Private ruling: Is grant money not expended at the date of sale of the property, assessable income?
Date of advice: 29 April 2016
Published: June 2016
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the unused portion of the on grounds conservation management grant considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant financial year, the year in which the property was sold? | A1: Yes

Relevant facts and circumstances: An entity purchased a property with the intention of deriving assessable income from primary production activities on the property. The entity entered into an agreement with a relevant authority. The agreement was entered into for native conservation on the property, giving up rights of grazing and logging on the land in perpetuity. The entity received two types of incentive payments: 1. On grounds establishment works - Milestone 1; and 2. On grounds conservation management - Milestone 2 & 3. All funding received for Milestone 1 has been expended. An amount from the payments for Milestones 2 & 3 of the original grant was not expended at the date of sale of the property. This unspent part of the grant is not required to be paid back. The agreement states all activities are to be conducted in perpetuity in accordance with relevant Acts and Regulations. The agreement also outlines certain activities which are not, to be conducted. The agreement is binding on the current landholders and all future owners of the land as a covenant has been placed on the property. The entity sold the property.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 6-5(1)

Reasons for decision: Summary: Subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of 'ordinary income' in income tax legislation it is necessary to apply principles developed by the courts to the facts of each case. Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (the Pipecoaters case), the Full High Court stated: 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. In MIM Holdings Ltd v. Commissioner of Taxation 97 ATC 4420; (1997) 36 ATR 108 (the MIM case), Northrop, Hill and Cooper JJ, relying on Hayes v. FCT (1956) 96 CLR 47 and Reuter v. FC of T 111 ALR 716; 93 ATC 4037 said that 'amounts paid in consideration of the performance of services will almost always be income'. The question of whether an amount is a product of the taxpayer's services (that is, paid in consideration of the performance of the taxpayer's services) has been considered in a number of High Court decisions. The following guidance is afforded by those decisions: • the whole of the circumstances must be considered; • a generally decisive consideration is whether the receipt is the product in a real sense of any employment of, or services rendered by the recipient, or of any business, or any revenue production activity carried on by the recipient; • other considerations that are relevant but not decisive include: • the motive of the donor (payer) in paying the amount; • the regularity and periodicity of the payment, however a payment in a lump sum does not require a conclusion that the payment is capital; and • the recipient's expectation that an amount will be received The agreement between the entity and the relevant authority specifies the rights and obligations of both the landholders and the relevant authority under the agreement and includes a schedule of milestones the landholders are required to meet to receive the payments. Under the agreement the entity agreed to provide conservation management services to the relevant authority while they continue to own the property and bind future owners to the same commitment. The on grounds conservation management payments are the product, in a real sense, of the services rendered by the entity. Other factors such as the entity's expectation of receipt of the payment in return for undertaking activities as set out in the agreement and the purpose of the relevant authority in making the payment (to provide an incentive for the entity to carry out the work) also support the conclusion that the on grounds conservation management payments are the product of the services rendered. The fact that the payments are made in a number of lump sums does not alter this conclusion Although the conservation management activities are to be undertaken in perpetuity under the agreement, the payments are made in a number of single lump sums. Accordingly, a question arises as to when the payments received under the agreement are assessable. Taxation Ruling TR 98/1 states that when accounting for income in respect of a year of income, a taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. Where income results primarily from the services rendered, or work performed by the taxpayer personally, it is generally assessable on a receipts basis and the total amount received under the agreement is assessable in the income year that it is received. However there are circumstances in which an advance payment is made where the amount received is not derived as income when it is received, but as it is earned. The High Court in Arthur Murray (NSW) Pty Ltd v. Federal Commissioner of Taxation 114 CLR 314; 14 ATD 98; (1965) 9 AITR 673 (the Arthur Murray case) referred to the significance of an amount not being income unless it had been earned. In that case the High Court decided that prepaid fees in relation to dancing lessons not yet delivered should not be treated as income derived at the time the fees were paid. The principles arising out of the Arthur Murray case may be summarised as follows: • subject to any special statutory provision, the inquiry to be made in each case is whether the receipt would, according to established accounting and commercial principles, be regarded as income derived; • as a matter of business good sense, the recipient should treat each amount of fees received but not yet earned as subject to the contingency that the whole or some part of it may have in effect to be paid back; and • nothing in the ITAA 1997 is contraindicated or ignored when a receipt of money as a prepayment under a contract for future services is said not to constitute by itself a derivation of assessable income. The Administrative Appeals Tribunal (AAT) in Case U7 87 ATC 127; Tribunal Case 20 18 ATR 3120 (Case U7) considered that there was a close analogy between the taxpayer's situation and that of a prepayment under a contract for future services. The AAT applied the principles arising from the Arthur Murray case, notwithstanding that the taxpayer was not held to be contracting to render future services to the Commonwealth. In Case U7 the taxpayer had received an advance of grant monies that it would become entitled to on making certain expenditure on agreed research and development activities. The taxpayer's entitlement to the grant was in direct proportion to the proper expenditure on that work and the AAT considered that the taxpayer, in the year in question, had not done all that was required of it to earn the full amount prepaid to it. The decisions in both the Arthur Murray case and Case U7 support the position taken in Taxation Ruling TR 2006/3 which states that 'an assessable [government payment to industry] that is an advance payment is derived by the recipient to the extent that the recipient has done everything necessary to be entitled to retain the amount received'. The circumstances underlying the payment of the funding for ongoing conservation management are that the lump sum payment is intended to provide payment for ongoing conservation management activities that the landholders are to provide on a regular basis. It is considered that the lump sum payments to the entity for ongoing conservation management activities to be provided over the term of the contract is to be accounted for as it is earned over the period of the contract. This means that the entity's income tax return for each year covered by the agreement will include an amount for ongoing conservation management based on the activities undertaken in each year. As the entity disposed of the land before the expiration of the agreement, it is considered that the balance of the advance payment not already accounted for as income is derived at the time of disposal as there is nothing more for the entity to do to earn the income. Consequently the part of the lump sum which had not been expended at the time of the disposal of the property is considered derived and assessable under section 6-5 of the ITAA 1997 at the date of disposal.