Private ruling: Assessable income – government grant
Date of advice: 18 April 2018
Published: July 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the funds received from an Australian Government Agency’s (Agency) under a Funding Agreement (Agreement) be included in your assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: You applied for funding from the Agency to carry out your project. The aim of your project is to advance your technology to a commercial position. One of the eligibility criteria for submitting a proposal for funding is that your project does not include research. The Agency agreed to provide you with funding for your project subject to the terms and conditions of the Agreement executed between you and the Agency. Clause X of the Agreement lists the defined terms in the Agreement with clause X providing the interpretation. Subclause X of the Agreement states: headings are for ease of reference only and do not affect interpretation. In accordance with Schedule X of the Agreement the total amount of funding provided by the Agency under the Agreement is $X excluding GST (total funds). The Agreement also requires you to make equal contributions (Recipient Contributions) at the same time. Clause X of the Agreement outlines what you can use the funds for, such as: (a) only for the purposes of undertaking the Activity and purposes that are incidental to the Activity. (b) only for Eligible Expenditure. (c) only in accordance with the Budget. Clause X and Schedule X of the Agreement outlines the Activity which you were required to perform. This includes Knowledge Sharing Activities and reports outlined in another clause for each milestone. Schedule X of the Agreement outlines the reporting requirements you must perform. In accordance with Clause X and Schedule X of the Agreement, the Agency will advance funding to you in instalments when certain Milestones have been achieved. Your Recipient Contributions are due at the same time under clause X and Schedule X of the Agreement. Clause X of the Agreement permits the Agency to direct you when Funds cannot be used. Clause X of the Agreement states that you own any asset under the project (subject to the terms of any lease) with another clause outlining how you must use the assets. However, under clause X of the Agreement, if you sell or otherwise dispose of an asset during the Agreement Period, the Agency is entitled to recover from you: (a) the proportion of the value of the asset following depreciation calculated as at the date of the sale or disposal which is equivalent to the proportion of the purchase price of the asset that was funded, or (b) the proportion of the market value of the asset which is equivalent to the proportion of the purchase price of the asset that was funded. Clause X of the Agreement generally requires you to pay to the Agency an amount equal to the total funds provided to you by the Agency. You must periodically pay to the Agency an amount (periodic amount) equal to a defined percentage of the Revenue received by you in that period (Clause X of the Agreement). Your liability to pay this amount will be extinguished once the amount determined by clause X reaches zero. You may at any time after the Agency has paid the final Milestone payment, give the Agency notice (Payout Notice) of your intention to pay the Agency the amount determined by clause X. This Payout Notice needs to include a full breakdown of your calculation of the amount determined by clause X and confirmation of the intended payment date. Your obligation to pay the periodic amount will end when you pay the amount determined by clause X to the Agency on or before the payment date stated in the Payout Notice (clause X of the Agreement). At any time, the Agency is entitled to recover from you the amount of any Funds which in the Agency’s opinion (acting reasonably), have been spent or used other than in accordance with the Agreement (Clause X of the Agreement). On expiry or termination of the Agreement, the Agency is entitled to recover from you any Funds which have not been spent, or legally committed for expenditure by you in accordance with the Agreement and payable by you as a current liability (Clause X of the Agreement). If your (recipient) contributions have not been used for your project, the Agency is entitled to recover from you an amount that represents the same proportion of the funds as your contributions which have not been used are of your total contributions (clause X of the Agreement). If you abandon the project, notify the Agency of an intention to abandon the activity, or state an intention to abandon the activity, the Agency is entitled to recover an amount equal to the total funds (clause X of the Agreement). However, the Agency is not entitled to recover under clause X if you satisfy the Agency that you acted on reasonable technical grounds in deciding to abandon the activity (clause X of the Agreement). If you receive any contribution to your activity from the Commonwealth or a State, Territory or local government, the Agency is entitled to recover the lesser of the Funds and the amount of the contribution from you (Clause X of the Agreement). The Agency may give you a notice requiring you to pay to the Agency an amount which the Agency is entitled to recover. If the Agency gives this notice, you must pay the amount specified in the notice in full (or deal with it as specified by the Agency) within 30 days after the date of the notice (clause X of the Agreement). If you fail to make payment as required by the notice from the Agency, you must pay the Agency interest (clause X of the Agreement). Clause X of the Agreement details the circumstances should the Agreement be terminated. Clause X of the Agreement details your rights if the Agency was to terminate the Agreement. This includes you not being obliged to repay the Funds (clause X of the Agreement). Any amounts owed or payable to the Agency (including by way of refund), or which the Agency is otherwise entitled to recover from you under the Agreement will be recoverable by the Agency as a debt due and payable to the Agency by you (clause X of the Agreement).

