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Edited version of your written advice

Authorisation Number: 1051209488789

Date of advice: 3 April 2017

Ruling

Subject: Compensation receipt - capital gain - CGT exemption - discount capital gain

Question 1

Is the capital gain you make from receiving the payment disregarded?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts

You invested money in a scheme to purchase land located in overseas from a company.

You made instalment payments during the period of 200X and 200Y.

After investigations you identified that the investment was a scam activity.

You commenced negotiations in 201Z with the company to recover the monies you had invested.

These negotiations were unsuccessful, so you commenced expensive legal proceedings.

After a lengthy period of time the relevant legal body, found in your favour.

A payment was received as full and final compensation for the claim.

You have made a small gain from this series of events.

Relevant legislative provisions

Income tax assessment Act 1997 Section 104-25

Income tax assessment Act 1997 Section 108-5

Income tax assessment Act 1997 Section 110-25

Income tax assessment Act 1997 Section 115-25

Income tax assessment Act 1997 Section 118-37

Reasons for decision

Summary

The capital gain or loss made from the receipt of damages compensation is not a disregarded capital gains tax event unless the amount is received for a wrong suffered personally.

Detailed reasoning

In determining whether or not an exemption for a CGT event can be applied it is important to identify the most relevant asset involved in the transaction or arrangement which generates the compensation receipt.

In order to do this we must determine how the compensation receipt has been derived.

Section 108-5(1) of the ITAA 1997 identifies that a CGT asset is any kind of property or a legal or equitable right that is not a property, this includes a right to enforce a contractual obligation.

This includes the right to sue in relation to a breach of contract. In Loxton v. Moir (1914) 18 CLR 360, Rich J at 379 noted:

The cost base of a right to seek compensation must be determined in accordance with section 110-25 of the ITAA 1997. This generally includes the amount you paid in respect to acquiring the asset, costs incurred in acquiring the asset or relating to the CGT event and the costs of owning the asset.

Taxation Ruling TR 95/35 Capital gains: treatment of compensation receipts (TR 95/35) sets out the Commissioner's view in relation to the treatment of compensation receipts.

Paragraph 18 of TR 95/35 states that if the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

Section 104-25 of the ITAA 1997 identifies that:

Section 115-25 of the ITAA 1997 identifies that a discount capital gain can be applied to an asset that was acquired at least 12 months before the CGT event takes place. In relation to a C2 CGT event this discount amount is 50%.

Section 118-37 of the ITAA 1997 disregards a capital gain or loss from a CGT event when the compensation or damages is received for:

In your circumstance you have entered into a contractual arrangement to invest in the purchase of land. Although the land did not physically exist, by investing in the scheme you obtained the right to enforce the contractual obligation.

You have made a choice to execute this right by commencing legal proceedings to recover the amounts that you had invested. The outcome of the legal action, being the compensation payment that you have received is the transaction that we are able to use in order to determine the asset for CGT purposes.

That is, that the nature of the court ordered payment is the transaction that creates the CGT event. As the event that took place resulted in the surrender of your right to enforce the contractual obligation, CGT event C2 has taken place at the time the court order was given and you forfeited your right to seek further action.

As you acquired the asset at the time that you entered into the arrangement of investing into the scheme, you have held the asset for longer than 12 months. Therefore you are eligible to apply the 50% CGT discount to any capital gain that has resulted from this CGT event.

You are unable to apply an exemption to the capital gain or loss from this activity as the wrong that you suffered was not personally. When considering the phrase “personally” we look at the nature of the interactions that took place. In this instance you suffered a wrong in a financial sense brought about from an investment decision and not an interaction that is considered to be private or domestic in nature.

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