Private ruling: Income - grants
Published: June 2012
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 1 July 2010

Ruling: Q1: Does the grant form part of the assessable income of the trust under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A5: Yes


Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 6-5(1) Income Tax Assessment Act 1997 section 15-10 Income Tax Assessment Act 1997 subsection 20-20(2) Income Tax Assessment Act 1997 section 104-25 Income Tax Assessment Act 1997 subsection 104-25(2) Income Tax Assessment Act 1997 subsection 108-5(1) Income Tax Assessment Act 1997 paragraph 118-37(2)(a)

Reasons for decision: Summary: The character of the government payment to provide seed capital is capital in nature and therefore not ordinary income under subsection 6-5(1) of the ITAA 1997. The government payment received to provide seed capital is also not a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997. | Detailed Reasoning - Ordinary Income: Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts, which is called ordinary income. Relevant factors in determining whether a payment is ordinary income include whether the payment is for services rendered, such as from personal services, and the character of the payment in the hands of the recipient. Other characteristics of income that have evolved from case law include receipts that: · are earned · are expected · are relied upon · have an element of periodicity, recurrence or regularity. The payment of the grant that you received is not income from personal services. The payment is not earned, as it is a requirement that you have not yet commenced work to receive the payment, and it was not expected or relied upon as you had to apply for it and you may not have been successful. The payment also has no element of periodicity, recurrence or regularity, in the respect that it is a one off payment. Therefore, the character of the payment is not ordinary income under subsection 6-5(1) of the ITAA 1997. | Detailed Reasoning - Whether a bounty or subsidy: Section 15-10 of the ITAA 1997 provides that assessable income includes a bounty or subsidy that is received in relation to carrying on a business and that is not assessable as ordinary income under section 6-5 of the ITAA 1997. Taxation Ruling TR 2006/3 Income Tax : government payments to industry to assist entities (including individuals) to continue, commence or cease business sets out the Commissioner's view on circumstances in which a government payment will be considered to be a bounty or subsidy. The terms 'bounty' or subsidy are not defined terms for the purposes of either the ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936). However, the Courts in their consideration of how the terms were used in paragraph 26(g) of the ITAA 1936 (the predecessor to section 15-10 of the ITAA 1997) have provided some guidance as to their meaning which are equally relevant for section 15-10 of the ITAA 1997 (see Plant v. FCT 2004 ATC 2364; 58 ATR 1070). In Reckitt and Colman PTY LTD v. FCT (1974) 4 ATR 501, 74 ATC 4185 Mahoney J said that the terms 'bounty' or subsidy include a financial grant made by the State for the purpose of encouraging a particular activity in the field of trade and commerce. A bounty or subsidy will be 'in relation to' carrying on a business when there is a real connection between the receipt and the carrying on of the business and the payment is directed to the income earning activity of the business. In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 56 FCR 320; [1995] FCA 1101; 95 ATC 4145; (1995) 30 ATR 207 ( First Provincial ), the Full Federal Court held that, as the payment there assisted the taxpayer to continue to carry on the taxpayer's business activities, it was made in relation to the carrying on of its business, although it lacked the necessary connection with the taxpayer's business activities to constitute ordinary income. The comments by Hill J in First Provincial make it clear that all that is required for a bounty or subsidy to be received in relation to carrying on a business is that there is 'a relationship' to the carrying on of a business that is not so remote as to be insignificant. It is also clear from the use of the expression 'any relationship' by Hill J and the conclusion that the relationship may be indirect that there is no requirement that the relationship be the dominant or main relationship. The degree of the connection will be a matter of judgement on the facts of each case. A bounty or subsidy must be related to the 'carrying on' of the business and not merely for commencing or ceasing a business. In looking at the meaning of the phrase 'in relation to carrying on a business' Hill J stated in First Provincial that : 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. A bounty or subsidy to commence or cease a business is not included in assessable income as a bounty or subsidy in relation to carrying on a business under section 15-10 of the ITAA 1997 (see paragraph 26 of TR 2006/3). A bounty or subsidy is received to 'commence a business' if the bounty or subsidy is to enable the recipient to reach the necessary point where the recipient is committed to proceed with the implementation of its purpose to carry on a business. 