Private ruling: Capital gains tax
Date of advice: 10 December 2015
Published: February 2016
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2011

Ruling: Q1: Is the payment received by you assessable income under sections 6-5 or 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Do the capital gains tax (CGT) provisions apply to the payment? | A2: Yes. | Q3: Will the Commissioner of Taxation exercise his discretion under paragraph 103-25(1)(b) of the ITAA 1997 and allow you to make a choice to apply the CGT small business concessions after the lodgement of the relevant income tax return? | A3: Yes. | Q4: Can you elect to apply the small business 50% reduction in subdivision 152-C of the ITAA 1997 to the capital gain? | A4: Yes.

Relevant facts and circumstances: You are a company. You applied for a competitive grant from a government department under a program (the program). The program was designed to assist eligible businesses to exit the X sector. Applications were assessed against merit criteria as well as an overall assessment by an advisory panel against the program's objectives. The merit criteria were based on a business's ability to reduce production tonnage, the nominated dollar amount and documented evidence of agreement with an exit plan by principals in the business's supply chain. The program is administered by the department and funded by the Commonwealth. Your business met the eligibility criteria, and your application was successful. The grant was made in two payments. The first payment (milestone 1) was X per cent of the total approved amount and was made on the execution of the Funding Deed and the execution of a Deed of Undertaking by your nominated individuals. There were conditions relevant to that payment. The second payment (milestone 2) of X per cent of the total approved amount was made to you for meeting all the above program requirements and providing the supporting information to the department. If the conditions of the Funding Deed or Deed of Undertaking are breached the Commonwealth can demand repayment or seek the recovery of the grant money. The program is not intended to compensate for contracts lost or cancelled and does not seek to provide for individual circumstances. Assistance is provided to support the contracting sector and communities adjust to a changed operating environment. Although you have ceased the part of your business that is the subject of the Funding Deed, you have continued to operate in the plantation forestry contracting industry and under existing contracts as permitted by the Funding Deed. You satisfy the maximum net asset value test for the purposes of section 152-15 of the ITAA 1997. You have, since incorporation in 200X, had X shareholders each holding equal numbers of shares. Each shareholder is a significant individual for the purposes of section 152-50 of the ITAA 1997. The tax agent who lodged your tax returns for the years ending 30 June 20XX and 20XX included the grant payment as assessable income at the 'other income' label.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5. | Income Tax Assessment Act 1997 Section 15-10. | Income Tax Assessment Act 1997 Section 102-5. | Income Tax Assessment Act 1997 paragraph 103-25(1)(b). | Income Tax Assessment Act 1997 Section 104-25. | Income Tax Assessment Act 1997 Section 108-5. | Income Tax Assessment Act 1997 Division 110. | Income Tax Assessment Act 1997 Division 112. | Income Tax Assessment Act 1997 Subsection 112-20(1). | Income Tax Assessment Act 1997 Subparagraph 112-20(a)(i). | Income Tax Assessment Act 1997 Subdivision 152-A. | Income Tax Assessment Act 1997 Section 152-10. | Income Tax Assessment Act 1997 Section 152-15. | Income Tax Assessment Act 1997 Section 152-20. | Income Tax Assessment Act 1997 Section 152-40. | Income Tax Assessment Act 1997 Section 152-50. | Income Tax Assessment Act 1997 Subdivision 152-C. | Income Tax Assessment Act 1997 Section 152-205.

