Edited version of your written advice

Authorisation Number: 1051331555202

Date of advice: 30 January 2018

Ruling

Subject: Compensation received as a result of a compulsory acquisition

Issue 1

Capital gains tax (CGT) consequences

Question 1

Does the disturbance payment form part of the capital proceeds received in respect of the surrender of the commercial lease?

Answer

No.

Question 2

Does the disturbance payment form part of the capital proceeds received in respect of the disposal of the right to seek compensation?

Answer

Yes.

Question 3

Does CGT event C2 occur in relation to the disturbance payment received? If so, which items form the cost base?

Answer

Yes. Refer to the reasons for decision for more information.

Issue 2

Assessable recoupment

Question 1

Is any amount of the disturbance payment an assessable recoupment under Division 20 of the Income Tax Assessment Act 1997?

Answer

Partially.

Question 2

If the disturbance payment is assessable, in which financial year is it assessable?

Answer

The 2017–18 financial year.

Issue 3

Goods and services tax (GST)

Question 1

Does GST apply to some or all of the disturbance payment received?

Answer

No.

This ruling applies for the following period:

1 July 2016 to 30 June 2018 inclusive.

Relevant facts and circumstances

The company is registered for GST.

For a number of decades, and starting after 20 September 1985, the company rented a property (the property) from a related entity, which is a trustee for a trust (the landowner). The lease was on commercial terms, registered with the regulatory authority, and was for a long-term period.

In 20XX, the city council gave notice to the company of an intention to acquire the property under state legislation. In this notice, the council advised it was willing to negotiate the amount of compensation by agreement; failing agreement, the compensation would be dealt with under the relevant legislative process.

The landowner and the council reached an agreement regarding the acquisition of the property. The contract of sale was signed and settlement occurred.

Before settlement, a deed of indemnity was entered into for the company’s disturbance payment and to allow the company to remain at the property for a reasonable period of time after settlement. This was extended twice. According to the deed, the council is only obligated to pay the disturbance payment upon vacant possession of the property. This eventually occurred and the company received the disturbance payment a few months after settlement of the property.

The company provided a list of disturbance costs and their amounts. These included professional fees in relation to the negotiation of the disturbance costs, as well as relocation-related costs such as removalist’s fees, refitting costs, utility disconnections and reconnections, marketing, stationary updates, new signage, and business interruption costs.

The company’s claim amounted to a sum that was reduced by the council, and then subsequently further reduced to a particular amount with the condition that allowed the company to remain at the property months after settlement.

It is unclear whether the council disagreed with certain disturbance items or apportioned them to arrive at the later lower amounts, or a combination of these approaches.

The deed of indemnity states the council requires the company to surrender its registered lease, in the form of a surrender of lease, and to vacate the premises. Another clause of the deed states that the company agrees to accept the disturbance payment:

…as full compensation for business disturbances associated with the proposed resumption of the Property under all heads in full and final settlement, satisfaction and discharge of any costs or expenses whatsoever incurred by the Claimant [the company].

Another clause of the deed also states:

The Claimant [the company] HEREBY RELEASES AND FOREVER DISCHARGES AND INDEMNIFIES the Council and its members, officers, agents, servants and workmen from all actions, suits, proceedings, sums of money, accounts, reckonings, claims and demands whatsoever which the Claimant or any other person has, had or hereafter may have in connection with or arising out of or incidental to the Claimant’s [the company’s] business disturbance associated with the proposed resumption of the Property [emphasis in original].

The deed of indemnity did not obligate the company to either incur any expenses or repay any part of the disturbance payment that was not expended. The company regards the disturbance payment as an undissected lump sum.

In the private ruling application, it was provided that the company does not expect to make any claims under Division 40 of the Income Tax Assessment Act 1997 as it applies the small business entity concessions in relation to depreciation under Subdivision 328-D.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 20

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 Subdivision 328-D

A New Tax System (Goods and Service Tax) Act 1999 section 9-5

A New Tax System (Goods and Service Tax) Act 1999 section 9-10

A New Tax System (Goods and Service Tax) Act 1999 section 9-15

A New Tax System (Goods and Service Tax) Act 1999 section 9-40

Reasons for decision

Issue 1

Question 1

Summary

The disturbance payment relates to the satisfaction of the right to receive the disturbance payment, rather than the surrender of the lease. As such, the disturbance payment does not form part of the capital proceeds received in respect of the surrender of the commercial lease.

