Assessable Income: derivation of government grant funds - conditional upon funds being expended

Are grant funds, used to acquire an asset, derived by a taxpayer for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year in which the asset is acquired?

Yes. Grant funds, used to acquire an asset are derived by a taxpayer for the purposes of section 6-5 of the ITAA 1997 in the income year in which the asset is acquired.

The taxpayer (the grantee) received a grant from a Government Agency (the grantor). Under the grant, the grantee received a certain sum of money over a defined period (the grant period). These funds were to be used by the grantee for the purpose of providing assistance to certain businesses.

The terms under which the grant funds were provided were set out in a Deed. The Deed provided inter alia that: • the grant funds were to be used for approved purposes, which included the acquisition of assets. • any grant funds which were unexpended as at the end of the grant period were to be repaid to the grantor. • if the grantee acquired an asset using grant funds, and then sold that asset during the grant period, the funds recovered must be repaid to the grantor if they were not otherwise expended in accordance with the Deed prior to the end of the grant period. • if a loss were made on disposal of an asset, acquired by the grantee using grant funds, the grantee was not required to make good the amount of the unrecovered funds (that is the amount of the loss) to the grantor.

The grantee was not compelled, under the Deed, to dispose of any assets acquired with the grant funds before the end of the grant period.

The taxpayer used a portion of the grant funds to acquire shares in the businesses to which they were providing assistance. Those shares were sold by the taxpayer prior to the end of the grant period.

The grantee was required to provide financial reports to the grantor. These reports were prepared by the grantees accountants using appropriate accounting standards and principles. The financial reports treated the grant funds received by the taxpayer, but as yet unexpended, as 'unearned income'.

When the grant funds were expended, whether to acquire assets or for any other purpose approved under the Deed, they were treated as 'income' in the taxpayer's accounts.

There was no evidence to suggest that the grantee or the grantor considered the payments made under the Deed to be a loan.

In the taxpayer's circumstances, the payments under the grant were ordinary income and would form part of their assessable income under section 6-5 of the ITAA 1997.

Under subsection 6-5(2) of the ITAA 1997 the taxpayer's assessable income will include ordinary income derived during the income year.

The issue to be considered is whether the income under the grant is derived by the taxpayer as grantee in the year when it is received, when that income may, in certain circumstances, have to be repaid in a future income year.

The question of when income is derived has been considered in a series of decisions of the Courts and it is often simply a question of whether a 'cash' or 'accruals' basis should be employed. However, in other cases the resolution of the issue is determined by applying the principles that have grown out of cases such as C of T (SA) v. Executor Trustee & Agency Co. of South Australia Ltd (Carden's case) (1938) 63 CLR 108; (1938) 5 ATD 98, Brent v. FC of T (1971) 125 CLR 418; (1971) 71 ATC 4195 ( Brents case ) and Arthur Murray (NSW) Pty Ltd v. FC of T (1965) 114 CLR 314; (1965) 14 ATD 98 ( Arthur Murray ).

In Brent's Case at p 420 Gibbs J stated: It has become well established that unless the Act makes some specific provision on the point the amount of income derived is to be determined by the application of ordinary business and commercial principles and that the method of accounting to be adopted is that which 'is calculated to give a substantially correct reflex of the taxpayer's true income. ( The Commissioner of Taxes (South Australia) v The Executor, Trustee and Agency Company of South Australia Limited (Carden's case) (1938) 63 CLR 108 at pp 152-154)

Carden's case was also considered in Arthur Murray, where the Court considered when amounts coded as 'unearned income' for accounting purposes, were derived for tax purposes. In discussing the possibility of having to make a refund, the Court said at CLR 319: But those circumstances nevertheless make it surely necessary, as a matter of business good sense, that 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, even if only as damages, should the agreed quid pro quo not to be rendered in due course. The possibility of having to make sure such a payment back (we speak in course in practical terms) is an inherent characteristic of the receipt itself. In our opinion it would be out of accord with the realities of the situation to hold, while the possibility remains, that the amount received has the quality of income derived by the company. For that reason it is not surprising to find, as the parties in the present case agree is fact, that according to established accountancy and commercial principles in the community the books of a business either selling goods or providing services are so kept with respect to amounts received in advance of goods being sold or of the services being provided that the amounts are not entered to the credit of any revenue account until the sale takes place or the services are rendered: in the meantime they are credited to what is in effect a suspense account, and their transfer to an income account takes place only when the discharge of the obligations for which they are a prepayment justifies their being treated as having finally acquired the character of income.

The Deed provides in certain circumstances for a refund of funds to the Government agency, where these funds were used to acquire assets which were later disposed of during the grant period. However, it is considered that the funds used to purchase the assets have 'come home' to the taxpayer when expended. In terms of the quid pro quo referred to in the quote from Arthur Murray above, the quid pro quo occurs when the grant monies have been spent for the intended purpose. At that point, the taxpayer has done everything necessary to earn the income. The fact that the Deed provides for a possibility, if certain events occur, that an amount expended may need to be refunded, is not sufficient to say that the point of derivation of the income is deferred.

The circumstances here can be distinguished from the situation in Case 22/94 94 ATC 225; AAT Case 9472 (1994) 28 ATR 1155. In that case it was decided that the true nature of the arrangement under which the relevant funds were provided was a conditional loan. As such the funds provided would not be recognised as income until they ceased to be conditionally repayable. In arriving at this decision the Tribunal took into account the fact that the grantor and the grantee had both treated the amount received as a loan in their books of account.

However this is not the situation here. There is no evidence which supports the conclusion the payments were intended to be or had the features of a loan.

The proper accounting treatment (which was in fact adopted by the taxpayer in their financial accounts) was to treat the grant funds expended on acquiring the assets as derived at the time they were expended . This treatment gives a true reflex of the taxpayer's income.

Accordingly, the grant funds used to acquire the assets, are derived by the taxpayer for the purposes of section 6-5 of the ITAA 1997 in the income year in which they are expended to acquire the assets.