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Ruling

Subject: Compensation payment

Question 1

Are the proceeds received in compensation for the acquisition of an easement over your land by a public authority assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No

Question 2

Are the proceeds received in compensation for the acquisition of an easement over your land by a public authority assessable under the capital gains tax (CGT) provisions of the ITAA 1997?

Answer:

Yes

Question 3

Will the cost base of the land need to be modified to take into account the acquisition of an easement over your land by a public authority?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You purchased a block of land.

The land is vacant and is not used for any business activity.

A state government body acquired an easement over your land.

The state government body had the authority to compulsorily acquire the easement, however, the easement was acquired by agreement with the state government body.

You received a sum of money, after legal fees, in compensation for the reduction in value of your land due to the easement.

You retain ownership of the land and easement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 112-30

Income Tax Assessment Act 1997 Subsection 112-30(3)

Reasons for decision

Summary

The capital proceeds received in compensation for the acquisition of an easement over your land is not assessable as ordinary income; however, it will be assessable under the capital gains tax provisions.

The proceeds are considered to be a payment in compensation for the loss of part of your ownership rights of the land and therefore constitutes a part disposal of the land. CGT event A1 (disposal of a CGT asset) is taken to have occurred. The time of the event is when you entered into the contract for the disposal of the easement or, if there is no contract, when the change of ownership occurs. Accordingly, you will be assessed on the net capital gain arising from the event.

Detailed reasoning

Assessable as ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property (rent) and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

In your case, you have not earned the lump sum payment as it does not directly relate to services performed. It is not income from property (rent) or from carrying on a business as you are not involved in either of these activities. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. In addition, the payment is neither expected nor relied upon.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. The compensation payment you have received is not compensation for the loss of income, but compensation for the loss of a capital asset (part of your ownership your rights). Accordingly, the lump sum payment is not considered ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Assessable under capital gains tax provisions

Amounts received which are not direct compensation for loss of income, will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Taxation Rulings TR 95/35 and TR 97/3 discuss the capital gains treatment of compensation receipts. Taxation ruling TR 97/3 extends the application of TR 95/35 and should be read in conjunction with that ruling. TR 97/3 specifically deals with compensation received by landowners from public authorities. This ruling, therefore, will have direct application in this case.

Paragraphs 6 through 10 of TR 97/3 state:

…In the case of easements acquired under statute and the consequential disposal of the right to compensation, the most relevant asset is the landowner's pre-existing land with its rights of ownership including, for example, a right to exclude all others. This right to exclude all others is forfeited in part when the easement comes into existence. The loss of part of this right constitutes the disposal of part of the underlying asset (the land).

The acquisition of an easement by a public authority using the compulsory process provided in the relevant statute culminates in a declaration by notice in the Gazette that the easement has been acquired. However, it is possible that a public authority may acquire an easement by agreement with the landowner. Because the grantee of the easement (the public authority) has available, if it chooses to exercise it, the power to compulsorily acquire the easement, the amount received, in our view, takes on the same character as compensation for a compulsorily acquired easement. It is therefore appropriate that Part IIIA apply in the same way, that is, the consideration (compensation) is paid in respect of the part disposal of the land and not in respect of the grant of the easement.

In your case, you received compensation from a state government body for the reduction in your land value due to the acquisition of an easement over part of your land. The state government body had the authority to compulsorily acquire the easement if necessary. You still retain ownership of the easement.

As per ruling TR 97/3, the compensation payment is considered to be in respect of the loss of part of your rights of ownership which constitutes the disposal of part of the underlying land.

As such, CGT event A1 (the disposal of a CGT asset) has occurred. Section 104-10 of the ITAA 1997 provides that the time of the A1 event is taken to have occurred when you entered into the contract for the disposal of the easement or, if there is no contract, when the change of ownership occurs.

Accordingly, if the capital proceeds received in compensation exceed the cost base of the asset in question, you would be considered to have made a capital gain, and it will be assessable under the capital gains tax provisions.

Apportionment of cost base (CGT event happens to part of an asset)

Section 112-30 of the ITAA 1997 provides apportionment rules which can be used to calculate the cost base of an asset when a CGT event happens to some part of the asset. Subsection 112-30(3) of the ITAA 1997 provides the following formula:

In your case, as there has been a part disposal of the land, you should calculate the cost base of the asset in accordance with the apportionment rules as detailed above.

Capital gains tax implications on future disposal of asset

On subsequent disposal of the asset in question, CGT event A1 will occur.

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. land) is transferred to another entity.

In calculating any capital gain or loss made on the subsequent disposal of the property, you should take into account any adjustment made to the cost base of the asset as discussed above.

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