Detailed reasoning

All legislative references in this private ruling are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

A capital gain or a capital loss is made as a result of a CGT event happening to a CGT asset.

Subsection 108-5(1) provides that a CGT asset is any kind of property or a legal or equitable right that is not property. A leasehold interest in land is therefore a CGT asset.

The right to seek compensation is also a CGT asset in accordance with paragraph 34 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35). In this case, the right to seek compensation manifests as the right to receive the disturbance payment.

Subsection 104-25(1) provides that CGT event C2 happens when the company’s ownership of an intangible CGT asset ends by the asset:

● being redeemed or cancelled

● being released, discharged or satisfied

● expiring

● being abandoned, surrendered or forfeited.

Subsection 104-25(2) provides that the timing of the CGT event is the time that the contract that results in the asset ending is entered into. In this case, this was the date the deed of indemnity was entered into.

Subsection 104-25(3) provides that you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

It must therefore be determined to what extent, if any, the disturbance payment relates to the surrender of the lease and to what extent it relates to the satisfaction of the right to receive the disturbance payment. However, the nature of this particular disturbance payment is such that it may be considered an undissected lump sum compensation amount.

Paragraph 188 of TR 95/35 provides that whether a receipt constitutes income or capital in the hands of the taxpayer depends on the circumstances of the receipt and the reasons why it was paid to the taxpayer. Paragraph 190 provides that the facts and circumstances surrounding the receipt may enable a reasonable apportionment of the lump sum payment into its constituent elements, notwithstanding the fact that it has not already been separated into component elements.

Paragraph 204 of TR 95/35 provides that if the disturbance payment is unable to be allocated on any reasonable basis, for example, because there is insufficient information on the claims made or the basis of acceptance of the compensation, then we consider that the whole amount of compensation must relate to the disposal of the right to seek compensation.

The Full Federal Court in FC of T v Spedley Securities Ltd 88 ATC 4126; (1988) 19 ATR 938 accepted that an effective discharge document signed by the taxpayer on settlement of all possible claims arising out of the termination bars any further legal proceedings. It effectively represents the surrender or satisfaction of the right to seek compensation. Thus, if the compensation relates to a number of heads of claim, or causes of action, but the individual components of the compensation cannot be determined or estimated, no part of the compensation can be said to relate to any particular claim.

Applying this to the current case, as stated in the deed of indemnity and agreed to by the council and the company, the disturbance payment was paid ‘as full compensation for business disturbances’ associated with the council’s acquisition of the property. The disturbance payment is made in ‘full and final settlement, satisfaction and discharge of any costs or expenses whatsoever incurred by the [company].’ It is clear from the operative provisions of the deed of indemnity between the council and the company that the disturbance payment relates to the satisfaction of the right to receive the disturbance payment, rather than the surrender of the lease. As such, it is considered that the disturbance payment relates solely to the satisfaction of the right to receive the disturbance payment.

It follows that the disturbance payment does not form part of the capital proceeds received in respect of the surrender of the commercial lease.

Question 2

Summary

The disturbance payment forms part of the capital proceeds received in respect of the disposal of the right to seek compensation.

Detailed reasoning

As discussed above in the detailed reasoning for question one, the receipt of the disturbance payment relates solely to the satisfaction of the right to seek compensation.

Therefore, the disturbance payment forms part of the capital proceeds received in respect of the disposal of the right to seek compensation.

Question 3

Summary

CGT event C2 occurred when the company received the disturbance payment. The professional fees incurred in negotiating the deed of indemnity will form the cost base of the right to receive the disturbance payment. Other costs may also form the cost base, provided there is a direct and substantial link between the expenditure and the arising of the right to receive the disturbance payment.

Detailed reasoning

The right to seek compensation, or in this case, the right to receive a disturbance payment, is a CGT asset under subsection 108-5(1).

Subsection 104-25(1) provides that CGT event C2 happens if ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied.

CGT event C2 occurred when the company received the disturbance payment in satisfaction of the right to receive a disturbance payment.

Subsection 104-25(3) provides that you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Paragraph 94 of TR 95/35 provides that the cost base of a right to receive the disturbance payment must be determined in accordance with section 110-25, which includes the consideration paid in respect of acquiring the right. Paragraph 103 of TR 95/35 provides that expenditure or an outgoing forms part of the cost base of a right to receive a disturbance payment if there is a direct and substantial link between the expenditure or outgoing and the arising of the right to receive the disturbance payment.

