Assessability of a lump sum compensation payment as a bounty or subsidy

Is a lump sum payment received by the taxpayer as compensation for the cessation of an allowance, and to assist with operational costs, an assessable bounty or subsidy under paragraph 26(g) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. A lump sum payment received by the taxpayer as compensation for the cessation of allowance, and to assist with operational costs, an assessable bounty or subsidy under paragraph 26(g) of the ITAA 1936.

The taxpayer carries on a business in a particular industry.

The taxpayer had for many years received an allowance from an industry body. This industry body had been established by the government to control and regulate the industry. The allowance was paid to defray certain of the taxpayer's operational costs. The taxpayer had correctly included this allowance in their assessable income in prior years.

The industry body decided to cease paying the allowance to the taxpayer. The taxpayer and the industry body signed a deed under which the taxpayer agreed to accept a lump sum payment as compensation for the cessation of the allowance.

The lump sum was received by the taxpayer in the 1995-96 income year.

The Commissioner considers that paragraph 26(g) of the ITAA 1936 will apply to assess the compensation payment as income as an alternative basis to the general income tax provision in subsection 25(1) of the ITAA 1936.

Section 26(g) ITAA 1936 includes in assessable income:

any bounty or subsidy received in or in relation to the carrying on of a business (other than subsidy received under an agreement entered into under an Act relating to the search for petroleum), and such bounty or subsidy shall be deemed to be part of the proceeds of that business

The word 'subsidy', as noted by Windeyer J in Placer Development Ltd v. Commonwealth of Australia (Placer Development) (1969) 121 CLR 353 derives from the Latin subsidium meaning 'an aid or help'. Windeyer J, at page 373, went on to say that in relation to the meaning of subsidy that:

The word is no longer used in its early legal sense of a grant to the Crown . It ordinarily means today not aid given to the Crown but aid provided by the Crown to foster or further some undertaking or industry.

It is considered that the compensation payment made by the industry body to the taxpayer qualifies as a 'subsidy' within the meaning of that word in paragraph 26(g) of the ITAA 1936. The industry body paid this sum as a form of assistance to the taxpayer in relation to their operations within the industry. The industry body was the instrument by which the Crown in right of the state operated within the industry.

The lump sum compensation payment, like the allowances which it replaced, were intended to reimburse a proportion of the taxpayer's operational costs. The lump sum compensation payments were to this extent similar to subsidies paid in the Lincolnshire Sugar Co limited v. Smart ( Lincolnshire Sugar case) (1937) AC 697 and in the Reckitt & Colman Pty Ltd v. FC of T (Reckitt case) 74 ATC 4185; (1974) 4 ATR 505 . In the Lincolnshire Sugar Case payment to a sugar manufacturer designed to ensure a minimum price for the product was held to be a bounty or subsidy. And in the Reckitt & Colman Case it was held that a grant for Industry Research and Development carried on in a previous year was ordinary income and came within paragraph 26(g) of the ITAA 1936.

Paragraph 26(g) of the ITAA 1936 requires that the bounty or subsidy be received 'in or in relation to the carrying on of a business'. The meaning of these words was considered by Hill J in First Provincial Building Society v. Federal Commissioner of Taxation (First Provincial) (1995) 56 FCR 320; 95 ATC 4145; (1995) 30 ATR 207 who noted that 'in' carrying on a business means 'in the course of ' and requires a direct relationship between the subsidy or bounty and the carrying on of a business. On the other hand, a bounty or subsidy received 'in relation to' is one having a less direct relationship with the carrying on of the business. However under either limb the relationship must be a real one so that a merely remote connection between the payment and the carrying on of the business is not sufficient.

Applying the principles in First Provincial to the circumstances of the taxpayer it is considered that a real relationship existed under either, or both, limbs between the compensation amount paid and the carrying on of the taxpayer's business. Like the applicant in First Provincial the taxpayer was not restricted on the way in which they could use the compensation payment. The payment formed part of the ordinary circulating capital of the taxpayer to be used in its day to day activities. In a real sense the payment assisted the taxpayer to carry on its business activities.

Accordingly, the lump sum payment received by the taxpayer as compensation for the cessation of an allowance, and to assist with their operational costs, is assessable under paragraph 26(g) of the ITAA 1936 as a bounty or subsidy. (Note: Paragraph 26(g) of the ITAA 1936 has been rewritten as section 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997). Section 15-10 of the ITAA 1997 only applies to those bounties and subsidies which are not ordinary income under section 6-5 of the ITAA 1997.)