Reasons for decision: Summary: The grant payments you have received under the program are capital in nature and not assessable income under section 6-5 or section 15-10 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that assessable income includes income according to ordinary concepts. Ordinary income is not defined in the taxation legislation. The characteristics of ordinary income have been developed by case law. Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The grant payment has been made in consideration of you ceasing part of your business operations and agreeing not to re-enter the industry nationally for X years. It is a payment for the surrender of a part of your profit-yielding structure. The surrender is neither a normal incident of your business, nor is it a payment provided for a purpose for which the business was carried on. TR 2006/3 Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business is relevant in your case. Paragraph 26 of TR 2006/3 states that government payments to industry to cease a business are not assessable as ordinary income of the recipient under section 6-5. It is explained at paragraph 130 that a payment for the ending of a business (which would include a portion of a business) is capital in nature. Accordingly, the grant payment is not ordinary income under section 6-5 of the ITAA 1997. Where a government assistance payment is not assessable as ordinary income, consideration needs to be given to whether section 15-10 of the ITAA 1997 applies. Section 15-10 of the ITAA 1997 provides that an amount is included in assessable income if it is: • a bounty or subsidy • received in relation to carrying on a business and • not assessable as ordinary income under section 6-5 of the ITAA 1997. TR 2006/3 considered the application of section 15-10 of the ITAA 1997 to government payments to cease business, stating at paragraph 104 that the payment to cease business is not received in relation to carrying on a business. At paragraph 134 of the ruling it is concluded that government assistance for ending a business is not assessable under section 15-10 of the ITAA 1997. The grant payment you have received is in consideration for you ending certain activities within the sector and agreeing not to re-enter the industry nationally for X years. The payment is not directed at the income earning activity of the business. It is not a bounty or subsidy in relation to the carrying on of a business and is not assessable under section 15-10 of the ITAA 1997. | Summary: The CGT provisions apply to the payments received under the program. CGT event C2 under section 104-25 of the ITAA 1997 happens when the company receives the payment. | Detailed Reasoning - Detailed reasoning: A capital gain or capital loss is made if a CGT event happens. For most CGT events, the capital gain is the difference between the capital proceeds and the cost base of the CGT asset. A capital loss is made if the reduced cost base of the CGT asset is greater than the capital proceeds. A right to seek compensation is a CGT asset under section 108-5 of the ITAA 1997. CGT event C2 under section 104-25 of the ITAA 1997 happens when the ownership of that intangible asset ends by the asset being satisfied. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts advocates a look-through approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. The grant payment you have received is for the satisfaction of your right to seek compensation from the government. Your right to seek compensation was acquired at the time the government accepted your application under the program and determined the grant amount as set out in the Funding Deed. The grant payment received by you was the capital proceeds for the satisfaction of that right. CGT event C2 happened when, pursuant to the relevant deeds, you surrendered the right to seek compensation. | Summary: The Commissioner of Taxation will exercise his discretion under paragraph 103-25(1)(b) of the ITAA 1997 and allow you to make a choice to apply the CGT small business concessions after the lodgement of the relevant income tax return. | Detailed Reasoning - Detailed reasoning: The general rule is that a choice available under the CGT provisions once made cannot be changed. Such a choice must usually be made by the time the income tax return is lodged for the income year in which the CGT event happened or within such further time as the Commissioner allows under paragraph 103-25(1)(b) of the ITAA 1997. A taxpayer who has not considered the availability of a CGT concession and has accordingly included a capital gain in their income tax return has not made a choice. Therefore, the taxpayer can later make the choice and amend their return to reduce or disregard the capital gain provided the Commissioner allows them further time to make the choice. In your case, your tax agent treated the grant payment received as assessable income and did not consider the small business concessions within the capital gains tax provisions. As you had substantial trading losses there was no immediate tax cost. To determine if more time should be allowed to make a choice, we consider factors such as whether: • you have an acceptable explanation for not making the choice by the time it should have been made • it would be fair and equitable in the circumstances to allow you more time to make a choice • prejudice to the Commissioner may result from additional time being allowed to you (note that the absence of prejudice by itself is not sufficient to justify the granting of an extension) • there has been any unsettling of people, other than the Commissioner, or of established practices • it would be fair and equitable to people in similar positions and the wider public interest • any mischief is involved. At the time you originally lodged your income tax return you were not advised of your entitlement to make a choice to apply the small business CGT concessions. Your new tax agent has advised you of the possibility of the concessions applying to your circumstances and has requested a ruling on your behalf. It is considered that the Commissioner would not be prejudiced if additional time is allowed and it is therefore reasonable for the Commissioner to grant an extension of time to make the choice to apply the small business 50% reduction under Subdivision 152-C of the ITAA 1997. An extension of time is granted until 31 March 20ZZ. | Summary: You can apply the small business 50% reduction to the capital gain. | Detailed Reasoning - Detailed reasoning: The small business 50% reduction is a small business concession available under section 152-205 of the ITAA 1997 if the basic conditions listed at section 152-10 of the ITAA 1997 are met. You have satisfied the basic conditions as: • CGT event C2 happened in relation to the right to seek compensation, resulting in a capital gain • the maximum net asset value test is satisfied • the right to seek compensation is an active asset that satisfies the active asset test. The meaning of an active asset is given at section 152-40 of the ITAA. A CGT asset is an active asset if you own it and it is used or held ready for use in the course of carrying on your business or, for an intangible asset, you own it and it is inherently connected with that business. Note 3 to section 152-40 gives two examples of assets that are inherently connected with a business; goodwill and the benefit of a restrictive covenant. The grant payment received for the disposal of your right to seek compensation is an active asset as it is inherently connected with your contracting business that continued after you ceased the activities specified in the Funding Deed. The value of the continuing business would have been adversely affected by the restrictions imposed as a consequence of the Funding Deed. Similar to the benefit of a restrictive covenant, the ongoing restrictions imposed as part of your right to compensation result in a continuing inherent connection with your continuing business. Furthermore, the objectives of the program were to assist the industry to adjust to the reduced scale and to support the contracting sector adjust to a changing operating environment. The payment was therefore integral to your business operations. Accordingly, the requirements of Subdivision 152-C have been met and you can apply the small business 50% reduction in relation to the grant payment when calculating your net capital gain for the year under section102-5 of the ITAA 1997.