Bounties and subsidies: whether a repayable government payment a 'bounty or subsidy'

Is a government payment that is received to undertake activities to develop a new product to the stage where it can be taken to market a bounty or subsidy for the purposes of section 15-10 of the Income Tax Assessment Act 1997 (ITAA 1997), if the receipt is subject to a repayment obligation that may arise upon the happening of certain subsequent events?

Yes, a government payment received to undertake activities to develop a new product to the stage where it can be taken to market is a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997, even though the receipt is subject to a repayment obligation that may arise upon the happening of certain subsequent events.

In carrying on a commercialisation project, the taxpayer received a government payment to undertake project activities to develop a new product to the stage where it can be taken to market.

In order to receive this payment, the taxpayer was required to demonstrate, amongst other things, that: • it has insufficient resources to fund the entire project • it could not obtain financing from alternative means, and • there is a market need to complete the project in a timeframe that would not be possible without government support.

The funding agreement provides that the receipt of the government payment is subject to a repayment obligation that aligns with the success of the project. The project is considered successful if a specified accumulated sales level arising out of or in connection with the project is achieved.

Where the specified accumulated sales level is not met within a certain period, no obligation to repay the funding arises unless or until notified by the government. Where the specified accumulated sales level is met, the obligation to repay will arise; however the government has the discretion to modify the obligation which will nevertheless conclude after ten years. That is, there is no obligation to repay outstanding funding amounts after the tenth anniversary of the project end date.

Section 15-10 of the ITAA 1997 provides that assessable income includes a bounty or subsidy that is received in relation to carrying on a business and that is not assessable as ordinary income under section 6-5 of the ITAA 1997. Not all government grants are bounties or subsidies for the purposes of section 15-10 of the ITAA 1997. Taxation Ruling TR 2006/3 Income Tax : government payments to industry to assist entities (including individuals) to continue, commence or cease business sets out the Commissioner's view on circumstances in which a government payment will be considered to be a bounty or subsidy.

The terms 'bounty' or 'subsidy' are not defined terms for the purposes of either the ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936). However, the Courts in their consideration of how the terms were used in paragraph 26(g) of the ITAA 1936 (the predecessor to section 15-10 of the ITAA 1997) have provided some guidance as to their meaning which are equally relevant for section 15-10 of the ITAA 1997 (see Plant v. FCT 2004 ATC 2364; 58 ATR 1070.)

In Reckitt and Colman PTY LTD v. FCT (1974) 4 ATR 501, 74 ATC 4185; Mahoney J said that the terms 'bounty' or 'subsidy' include a financial grant made by the State for the purpose of encouraging a particular activity in the field of trade and commerce. In First Provincial Building Society Ltd v. Commissioner of Taxation (1995) 30 ATR 207; 95 ATC 4145, Hill J referred to Jowitt's Dictionary of English Law's observation that the word subsidy generally means 'financial assistance granted by the Crown' and said that 'This is the meaning which the word truly has in the present context'.

In this case, the government payment was provided to the taxpayer to undertake project activities to develop the product to the stage where it can be taken to market. The government payment is financial assistance granted to the taxpayer as it not only increased the financial capacity of the taxpayer to undertake the relevant activities but also reduced the taxpayer's risk of economic loss because the obligation to repay the payment only arises either if the project is successful or in very limited circumstances if the project is not successful.

While some or all of the government payment may be repayable, this is not a case where the substance of the transaction is the provision of funds in consideration of a promise to repay that sum (c.f. AAT Case 9472 94 ATC 225; (1994) 28 ATR 1155 Case 22 / 94 ). That is, the provision of the government payment is not characterised as a loan (which would not be a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997) as the essential feature of a loan (a definite obligation to repay the principal sum) is absent on entering the agreement. The provision of the government payment is subject to a contingent liability that may result in repayment in limited circumstances that might or might not ever eventuate. Whether or not the contingency occurs, the obligation to repay the funding did not exist at the time the funding agreement was entered into. In Smart v. Lincolnshire Sugar Co. Ltd (1933-1937) 20 TC 643, the court found that the presence of a similar contingent liability to repay a subsidy in a certain event did not in any way affect the characterisation of the receipt as a subsidy. Therefore, the fact that the government payment in the present case may become repayable does not change the substance of the transaction which is the provision of financial assistance.

Accordingly, a government payment received to undertake activities to develop a new product to the stage where it can be taken to market is a bounty or subsidy for the purposes of section 15-10 of the ITAA 1997, even though the receipt is subject to a repayment obligation that may arise in certain events. Note : Where the taxpayer's receipt of funding is assessable under section 15-10 of the ITAA 1997 (because it is received in relation to carrying on a business) it is assessable in the income year in which it is received but subject to amendment to exclude any amount repaid as non-assessable non-exempt income if the repayment is not otherwise deductible (section 59-30 of the ITAA 1997).