Private ruling: Assessable income - Grants
Published: August 2013
Ruling period: Year ended 30 June 2013 Year ending 30 June 2014 Year ending 30 June 2015 Year ending 30 June 2016 Year ending 30 June 2017
Date scheme commenced: 1 July 2012

Ruling: Q1: Will government funding paid to you for the purchase of vacant land and construction of the subject facility be considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will government funding paid to you for the purchase of vacant land and construction of the facility be considered assessable income under section 15-10 of the ITAA 1997? | A2: No | Q3: Will any of the government funding paid to you for the purchase of vacant land and construction of the facility be considered an assessable recoupment under Subdivision 20-A of the ITAA 1997? | A3: Yes | Q4: Will you be entitled to a deduction under Division 43 for the qualifying construction costs in relation to building the facility? | A4: Yes | Q5: Will government funding paid to you under the Program which is used for recurrent costs (i.e. operating costs) and costs of relocating staff after you have commenced business operations be considered assessable income under section 6-5 of the ITAA 1997? | A5: Yes | Q6: Will government funding paid to you under the Program which is used for recurrent costs (i.e. operating costs) and costs of relocating staff after you have commenced business operations be considered assessable income under section 15-10 of the ITAA 1997? | A6: No | Q7: Will government funding paid to you under the Program which is used for recurrent costs (i.e. operating costs) and costs of relocating staff after you have commenced business operations be considered an assessable recoupment under Subdivision 20-A of the ITAA 1997? | A7: No

Relevant facts and circumstances: You applied for government funding in respect of a program. You received approval under the program for funding for the development and operation of the facility. A copy of the Funding Agreement (the Agreement) has been provided and forms part of the facts of this ruling. The funds are paid by instalments as certain predetermined milestones are met as specified in Annexure A to the Agreement. The terms of the funding are detailed in the Agreement. The funds are only made available to you for the specific purposes set out in the Agreement. You (and any lessee) are required to use the property for the designated use for x years from the date of commencement of operations. You do not currently and have never previously carried on any income producing business activities. You will in the future build, own and operate the business at the facility and generate income through the provision of services to the public through your operation of the business. As per the Agreement, you will receive an amount to support the construction of the works and purchase of vacant land. As per the Agreement, you will receive an amount to cover some operating expenses as set out in the agreement. As per the Agreement, you will receive an amount for relocation incentive payments to be made to staff to encourage them to relocate at the facility. The Project consists of: a) the purchase of the Property by the Organisation; b) the construction of the Works on the Property to establish the facility so as to achieve the Program Objectives; and c) leasing areas within the Property to Tenants so as to provide services and achieve the Program Objectives.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 Income Tax Assessment Act 1997 Section 6-10 Income Tax Assessment Act 1997 Section 10-5 Income Tax Assessment Act 1997 Section 15-10 Income Tax Assessment Act 1997 Subsection 20-10(1) Income Tax Assessment Act 1997 Section 20-20 Income Tax Assessment Act 1997 Subsection 20-20(1) Income Tax Assessment Act 1997 Subsection 20-20(2) Income Tax Assessment Act 1997 Subsection 20-20(3) Income Tax Assessment Act 1997 Subsection 20-25(1) Income Tax Assessment Act 1997 Section 20-40 Income Tax Assessment Act 1997 Division 40 Income Tax Assessment Act 1997 Division 43 Income Tax Assessment Act 1997 Subsection 43-70(1) Income Tax Assessment Act 1936 Paragraph 26(g) Income Tax Assessment Act 1936 Paragraph 26(j)

Reasons for decision: Summary: Capital works component of funding - Whether ordinary income Section 6-5 of the ITAA 1997 states, in part, the following: 6-5(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income. 6-5(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year. … 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 of the ITAA 1997. ATO policy concerning government payments to industry is set out in Taxation Ruling TR 2006/3 Income Tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business. At paragraph 84, 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. In G P International Pipecoaters Pty Ltd v FC of T (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court commented on the characterisation of a payment that was intended to assist the recipient with capital costs, saying that such receipts would be capital in nature and therefore not ordinary income. Application to your circumstances In your situation, the capital works component of the payments received under the Agreement are in effect a one-off payment - the funding for one capital construction project in accordance with the Agreement being entered into. This is despite the fact the total amount is being paid in instalments as certain milestones are met. 