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5

Reasons for decision: Summary: Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts, which is also called ordinary income. Income according to ordinary concepts is not defined in the taxation legislation. The classic definition was given by Chief Justice Jordan in Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215. Chief Justice Jordan considered that: The word “income” is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts. Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business. Case law has established guidelines to assist in determining the nature of a receipt, including: ● the nature of a payment is determined by examining the character of the payment in the hands of the recipient ● the test in determining if a payment is income or capital is an objective test ● the question is not decided by determining whether the expenditure by the payer is revenue or capital in nature ● the question is not decided by determining whether any expenditure the recipient is required to make is revenue or capital in nature, and ● a payment provided for a particular revenue expense is a factor supporting a conclusion of income. You consider the funding provided by the Agency under the Agreement to be a loan and therefore non-assessable. It is well established that a borrower does not include loan proceeds in their assessable income. In essence, the mere receipt of money under an agreement which one has an unconditional obligation to repay in full in the future lacks the essential characteristics of income. In the Victorian Supreme Court case of Brick and Pipe Industries Ltd v. Occidental Life Nominees Pty Ltd and others [1992] 2 VR 279, Ormiston J noted at pages 321-322: Strangely the word 'loan' has not been frequently defined and in the many authorities cited, although the concept of lending was assumed to be understood, only one definition appears, namely in the judgement of Richardson J. in Re Securitibank Ltd. (No. 2) [1978] 2 NZLR 136, at p. 167: '... the essence of a loan of money is the payment of a sum of money on condition that at some future time an equivalent amount will be repaid.' In Prime Wheat Association Ltd (ACN 000 245 269) v. Chief Commissioner of Stamp Duties (1997) 42 NSWLR 505, Gleeson CJ said at 512G: ‘The essence of a loan is an obligation of repayment’. In ‘ The Law of Money Lenders in Australia and New Zealand’ , Dr CL Pannam defines a loan contract as follows: A loan of money may be defined, in general terms, as a simple contract whereby one person (‘the lender’) pays or agrees to pay a sum of money in consideration of a promise by another person (‘the borrower’) to repay the money upon demand or at a fixed date. The promise of repayment may or may not be coupled with a promise to pay interest on the money so paid. The essence of the transaction is the promise of repayment. Repayment is the ingredient which links together the definitions of ‘loan’ to be found in the Oxford Dictionary, the various legal dictionaries and the textbooks. What amounts to an ordinary loan was explained by Sackville and Lehane JJ in Federal Commissioner of Taxation v. Radilo Enterprises Pty Ltd [1996] ACT 4199, as follows: ‘A loan involves an obligation on the borrower to repay the sum borrowed’. The Court accepted the definition of loan suggested by Dr CL Pannam and went on to suggest, citing Chitty on Contracts , that: ‘The essence of a loan is that there be a debt, that is moneys outstanding to be repaid at a fixed or determinable time or on demand...’ In Case 5/94 94 ATC 130 ; AAT Case 9221 (1993) 27 ATR 1117 at 1125, it was said: the term loan is not defined in the Act, but is defined in Chitty on Contracts, 1989, 26th ed, at para 3574: Definition of loan. A contract of loan of money is a contract whereby one person lends or agrees to lend a sum of money to another, in consideration of the promise expressed or implied to repay that sum on demand, or at a fixed or determinable future time, or conditionally upon an event which is bound to happen, with or without interest. In many circumstances, the question whether a particular transaction is, in law a loan or not will be immaterial, since the transaction will take effect according to the intention of the parties, however the contract may be classified... From the above, it is reasonable to conclude that in normal usage the term 'loan' describes an arrangement that exhibits the following elements: ● a person lends or agrees to lend money to another ● in consideration of an unconditional promise to repay that sum ● the repayment is at a fixed or determinable future time ● the repayment can be made with or without interest, and ● an equivalent amount will be repaid. 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) sets out the Commissioner’s view on the tax treatment of government payments to industry to assist entities to continue, commence, or cease business operations. TR 2006/3 provides at paragraph 22 that financial assistance provided by government by way of a loan provided at a concessional rate of interest is not a government payment to industry. At paragraph 23, TR 2006/3 clarifies that financial assistance to business provided on terms where the amount must be repaid unless the recipient meets agreed conditions within a specified period is a conditional grant (and not a loan). The main difference between a loan and a grant is that a loan involves an obligation on the recipient to repay an equivalent amount of the monies received with or without interest at a fixed or determinable future time. Whereas a grant, a bounty or a subsidy does not impose an obligation on the recipient to repay the amount received (ATO Interpretative Decision ATO ID 2006/292 Income Tax: Whether funding provided by a State government to a company under an industry investment incentive scheme is a grant or a loan ). ATO Interpretative Decision