Edited version of private ruling

Authorisation Number: 1011546618161

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Ruling

Subject: Compensation receipt

Questions

1. Will the lump sum compensation receipt trigger a capital gains tax (CGT) event under section 104-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

2. Can you apply the 50% discount under section 115-100 of the ITAA 1997 to any capital gain made?

Yes.

3. Are you eligible to roll-over the compensation receipt under section 124-75 of the ITAA 1997?

You may be eligible if you satisfy the requirements of section 124-75 of the ITAA 1997.

4. Will the asset disposed satisfy the definition of active asset under section 152-40 of the ITAA 1997 so that the small business concessions may apply?

Yes, if you satisfy the basic conditions for the small business CGT concessions.

This ruling applies for the following period

Year ending 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

The building where you operate your business has been resumed by an authority of the State Government. You have held a lease with the building owners for a number of years.

Compensation was agreed and a Deed of Release was executed by you.

You have obtained a new lease which has no acquisition costs, just monthly rent payments which will be tax deductible via the partnership.

Relevant legislative provisions

Section 104-5 of the Income Tax Assessment Act 1997

Section 115-100 of the Income Tax Assessment Act 1997

Section 124-75 of the Income Tax Assessment Act 1997

Section 152-40 of the Income Tax Assessment Act 1997

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA of the ITAA 1936 applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA of the ITAA 1936 may apply.

For more information on Part IVA of the ITAA 1936, go to our website and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified.

The general CGT provisions are set out in Part 3-1. Under the CGT provisions you will make a capital gain or loss only if a CGT event happens.

To determine if a CGT event happens in respect of a compensation payment it is necessary to consider the nature of the asset to which the compensation payment relates.

The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 (capital gains: treatment of compensation receipts). TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be:

· an underlying asset;

· a right to seek compensation; or

· a notional asset in terms of section 104-155.

In determining which is the most relevant, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt.

In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as:

the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

TR 95/35 advises the following guidelines on the treatment of compensation for the disposal of an underlying asset.

4. If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation.

5. If the underlying asset was acquired by the taxpayer on or after 20 September 1985, a capital gain or loss may arise on the disposal.

On the facts of your case, the compensation received had a link with the underlying asset, being the lease. Accordingly, in line with the guidelines provided in paragraph 4 of TR 95/35 the compensation amount was received for assigning your leasehold interest.

50% discount

Subparagraph 115-100(a) provides that a 50% discount may be applied to a discount capital gain realised by an individual. In order to be considered a discount capital gain, the asset that gave rise to the capital gain must have been owned for a period of at least 12 months prior to the CGT event by virtue of section 115-25.

In your case, you have held the lease for a period longer than 12 months, therefore you would be eligible for the discount capital gain.

Roll-over requirements

Section 124-70 allows capital gains tax roll-over relief if an asset owned by the taxpayer is compulsorily acquired by an Australian government agency. A further requirement is that the owner of the original asset must receive money or another CGT asset or both for the CGT event to be eligible for roll-over. On satisfying these conditions section 124-75 provides other requirements which must be satisfied if money is received for the event happening.

Under subsection 124-75(2), the owner of the asset must incur expenditure in acquiring another CGT asset except a depreciating asset whose decline in value is worked out under Division 40 or deductions which are calculated under Division 328. Division 40 and Division 328 are briefly discussed below.

Division 40 allows you to deduct an amount for the decline in value of an asset that has a limited effective life and that is reasonably expected to decline in value over the time it is used. Division 328 is the STS provision where you can put depreciating assets into either a long life pool or a general pool and treat each as a single asset.

A CGT asset is defined in section 108-5 as any kind of property or a legal or equitable right that is not property. Section 100-25 states that CGT assets include land and buildings, shares, units in a unit trust, collectables which cost over $500, personal use assets which cost over $10,000, your home, contractual rights, goodwill, and foreign currency.

Subsection 124-75(3) states when the expenditure on replacement assets must occur. Paragraph 124-75(3)(b) states that the expenditure must be incurred no later than one year after the end of the income year in which the event happens, or within such time as the Commissioner allows in special circumstances.

Subsection 124-75(4) states the requirements where money is received for a CGT asset that is compulsorily acquired. Either of the two requirements needs to be satisfied.

The first requirement is that if the original asset was used, or installed ready for use in your business just before the CGT event, the replacement CGT asset must be used, or installed ready for use, or in the process of being installed ready for use in the same business for a reasonable time after it is acquired.

The second requirement in subsection 124-75(4) is that the replacement is used for the same purpose as, or for a similar purpose to, the purpose for which the original asset was used, if used in a different business.

Taxation Determination TD 2000/41 provides guidelines for interpreting subsection 124-75(4).

Active asset

An active asset is defined in section 152-40 as an asset that is owned by you and is:

· used or held ready to use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you, or

· an intangible asset inherently connected with a business carried on (whether alone or in partnership), by you, your affiliate, your spouse or child, or another entity that is connected with you, carries on for example, goodwill.

The surrender of the right under the lease is a disposal of an active asset as it satisfies the definition of an active asset according to paragraph 152-40(1) (b). That is it is an intangible asset that is inherently connected with a business that is carried on.

Any capital gain that results from a CGT event may be reduced or disregarded under the small business concessions if you satisfy certain conditions. All of these concessions require that the basic conditions in subsection 152-10(1) are satisfied. Some of the concessions also require that other conditions are also satisfied.

The basic conditions in section 152-10 to be satisfied for the gain are:

(a) a CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1

(b) the event would (apart from Division 152) have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test (section 152-15)

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test in section 152-35.

Summary

A CGT event occurred at the time the lease was assigned:

· you may apply the general 50% discount;

· the lease is an intangible active asset and the small business concession may apply.

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