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 any existing business activity. Therefore, the capital works component of the grant does not constitute ordinary income. | Detailed Reasoning - Capital works component - Whether assessable as a bounty or subsidy: Statutory income, pursuant to section 6-10 of the ITAA 1997 includes amounts that are not 'ordinary income' but are included in your assessable income by other provisions of the tax law. Many of these provisions are listed in section 10-5 of the ITAA 1997. One such provision is section 15-10 of the ITAA 1997 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. | Detailed Reasoning - 'In relation to' carrying on a business: A grant will be "in relation to" carrying on a business when there is a real connection between the payment and the business. The term "in relation to" includes within its scope payments that have a direct or indirect connection to the business…' (Paragraph 100 of TR 2006/3) In the Full Federal Court decision in First Provincial Building Society Ltd v. FC of T (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207 ( First Provincial ), Hill J was discussing the antecedent of section 15-10 of the ITAA 1997, that is, paragraph 26(g) of the Income Tax Assessment Act 1936 (ITAA 1936). He stated that it is important to note that the former provision contained the words ' received in or in relation to carrying on of a business ... (emphasis added).' When the provision was incorporated into the ITAA 1997, it was rewritten as a bounty or subsidy 'you receive in relation to carrying on of a business.' In First Provincial , Hill J concluded that the scope of the term 'received in relation to' was sufficiently broad enough to also cover the meaning of the narrower 'received in' which implied a more direct connection. 'Carrying on a business' or 'commencement' The First Provincial case demonstrates that the scope of the phrase 'in relation to carrying on a business' in section 15-10 of the ITAA 1997 is to be interpreted widely. Payments made towards the restructuring of business operations with a view to improving overall efficiency are generally considered to be 'in relation to carrying on a business'. (Paragraph 102 of TR 2006/3) 'Some business restructures may not be in relation to carrying on a business, for example if a business changes its structure to facilitate a new activity …' (emphasis added). This is decided on the merits of each case. (Paragraph 102 of TR 2006/3) 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 First Provincial case illustrates that 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) Government payments 'to commence or cease business' as opposed to 'in relation to carrying on a business' are not considered to be assessable as ordinary income under section 6-5 of the ITAA 1997 or as a bounty or subsidy under section 15-10 of the ITAA 1997 (paragraphs 103 and 128 of TR 2006/3.) Application to your circumstances The capital works funding component of the grant 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. You applied for the government funding to construct and operate the new facility. You will own the land and buildings and will perform the operations of the facility, as well as lease areas within the property to tenants so as to achieve the Program objectives. You will be carrying on a business once you receive funding to facilitate the commencement of the new business. The capital works funding will be received for expenditure that will be preliminary to the actual carrying on of the new business at the facility. It is paid solely in relation to the capital costs associated with the construction of the facility which will be incurred prior to the commencement of the carrying on of the new activities. Therefore, because it will not be received 'in relation to carrying on' the business the capital works funding received under the Program will not be assessable under section 15-10 of the ITAA 1997 | Detailed Reasoning - Capital works component of funding - Whether assessable recoupment: The meaning of an assessable recoupment is set out in section 20-20 of the ITAA 1997. Recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery however described and a grant in respect of the loss or outgoing: subsection 20-25(1) of the ITAA 1997. An amount will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997 if it is considered to be received by way of insurance or indemnity and the taxpayer can deduct or has already claimed a deduction for it. The term 'indemnity' as used in subsection 20-20(2) of the ITAA 1997 is not a defined term and is given its ordinary meaning. The issue of whether an amount is received by way of indemnity for the purposes of the predecessor provision to subsection 20-20(2) of the ITAA 1997 (paragraph 26(j) of the ITAA 1936) has been considered in a number of cases including: Federal Commissioner of Taxation v. Wade (1951) 84 CLR 105; (1951) 9 ATD 337; 5 AITR 214, Goldsbrough Mort & Co Ltd v. FC of T 76 ATC 4343; (1976) 6 ATR 580 and Commercial Banking Company of Sydney Limited v. FC of T 83 ATC 4208; (1983) 14 ATR 142. These cases make it clear that an amount received by way of indemnity is not restricted to payments received under a contract of indemnity. The cases also make it clear that an amount received by way of indemnity would include a receipt pursuant to an antecedent obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good or compensate for a loss which arises after the obligation comes into existence. In your case, the grant can be considered to be an amount received to make good or compensate you