ATO ID 2010/147 Income Tax: Bounties and subsidies: whether a repayable government payment a ‘bounty or subsidy ’ deals with the taxation treatment of a government receipt which was subject to a repayment obligation in limited circumstances. In arriving at the view that the requirement for repayment in limited circumstances does not change the character of the payment to a loan, ATO ID 2010/147 cites Smart v. Lincolnshire Sugar Co Ltd (1937) 20 TC; [1937] 1 ALL ER 413 and AAT Case 9472 (1994) ATC 225; (1994) 28 ATR 1155 (Case 22/94), which emphasise that it is necessary to characterise a payment by reference to the substance of the transaction rather than terminology used to describe the payment. Based on the terms of the Agreement, the Commissioner is not satisfied that a loan or borrowing exists between yourself and the Agency. The terms of the Agreement essentially requires the Agency to pay you funds once you have performed the relevant activities. The Agreement does not state that the Agency agrees to lend funds to you and does not state that you are obligated to repay the funds back to the Agency. In other words, you are not unconditionally obligated to repay the funds to the Agency. The terms of the Agreement do however require you to pay an amount of funds to the Agency being a percentage of revenue you receive during the relevant periods. If you do not receive any revenue, then there is no obligation for you to pay any amount. In accordance with clause X of the Agreement, you must pay to the Agency the periodic amount, which is an amount equal to a percentage of the revenue received by you in a particular period. This means that, if you do not receive any revenue from the project in a particular period, it is not mandatory for you to make any payment to the Agency. As such, if you do not generate sufficient revenue to pay the total periodic amount equal to the amount of funding from the Agency under the Agreement, you will never be required to pay an ‘equivalent amount’ to the Agency. Payments you are required to make to the Agency under clause X of the Agreement are not repayments of the funding received from the Agency. Under clauses X to Y of the Agreement, the Agency will only be entitled to recover amounts from you if: ● you spend or use the funds other than in accordance with the Agreement ● have not spent the funds, or legally committed them for expenditure ● you do not commit an equal amount an equal amount of contributions as required under the Agreement ● abandon the project (other than on reasonable technical grounds), or ● you receive other Government funding for the project. Under clause X of the Agreement, it is only amounts owed or payable to the Agency (including by way of refund), or which the Agency is otherwise entitled to recover from you under the Agreement that are recoverable by the Agency as a debt due and payable to the Agency by you, not the total funds paid to you by the Agency, except in limited circumstances (for example, in the case of an Insolvency Event). In accordance with some other clauses of the Agreement, the Agency’s right to recover amounts is limited to the amount of the ineligible expenditure, the amount not spent or legally committed for expenditure or the amount of Government funding received. In accordance with clause X of the Agreement, the Agency is not entitled to recover any amount from you if you decide to abandon the project on reasonable grounds. In the event you are able to derive revenue from the project, you have agreed to pay the Agency a share of the revenue not exceeding a particular amount. Having regard to the terms of the Agreement between you and the Agency, it is considered that the funding received by you is not a loan. The Agreement is not one where there is an unconditional agreement to repay an equivalent amount at a fixed or determinable future time. The limited circumstances that you will be required to repay or pay amounts to the Agency do not change the character of the funding. You applied for and received the funding to carry out your project. The aim of your project is to advance your technology to a commercial position. Therefore, the funding you will receive from the Agency is not classified as a loan. Grants received by a business in relation to the carrying on of that business are generally assessable income either according to ordinary concepts under section 6-5 of the ITAA 1997 or as a bounty or subsidy under section 15-10 of the ITAA 1997. The commencement of a business is a question of fact. An entity does not commence to carry on a business only when it commences to engage in the operations or transactions that are directly productive of assessable income. Section 6-5 of the ITAA 1997 provides that a taxpayer’s assessable income includes income according to ordinary concepts, which is called ordinary income. Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient not the nature of the asset acquired with the payment of the grant. In GP International Pipecoaters Pty Ltd v Commissioner of Taxation (Cth) (1990) 170 CLR 124 , the Full High Court stated at 136-7: 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 of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. The Agency grant is received following specified activities you are required to perform as outlined in the Agreement. The activities are those that support the Program outcomes. The size and scale of the commercial activities you perform to receive the grant together with the intention to make a profit certainly indicate the carrying on of a business. Therefore, it is considered that you received the Agency grants in the course of carrying on your business rather than commencing it. The full amount of the funding is included in your assessable income under section 6-5 of the ITAA 1997 when it is derived. You are considered to have derived the funding when you are entitled to receive it.