported by ATO Interpretative Decision report, ATO ID 2003/902 which cited the same reasoning in finding that a government grant paid in two instalments to a medical practitioner was not assessable under section 6-5. ATO policy concerning government payments to industry (GPI) is set out in Taxation Ruling TR 2006/3 . At paragraph 84 of TR 2006/3, it provides that ordinary income generally falls within three categories: · Income from providing personal services, · Income from property, or · Income from carrying on a business. | Detailed Reasoning - Application to your circumstances: The funding does not constitute ordinary income. 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. Further, in terms of TR 2006/3 it does not constitute income from the provision of personal services, is not sourced from property, and has not been derived directly from the individual's business activities. Accordingly, the grant is not assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Statutory Income - a Bounty or Subsidy: Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law. These amounts are referred to as 'statutory income'. Subsection 6-10(1) of the ITAA 1997 refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5 of the ITAA 1997. Section 15-10 provides that 'assessable income includes a bounty or subsidy that: (a) is received in relation to carrying on a business; and (b) is not assessable as ordinary income under section 6-5.' To be assessable under section 15-10 of the ITAA 1997 the subsidy must relate to the 'carrying on' of the business, not merely to the commencement or cessation of it. The expression 'carrying on of the business' is limited to the activities of the business which are directed towards the gaining or producing of assessable income rather than merely to the business itself (Paragraph 101 of TR 2006/3). | Detailed Reasoning - Application to your circumstances: The funding does not constitute an assessable bounty or subsidy. To be considered assessable under section 15-10 of the ITAA 1997 the receipt must be in relation to the carrying on of a business. The individual owns the property and has been allocated government funding to make improvements to the building. The individual will not be operating the relevant business, this will be conducted by Company B. The individual's only activity will be to act in the capacity of lessor in relation to the property and to derive periodical rental payments from the entity that will be operating the business. The extent of the individual's activities as a lessor will be aligned more readily with the type of activities generally undertaken by a passive investor; it is clear that the individual will not be carrying on a business in this regard. As the individual will not be carrying on the business or a business of leasing properties, any receipts in relation to the funding will not be assessed under section 15-10 of the ITAA 1997 as a bounty or subsidy. | Detailed Reasoning - Capital gains tax: Section 104-25 of the ITAA 1997 deals with cancellation, surrender and similar endings to CGT assets (CGT event C2). A C2 event occurs when the ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. This would occur when a taxpayer's rights under an agreement come to an end - generally at the time the taxpayer's obligations have been discharged and the taxpayer receives payment. A capital gain occurs if the capital proceeds from the ending of the rights are more than the asset's cost base. | Detailed Reasoning - CGT exemption under paragraph 118-37(2)(a): Paragraph 118-37(2)(a) of the ITAA 1997 provides, in part, that a capital gain may be disregarded if you make it as a result of receiving a payment as reimbursement or payment of your expenses under a scheme established by an Australian government agency or local governing body. In relation to this paragraph, the Revised Explanatory Memorandum (EM) in relation to the Tax Laws Amendment (2006 Measures No. 3) Act 2006 provides that the requirement that 'the scheme be established under an enactment or an instrument of a legislative character would be satisfied where the scheme is established that way either expressly or by necessary implication. An enactment would include an Appropriation Act (or equivalent) having regard to associated documentation such as budget papers. An instrument of a legislative character would include regulations (and similar instruments) and local government by-laws.' Paragraph 6 of TR 2006/3 provides that if a payment recoups expenditure forming one of the elements of the cost base, the cost base is taken never to have included the original expenditure, thus potentially increasing a future capital gain or decreasing a future capital loss. | Detailed Reasoning - Application to your circumstances: Under the agreement, the Government department creates rights in the individual to receive payments upon the completion of several milestones and the provision of progress reports as stated in the agreement. These rights will be satisfied under CGT event C2 when the department makes the payments to Company B as an agent for the individual. However, we find that the funding meets the requirements of paragraph 118-37(2)(a) of the ITAA 1997 as outlined in the revised EM and the grant complies because it is a payment received as reimbursement or payment of expenses incurred in relation to the approved project. Therefore, any capital gain made by the individual from the C2 CGT event will be disregarded under paragraph 118-37(2)(a) of the ITAA 1997. Although there is no capital gain or loss at the time of receipt of the grant, there will be capital gains consequences when the individual eventually disposes of the property. To the extent that the grant is received to fund the cost of constructing or renovating buildings, it is a recoupment of those costs. This recoupment reduces the cost base and reduced cost base of the property as per subsection 110-45(3) and subsection 110-55(6) of the ITAA 1997.