Grants or subsidy payments may not be taxable, but then the associated expenditure will not be deductible. It may be subject to GST. Here are all the ins and outs of how grants and subsidies are taxed.

What is a grant or subsidy?

Following the floods in Auckland along with Cyclones Hale and Gabrielle, the Government immediately set up avenues to give funding to those most affected mainly through the Ministry of Primary Industries, Civil Defence and Mayoral Relief Funds.

This has raised the question as to how the various grants and subsidies should be treated for tax purposes – and it’s not straightforward. Fortunately, Inland Revenue has recently released two draft statements outlining the proposed treatment of grants and subsidies. The first deals with income tax and the second with GST.

To be a grant or subsidy for both income tax and GST, the grant payment must be made from a local or public authority or public purpose Crown Controlled Company. In addition, it must have one of the following characteristics:

• be paid gratuitously (without obligation) out of public funds by the Crown or another public body
• be paid to further objectives in the public interest
• be often made to public, charitable or private bodies to confer benefits on third parties
• be made to promote or encourage an industry or enterprise

This means that some grant payments made as a result of the cyclone will not be grants or subsidies – for example, payments made by the Red Cross or food vouchers from a local church group. In addition, loans made under the Small Business Cashflow Scheme are not considered grants as they must be paid back. A settlement is also not a “grant or subsidy”. In addition, payments made by the Crown as a result of a contract for goods or services are not a grant or subsidy. The payment is not made without obligation even though the services provided may be in the public interest.

The focus is on the character or quality of what the payer pays and of the consideration they give, rather than on what the payee receives.

The GST Act also has a schedule with a list of payments that are not taxable grants and subsidies for GST purposes. These include some earthquake subsidy payments and certain COVID-19 payments, but do not include any payments for the 2023 weather events.

What is the income tax treatment?

The objective of the tax rules is to have a neutral tax result. If the grant payment is made to a business and will fund deductible expenditure, the receipt of the grant will not be taxable. On the other hand the expenditure will not be deductible.

The grant payment does not need to be matched to specific expenditure. If the grant is for a type of expenditure that is usually deductible, that is enough.

Expenditure incurred that exceeds the amount of the grant payment will still be deductible.

A grant may be used to purchase depreciable property. In that case, the grant is not taxable but the value of the asset for depreciation purposes must be reduced by the amount of the grant.

If the amount received does not meet the definition of “grant or subsidy” it will be taxable on receipt and the expenditure will be deductible when incurred.

When should the grant or subsidy be recognised for income tax?

Generally the grant payment will be derived at the time when the business can keep the payment. In addition, it is expected that the expenditure will be incurred within a reasonable timeframe.
In most cases the grant payment can be recognised as non-taxable income straight away, with the expectation that it will be spent on normal business expenditure, which will then be treated as non-deductible.

However, there are some situations where the timing may be different:

• If the grant payment is to reimburse the business for a particular item of expenditure, the receipt will not be derived until the expenditure for the particular item is incurred
• If the grant payment has conditions attached, the receipt cannot be recognised until the conditions are met
• If the grant payment is made to reimburse expenditure that was incurred in a prior year, a business may need to amend previous assessments to reverse out any deductions previously claimed
• If the grant payment is not spent in one income year, it may be carried over until the next income year (unless the conditions stipulate otherwise)

In the case of some of the COVID-19 payments, Inland Revenue considered that they should be accrued in the balance sheet and released in the following year as the money was spent.

If a grant is paid subject to conditions regarding the nature or timing of spending, usually it must be returned to the grantor if the conditions cannot be met. It is not enough for the recipient to recharacterise the payment as a taxable receipt.

What is the GST treatment?

When a payment in the nature of a grant or subsidy is made to a person in respect of or in relation to their taxable activity, the payment is deemed to be consideration for a supply of goods and services by the person as part of their taxable activity.

This means that if the recipient is registered for GST, they will need to pay GST output tax on the amount received.

For GST purposes, the grant should be recognised in the GST period when it is received.

Conclusion

If you or your client has received a “grant” payment, it may be taxable. It may also be subject to GST. This will make a difference to how much you have to spend on cyclone and flood reparation. Inland Revenue has some basic rules on its website, but it may also be time to talk to a specialist tax advisor to make sure you’ve got the right treatment.