Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of private ruling

Authorisation Number: 1011621484647

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fac sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Compensation payment - whether revenue or capital

Question 1

Is the compensation amount received from a government authority for decommissioning of the irrigation system by closing one outlet and constructing a new connection channel and installing new pipeline to transfer Delivery Share from the existing outlet to two new outlets a capital receipt?

Advice/Answers

Yes.

Relevant facts

The taxpayers, W, X and Y are partners of a partnership for income tax purposes.

The taxpayers, X and Y, have received some money form a state irrigation authority under an irrigation modernisation project.

The irrigation modernisation project requires that the current outlet be moved and a new pipe and outlet be entered on a neighbouring property.

All costs relating to the removal of the existing channel and constructing the new connecting channel be carried out by the taxpayers with costing estimates provided equalling the total funds to be received.

Reasons for decision

Unless otherwise stated, all legislative references in this section are to the Income Tax Assessment Act 1997 (ITAA 1997)

Question 1

Summary

The compensation amount received from the state authority for closing the existing outlet and constructing a new connection channel as well as installing new pipeline to transfer Delivery Share from the existing to two new outlets is capital in nature.

Detailed reasoning

The ITAA 1997 does not define either the concept of income or the concept of capital. As a result, the courts have developed tests to characterise whether an amount received is of revenue or capital nature. In GP International Pipecoater's Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (Pipecoater's Case), the judges stated (at CLR 138; ATC 4420) that:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

The following factors identified in the Pipecoater's Case gives some indication for determining whether a receipt is income or capital in the hand of the recipient:

Income element usually has an element of periodicity, recurrence or regularity. On the other hand, a receipt which is one-off payment (a lump sum) can generally be characterised as a capital receipt. This, however, will depend on the fact of the case. In Rolls-Royce v Jeffrey (1962) 1 ALL ER 807; 40 TC 443, the House of Lords decided that the sump sum payment received by the company for entering into licensing agreements to supply the technical data and skilled personnel necessary to enable local enterprise to manufacture the engines as income. The reason being that the company was exploiting their know how the best and only method open to it and by granting of the licences was an extension of the company's business. On the other hand, in Moriarty v Evans medical Supplies Ltd (1957) 3 All ER 718; 37 TC 540, money received by the company from the Burmese government for process and ancillary knowledge to set up pharmaceutical industry in Burma was held as capital as setting up such companies in Burma would reduce the company's business in Burma and hence in effect considered as part disposal of its market share and with this a source of its profit.

In the present case, the taxpayers received the compensation amount as a one off payment. Although a one-off payment can still be income as seen above, the nature of the payment in the hand of the taxpayer is in relation to the infrastructure of the agricultural business not the outcome of the business. Closing the existing outlet and constructing the new channel to connect to new irrigation outlets will replace the infrastructure that is used in continuing their agricultural business. Considering this, the compensation receipt to make this infrastructure is capital in nature.

The character of the right disposed also can determine whether a receipt is income or capital. In Federal Coke Co Pty Ltd v Federal Commissioner of Taxation (1977) 34 FLR 375; (1977) 7 ATR 519; 77 ATC 4255, Brennan J in Full Federal Court stated (at FLR 401; ATR 539; ATC 4273) that:

When a receipt of moneys provides consideration for the payment, the consideration will ordinarily supply the touchstone of ascertaining whether the receipt is on revenue account or not. The character of an asset which is sold for a price, or the character of a cause of action discharged by a payment will ordinarily determine, unless it is a sham transaction, the character of the receipt of the price or payment. The consideration establishes the matter in respect of which the moneys are received. The character of the receipt may then determine by the character, in the recipient's hands, of the matter in respect of which the moneys are received.

Dixon J in Sun Newspapers Ltd & Anor v Federal Commissioner of Taxation (1938) 61 CLR 337 also used similar analogy in that if a receipt is derived from disposing of a right or advantage as part of the process by which the profit-earning structure or organisation operates to obtain regular returns, the receipt is income. Conversely, if the right or advantage disposed of is part of the profit yielding structure, the receipt will be capital.

In the present case, the compensation amount is in relation to disposing of part of the profit yielding structure and undertaking works to replace it with different outlets in the neighbouring property. Therefore, the nature of the receipt is capital in nature.

The purpose in engaging in a transaction, venture or business, namely profit making intention is another factor to determine whether a receipt is capital or income: Federal Commissioner of Taxation v the Myer Emporium Ltd (1987) 163 CLR 199;(1987)18 ATR 693; 87 ATC 4363.

In the present case, there is no profit making intention from the receipt of the compensation. The taxpayers received the amount as part of the modernisation of the state's irrigation system. The amount is not to replace the income of the taxpayers rather to rationalise the infrastructure of the income earning procedure.

Thus, considering the above, the compensation amount in the hand of the taxpayers is of the nature of capital.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).