Edited version of private ruling

Authorisation Number: 1011742445339

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Ruling

Subject: Capital gains tax on compensation payment

Question 1

Is the compensation payment you received for loss of future earnings and therefore assessable under the income tax provisions of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the compensation you received subject to the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997?

Answer

No

Question 3

If the compensation is capital, does a reduced cost base apply to the CGT calculation?

Answer

Not applicable

This ruling applies for the following period:

1 July 2008 to 30 June 2009

The scheme commences on:

1 July 2008

Relevant facts and circumstances

A company (A) owned the venue where the business was located.

The company (B) was a tenant conducting a business as a trustee of a trust.

The taxpayers were corporate officers, share holders and employees of B. They were also beneficiaries of the trust.

A decided to renovate and served two separate relocation notices on B.

B disputed these notices and did not vacate the premises.

A commenced proceedings.

It was held that the relocation notices were not properly invoked and were invalid. B vacated the premises on an undertaking as to damages by A.

The taxpayers sought to be joined to the proceedings and the defendants together sought damages.

The taxpayers were joined to the proceedings and the findings were that each of the defendants were entitled to compensation from A.

Compensation was payable separately to B and the taxpayers.

A letter explains the options for calculating the loss as:

· by reference to future cash flows that the business might have been expected to generate in the period in which occupancy of the premises was certain

· by extending the period in a) which would involve extending the lease

· by reference to the amount the business might realise if it was put up for sale.

The losses were determined based on future cash flows for the known period of the occupancy to from option a) above.

B paid capital gains tax (CGT) on the compensation received.

The taxpayers declared the compensation payment as eligible termination payments (ETPs).

A has appealed the award, saying it has been over calculated. They argue that the entire amount was subject to CGT and the taxpayers are eligible for the small business discount.

A also suggests that the CGT calculation is in error with regard to the original purchase price as opposed to the reduced cost base.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1,

Income Tax Assessment Act 1997 Section 6-5 and

Income Tax Assessment Act 1997 Section 118-20.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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 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 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, 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 contained herein refer to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

The compensation payments received by B and the taxpayers are for loss of future earnings, and are therefore assessable income.

Detailed reasoning

Income according to ordinary concepts is stated in section 6-5 as follows:

(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income…

The ITAA 1997 does not provide any specific guidance on what is meant by the term 'income according to ordinary concepts'.  However, a substantial body of case law has evolved to identify various factors that indicate whether an amount is income according to ordinary concepts.  In this regard, the distinction between income and capital is important.

The following extract taken from the judgement of the full bench of the High Court in GP International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124 at p 131 possibly sets out most clearly the factors which Australian courts will apply to determine whether a receipt is on revenue or capital account.

To determine whether a receipt is of an income or of a capital character, various factors may be relevant.  Sometimes, the character of the receipt 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 factors relevant to the ascertainment of the character of a receipt or money are not necessarily the same as the factors relevant to the ascertainment of the character of its payment.

Whether a lump-sum compensation payment is income or capital in character may be determined by the character of the right, thing or transaction that gave rise to the compensation receipt.

The compensation payment may be assessable income if it constitutes recoupment for the loss of profits or income that might have been derived from the property.

In your case:

You received compensation payments for B and for you individually.

The compensation for B arose because you were required to surrender the premises and you were not provided with 'details of reasonably comparable alternative retail premises' that were available to you.

The taxpayers', as directors, corporate officers and employees of B were also entitled to recover damage which they had suffered in the form of compensation.

A letter explains the options for calculating the loss as:

· by reference to future cash flows that the business might have been expected to generate in the period in which occupancy of the premises was certain

· by extending the period in a) which would involve extending the lease

· by reference to the amount the business might realise if it was put up for sale.

The losses were determined based on future cash flows for the known period of the occupancy from option a) above. Paragraph 27 of the above letter describes this method as 'best fits with the circumstances of the matter' and describes that the tenants had 'the certain right to occupy the premises until the termination of the lease, and work to generate future cash flows'.

The details of the hearings and orders provided are not explicit with regards to the reasons the compensation was paid. As such, it is considered that the method used to calculate the amount of damages should give an indication as to the character of the payment. As the losses have been determined based on future earnings, then the compensation received for loss of future earnings appear to be of the same nature.

The compensation payments received by B and the taxpayers are for loss of future earnings, and are therefore assessable income.

Question 2

Summary

The compensation you received is not subject to CGT.

Detailed reasoning

Your compensation payments have been determined to be ordinary income. They are therefore not capital.

Question 3

Summary

As the compensation payments are not capital, this question is not considered.

Detailed reasoning

The compensation payments have been determined to be ordinary income and not capital. Therefore calculation of capital gains does not need to be considered.

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