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Edited version of private advice
Authorisation Number: 1012685777997
Ruling
Subject: Default purchase
Questions and Answers
Can your outgoing for the payment of a compensation amount paid to avoid possible legal action be used to offset gains from a property sale?
No
Can your outgoing for the payment of a compensation amount paid to avoid possible legal action be used to reduce your assessable income?
No
This ruling applies for the following period
Year ended 30 June 2012
The scheme commences on
1 July 2011
Relevant facts and circumstances
You were told by a financial advisor that you were in a position to bid on a property that you were looking to purchase.
You attended the auction and had the winning bid ($xy).
You were subsequently told by your financial advisor that the bank would not approve your financing for the property you bid on.
You notified the real estate agent of your circumstances.
The real estate offered the property to the losing bidder who offered a lesser amount ($x less than your bid).
You were given the option of paying the difference ($x) to the vendor or risk being taken to court.
You paid the difference.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 102-20
Reasons for decision
Capital gains and determining what is an asset
Where a compensation payment is made in relation to a real estate contract, it is necessary to distinguish what is the relevant asset for the purposes of CGT.
The underlying asset approach
In determining what is the most relevant asset it is appropriate to adopt a 'look-through' approach to the transaction or arrangement which generates the compensation receipt. We regard this concept as the most appropriate basis on which to determine whether any capital gain arises on the disposal of any asset of the taxpayer.
Warner J in Zim Properties v. Procter (Inspector of Taxes) STC 90; 58 TC 371 applied this look-through approach in determining from which asset the settlement sum was derived. His Honour considered that the choice of which was the most relevant asset depended on the 'reality of the matter'. There, the taxpayer had contracted to sell certain property. However, the buyer was able to repudiate the contract because the taxpayer could not show good title to the property. The taxpayer then sued its solicitors for negligence and was awarded an amount of compensation for that negligence.
Warner J held that the settlement amounts paid by the solicitors were not derived from the real estate but were derived from the right to sue.
The payment was made to avoid legal action being taken against you, it was not paid in relation to an asset of yours therefore there was no CGT event and no CGT loss.
The payment was not made in earning your assessable income or carrying on a business so there is no deduction available under section 8-1 of the Income Tax Assessment Act 1997
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