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, as the grant was approved based on the application lodged against the assessment criteria, the purpose of the grant is for the use of the Government funds as stated in the application. The grant monies in this case were approved for a mixed purpose of start up costs and to provide the seed capital to start the business's loan book. The seed capital will generate the income in the form of interest on the loans. The application for the grant also states that although the trust had obtained commitments for the 'matched' funding, without the grant it would have been difficult for the trust to procure the funding to enable the business to proceed and to provide the relevant loan products. Therefore, the commencement of its business was dependent upon the approval and receipt of the grant. The grant was to assist the trust to reach the necessary point where it could be said that it was committed to proceed with the implementation of its purpose to carry on a business. Accordingly, the grant monies are received to commence a business and do not qualify as a bounty or subsidy for the purposes of 15-10 of the ITAA 1997. | Detailed Reasoning - Capital gains tax: An entitlement to receive grant monies under the program is a CGT asset under subsection 108-5(1) of the ITAA 1997 that is acquired when the applicant signs the agreement. CGT event C2 happens under section 104-25 of the ITAA 1997 when a recipient's entitlement to receive the grant is satisfied. The time of the CGT event under subsection 104-25(2) of the ITAA 1997 is when the payment is made. However, any capital gain or capital loss resulting from CGT event C2 happening is disregarded under paragraph 118-37(2)(a) of the ITAA 1997. Paragraph 118-37(2)(a) of the ITAA 1997 provides a CGT exemption for a capital gain that results from the receipt of a payment as reimbursement or payment of expenses or anticipated expenses under a scheme established by an Australian government agency under an enactment. This program is such a scheme. | Detailed Reasoning - Whether an assessable recoupment?: Under Subdivision 20-A of the ITAA 1997, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable. Amounts included in assessable income under Subdivision 20-A are statutory income within the meaning of section 6-10 of the ITAA 1997. Subsection 20-20(2) of the ITAA 1997 provides that an amount received as recoupment of a loss or outgoing is an assessable recoupment if the taxpayer received the amount by way of insurance or indemnity; and the amount of the loss or outgoing is or was deductible under any provision of the ITAA 1997 or ITAA 1936. Recoupment is a defined term and has the meaning given by subsection 20-25(1) of the ITAA 1997. Under paragraph 20-25(1)(b), a recoupment of a loss or outgoing includes a grant in respect of the loss or outgoing. Indemnity is not a defined term and therefore must be given its ordinary meaning. The Macquarie Dictionary , [Multimedia], version 5.0.0, 1/10/01, definition of indemnity includes compensation for damage or loss sustained. It is well established in case law that the phrase 'by way of indemnity' broadens the range of receipts to be considered an assessable recoupment under subsection 20-20(2) of the ITAA 1997 to include receipts other than amounts received under a contract of indemnity. In the present case, as a portion of the grant: · does not constitute ordinary income or statutory income · the grant is used to meet costs and expenses which are deductible under a provision listed in 20-30 of the ITAA 1997 · it would constitute an 'assessable recoupment' for the purposes of section 20-25 of the ITAA 1997. The grant partially compensates for the outgoings required to commence business. That being so, the value of the grant is an amount received by way of indemnity. To the extent that the trust can deduct an amount for the loss or outgoing of the start-up costs (including establishing an office, purchase of equipment, travel and professional fees) under Division 40 and section 8-1 of the ITAA 1997, the recoupment of these expenses will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Does the grant form part of the assessable income of the trust under section 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Did the receipt of the grant trigger CGT event C2 under section 104-25 of the ITAA 1997? | Will any capital gain or loss made in respect of the grant be disregarded under section 118-37 of the ITAA 1997 to the extent that the grant has been, or will be, used: | (a) to cover the start-up costs already incurred prior to receiving the grant | (b) to meet start-up costs incurred after the receipt of the grant | (c) as 'guarantee funds' for the funding raised over the first five years of the operation? | Will a portion of the grant be included in the trust's assessable income under section 20-20 of the ITAA 1997 (assessable recoupment) to the extent that it is not ordinary income or statutory income and is used to meet an outgoing or expenses that are deductible under a provision listed in section 