for a loss which arises after the obligation to build the capital works came into existence. In other words, the grant is designed to indemnify you for the amount you are obliged to incur as a result of the agreement. Therefore, the portion of the grant that is received to fund the cost of capital works will be an assessable recoupment in accordance with subsection 20-20(2) of the ITAA 1997 to the extent that you are entitled to a deduction for an amount under Division 43 of the ITAA 1997 for the construction expenditure. Section 20-40 of the ITAA 1997 applies so that the assessable recoupment to be included in assessable income is limited to the total amount of the loss or outgoing that can be or has been deducted at that time. Any part of an assessable recoupment that is not included in assessable income in the year of receipt, because of this limit, is assessable in later income years to the extent that further amounts are deductible under Division 43 of the ITAA 1997 for the capital works (that is, at a rate of 2.5% per year). However, the tax effect of the assessable recoupment will be neutralised by the related deduction discussed below. To the extent that the grant is received to fund the cost of depreciating assets, such as equipment, it is an assessable recoupment under subsection 20-20(3) of the ITAA 1997. If the cost of a depreciating asset is deductible under Division 40 of the ITAA 1997 over two or more income years, section 20-40 of the ITAA 1997 will apply in a similar manner so that the total of assessable recoupment to be included in assessable income at a particular time is limited to the total amount of the loss or outgoing that can be or has been deducted at that time. | Detailed Reasoning - Construction costs - Whether deductible under Division 43 of the ITAA 1997: Division 43 of the ITAA 1997 allows a deduction for certain capital expenditure on qualifying capital works that are owned, leased or held by an entity to the extent that the works are used by the entity for the purpose of producing assessable income. 'Construction expenditure' is capital expenditure incurred in respect of the construction of capital works (section 43-70(1) of the ITAA 1997). Construction expenditure is determined on the basis of the actual cost incurred in respect of the construction of the capital works (Taxation Ruling TR 97/25). The deduction is based, at least in part, on a pool of construction expenditure for the entity's particular area. There is no basis in Division 43 of the ITAA 1997 on which the taxpayer must reduce a pool of construction expenditure for capital works it constructed by any portion of the grants it received to finance the construction of such capital works. Therefore, deductions allowable under Division 43 of the ITAA 1997 in respect of the amounts of construction expenditure you incurred on capital works can be calculated without applying any portion of the grants to reduce those amounts (but the tax effect of this deduction will be neutralised by the related assessable recoupment discussed above). | Detailed Reasoning - Funding for recurrent costs and costs of relocating staff after business has commenced - Whether ordinary income: A Government payment to industry (GPI) to assist a business to continue operating, except where the payment is for agreeing to give up or sell part of the profit yielding structure, is included as assessable income of the recipient under section 6-5 or section 15-10 of the ITAA 1997. A GPI to assist with business operating costs or liabilities is ordinary income in the hands of the recipient and is assessable under section 6-5 in the income year in which it is derived. Therefore, the funding for recurrent costs and costs of relocating staff after business has commenced constitutes ordinary income. However, the instalments for recurrent costs and costs of relocating staff under the Agreement after you have commenced business are not derived as income on receipt. It is only when obligations under the Agreement begin to be performed, and restrictions or conditions lift, and the recipient has done all required of it in order to retain the monies received, that it can be said that it will have begun to derive the amounts in question (refer paragraphs 23 and 24 of Taxation Ruling TR 2006/3). Accordingly, the instalments for recurrent costs and costs of relocating staff under the Agreement after you have commenced business are derived under section 6-5 of the ITAA 1997 when, and only to the extent, in an income year, they are applied towards the 'deliverables' in the Agreement. | Detailed Reasoning - Funding for recurrent costs and costs of relocating staff after business has commenced - Whether assessable as a bounty or subsidy: As previously stated, 15-10 of the ITAA 1997 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. It follows that, as recurrent costs and costs of relocating staff are assessable as ordinary income, they will not be assessable as a bounty or subsidy. | Detailed Reasoning - Funding for recurrent costs and costs of relocating staff after business has commenced - Whether assessable recoupment: Subsection 20-20(1) of the ITAA 1997 excludes an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside Subdivision 20-A of the ITAA 1997. As the funding components for recurrent costs and costs of relocating staff after your business has commenced are included in assessable income under 6-5 of the ITAA 1997, subsection 20-10(1) excludes this component of the funding from being an assessable recoupment.