Edited version of private ruling

Authorisation Number: 1011825766200

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Ruling

Subject: Assessability of insurance payment

Question 1

Will an insurance payout for damage to property constitute assessable income under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will Capital Gains Tax (CGT) event C1 occur in the circumstances described?

Answer

Yes.

Question 3

Will a rollover be available under subdivision 124-B in respect of any capital gain?

Answer

Yes

This ruling applies for the following period:

1 July 2010 - 30 June 2011

1 July 2011 - 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You inherited a property. A storm struck the house. It caused extensive damage to the roof, ceiling and contents. The insurer has indicated that they will settle the claim in cash. You then plan to repair the house.

You plan to retain the property for the foreseeable future for sentimental reasons but your main residence is elsewhere. Since acquiring the property you have only used it occasionally.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160ZH

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 124-70

Income Tax Assessment Act 1997 Section 124-75

Income Tax Assessment Act 1997 Section 124-85

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 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 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 www.ato.gov.au 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

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

Question 1

Detailed reasoning

Assessable income is made up of ordinary income under section 6-5 and statutory income under section 6-10. Section 6-10 provides that assessable income includes statutory income which constitutes amounts made assessable by specific statutory provisions.

Under subsection 6-5(1) ordinary income means income 'according to ordinary concepts'. Under subsection 6-5(2), the assessable income of an Australian resident includes the ordinary income you derived directly or indirectly from all sources during the income year.

The tax legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics. In determining whether an amount is ordinary income, the courts have established the following principles:

· what should be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as a statute dictates otherwise

· whether the payment received is income depends upon a close examination of all relevant circumstances

· whether the payment received is income is an objective test.

Relevant factors in determining whether an amount is ordinary income include:

· whether the payment is the product of any employment, services rendered, or any business

· the quality or character of the payment in the hands of the recipient

· the form of the receipt i.e. whether it is received as a lump sum or periodically

· the motive of the person making the payment, but noting that this latter factor is rarely decisive, as a mix of motives may exist.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413 at 4420; (1990) 21 ATR 1 the Full High Court stated:

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.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The entirety of the circumstances must be considered.

Amounts that are recurrent, relied upon by the recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income whereas one-off payments will often not be income unless paid in settlement of on-going future claims. Also, receipts that indicate the arrangement is private or domestic in nature are not likely to be ordinary income.

In the present case, viewed objectively the receipt is not ordinary income. It does not bear the characteristics of ordinary income identified above.

In respect of statutory income, the consequences of receiving the insurance money are addressed in section 124-85. Assuming that the entire insurance payment received is spent on the restorations, Item 3 of sub-section 124-85(2) will be applicable and any capital gain will be disregarded in calculating your income for the applicable year.

Question 2

Detailed reasoning

Taxation Determination TD 31 discusses the treatment of insurance payments received in respect of destroyed assets. It states that an insurance payment received consequent upon the destruction of an asset is received "as a result of or in respect of the disposal of the asset or part of that asset". That disposal would constitute a CGT event.

In the present case, damage to the roof and ceiling would represent damage to what might be referred to as the roof structure and that structure clearly forms a part of the total asset in question. It follows that an insurance payment in respect of damage to the roof and ceiling is received consequent upon "disposal of the asset or part of that asset" for the purposes of TD 31 and is therefore consequent upon the occurrence of a CGT event.

It is clear from section 104-20 that the CGT event that occurs is event C1 which covers the loss or destruction of a CGT asset. The capital gain is calculated by deducting the proportion of the cost base which relates to the damaged part of the asset from the consideration received in respect of it i.e. the insurance payment. As part of the cost base of the original asset is taken into account at this point, the cost base of the remaining portion of the property is reduced accordingly.

Taxation Ruling TR 95/35 states at paragraphs 6 and 7 that: "If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Accordingly, the total acquisition costs of the post-CGT asset should be reduced in terms of subsection 160ZH(11) by the amount of the compensation…"

For present purposes, the fact that the damage can be repaired does not alter the applicability of the principle stated in TR 95/35. Consequently, the total acquisition costs of the asset, and therefore its cost base, are reduced by the event.

Subsequently, the cost base of the asset would be increased by the spending of the insurance moneys on the restoration of the property. The expenditure would constitute part of the fourth element of the cost base as specified in sub-section 110-25(5).

Question 3

Detailed reasoning

In respect of the capital gain on the destroyed part of the property, where a capital gain has arisen sub-division 124-B provides, in appropriate circumstances, for that capital gain to be rolled-over until the occurrence of a future event. Paragraph 124-70(1)(b) states that you may be able to choose a roll-over if part of a CGT asset which you own is destroyed. Paragraph 124-70(2)(b) specifies that you may qualify for that rollover if you receive money or another CGT asset under an insurance policy.

Section 124-75 states other requirements which must be met in order to qualify for the rollover if you receive the money referred to in sub-section 124-70(2). Paragraph 124-75(2)(b) states that if part of the original asset is destroyed you must incur expenditure of a capital nature in repairing or restoring it. Subsection 124-75(3) states that at least some of the expenditure must be incurred no later than one year after the end of the income year in which the event happens. Subsection 104-20(2) states that, in respect of CGT event C1, the time of the event is the receipt of the insurance moneys.

In other words, provided that at least some of the insurance receipts are spent on restoration work within a year of the end of the tax year in which the insurance payment is received, the capital gain resulting from the damage to the property can be rolled-over until the occurrence of a future CGT event such as the ultimate disposal of the property.

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