20-30 of the ITAA 1997? | Relevant facts: The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: | Your application for private ruling | Appendix F - Funding Agreement | Appendix G - Grant Program Guidelines. | You are an Australian resident trust. | A program was established by the Australian Government after it announced that it would provide an investment to seed the establishment of at least two funds. | The Grant Program Guidelines document states the objectives of the program. The purpose of the program is to improve access to finance and support for Australia's social enterprises to help them grow their business and achieve positive social impacts in their communities. | The program was established with funding appropriated through an act. | The Government published a request for submissions to apply for grant monies under the program. | The taxpayer submitted an initial application to the government in respect of the program for a grant. | During the application process, a business plan was submitted to the government addressing the selection criteria. | During the 2010-11 income year, you were notified that your application for the grant was successful. The grant was made during the 2010-11 income year on terms set out in the Funding Agreement. | Activities undertaken prior to the receipt of the Grant | Under the Grant Program Guidelines, funding would only be granted to eligible Fund Managers. Applicants were required to demonstrate and provide evidence, prior to funding, that the Fund Manager would: | · be a legal entity validly incorporated or otherwise formed in Australia | · be registered with the ATO for GST | · have appropriate legal capacity and authority to contract with the government | · hold, or be able to meet the requirements to obtain, all necessary licencing and prudential requirements. | The selection criteria (in the grant application) indicated that the application will be assessed partly on what the grant monies will be used for. The application states in part: | Australian Government funds will be used to defray start-up costs and to provide collateral for the initial matched funding. Specifically the Australian Government grant will provide: | · security and comfort to commercial debt and equity investment; | · provide a bad debt reserve; | · provide funding for capacity building; | · comfort to allow sensible risk to be taken; and | · credibility for leveraged capital funds to be sought. | To meet the eligibility requirements, applicants were also required to provide evidence of at least indicative commitments for the initial leverage of at least 1:1 on the Australian Government's investment and evidence that such funding could be secured prior to, or at the same time as the grant funding. | An 'in principle approval' was provided on the condition that the application was successful and the grant would be made. That is, no funds would be provided unless and until the application was approved and the money had been received. | Consistent with this arrangement, following the establishment of the entities but prior to receipt of the Grant, no material or significant activities other than preparing preliminary documentation relating to the actual grant process and entering into various documents. | One of the conditions of the Funding Agreement was that the grant recipient supply an invoice specifying the amount of the grant monies including a description of the purpose for which the grant monies will be applied | The money received from the Grant has been, and will be, predominantly used: | a) to pay (or reimburse) start-up costs incurred to establish the operation (including establishing an office, purchase of equipment, travel and professional fees). Approximately five percent of the grant will be used in this respect; and | b) as structural capital and 'guarantee' funds over the first five years of operation. The balance of the grant will be used to fund loans as they are approved (with funds being invested in short term deposits (less than 6 months) prior to approval. | This is consistent with the Business Plan which states that the funds received under the Grant will be used to defray start-up costs and to provide collateral for the matched funding raised from investors that will enable the trust to make relevant loan products available. | The trust was not carrying on a business at the time the grant was received. | Subsequent to obtaining the successful grant, the trusts business essentially comprises the provision of loan products and business support and advice to Australian community and social enterprises. | As part of the Funding Agreement, the government agreed to pay the Grant monies to the trustee of the trust upon satisfaction of the agreement's conditions and receipt of an invoice. | If the trust complies with the funding agreement, it will not need to repay the grant. | The funding agreement defines interest as interest payable on the Grant monies at the Government Bond Rate. | The funding agreement commenced on the date of execution and terminates three (3) years (less one day) after the date of payment of the Grant monies, unless terminated earlier by the Commonwealth.