Paragraph 104 of TR 95/35 also states:

If the right to seek compensation arises in respect of a monetary loss of the taxpayer (e.g. in respect of a claim for breach of contract, as a result of which the taxpayer must incur additional expenditure) the amount of that loss is included in the cost base of the right to seek compensation for that loss. It is an amount which the taxpayer has paid or is required to pay in respect of the acquisition of the right to seek compensation for having to incur the expenditure.

On the facts provided in this case, there are not any clearly attributable costs of acquiring the right to receive the disturbance payment, except for the professional fees incurred in negotiating the deed of indemnity. Accordingly, those costs will form part of the cost base of the right. Other costs may also form the cost base, provided there is a direct and substantial link between the expenditure and the arising of the right to receive the disturbance payment.

Issue 2

Question 1

Summary

To the extent that the company’s expenses are deducted under Division 40, the disturbance payment will be an assessable recoupment. To the extent that the company’s expenses are deducted under Subdivision 328-D, the disturbance payment will not be an assessable recoupment.

Detailed reasoning

Subdivision 20-A provides that an entity’s assessable income may include an amount received by way of insurance, indemnity or other recoupment if it is for a deductible expense and is not otherwise assessable income.

Subsection 20-20(3) provides that an amount received as a recoupment of a loss or outgoing, except by way of insurance or indemnity, is an assessable recoupment if:

● it is for a loss or outgoing deductible in the current year; or

● you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

● under a provision listed in section 20-30.

Section 20-30 provides tables of deductions for which recoupments are assessable.

Subsection 20-25(1) states:

Recoupment of a loss or outgoing includes:

(a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

(b) a grant in respect of the loss or outgoing.

Under subsection 20-20(1), a disturbance payment will not be ordinary income (other than any part of it that is compensation for loss of profits) or statutory income because of a provision outside Subdivision 20-A.

It is considered that the disturbance payment is a grant in respect of various outgoings within the meaning of paragraph 20-25(1)(b). Therefore, a part of the disturbance payment will be an assessable recoupment under subsection 20-20(3) to the extent that the company can deduct an amount for a loss or outgoing under section 20-30. Outgoings related to the refitting out of a new property may be deductable in the income year in which they are incurred and also in future income years under Division 40 for the decline in value of any depreciating assets acquired with the disturbance payment. If the outgoing is deductible over two or more income years, the method for calculating the amount to be included in assessable income is contained in subsection 20-40(2).

To the extent that the expenses are deducted under Division 40, the disturbance payment will be an assessable recoupment. The company has informed that it deducts expenses under Subdivision 328-D. Subsection 328-175(1) allows a taxpayer to calculate its deductions and some amounts of assessable income under that subdivision instead of under Division 40 if it is a small business entity and meets other eligibility criteria. To the extent that the expenses are deducted under Subdivision 328-D, the disturbance payment will not be an assessable recoupment, as expenses deducted under Subdivision 328-D are not listed as expenses for which recoupments are assessable in section 20-30.

Question 2

Summary

A capital gain as a result of CGT event C2 happening will be assessable in the income year the company received the disturbance payment. To the extent that expenses are deducted under Division 40, the disturbance payment will also be included in the company’s assessable income in the income year it is received. To prevent overlap, the capital gain from CGT event C2 will be reduced to the extent that any part of the disturbance payment is included in the company’s assessable income.

Detailed reasoning

As determined in the reasoning for Issue 1, Question 3, CGT event C2 happens because ownership of the right to receive the disturbance payment ends by the asset being satisfied.

Subsection 104-25(2) provides that the time of CGT event C2 is when the asset ends. Thus, CGT event C2 occurred when the company received the disturbance payment in satisfaction of the right to receive a disturbance payment.

However, the capital gain from CGT event C2 will be reduced to the extent that any part of the disturbance payment is included, either in the income year the disturbance payment is received or any subsequent income year, in the company’s income under section 20-40.

In this regards and to the extent that the expenses relating to capital allowances are deducted under Division 40, the disturbance payment will be an assessable recoupment. Thus the provisions in Subdivision 20-A are relevant.

Subsection 20-40(1) states:

This section includes an amount in your assessable income if:

(a) you receive in the *current year an *assessable recoupment of a loss or outgoing for which you can deduct amounts over 2 or more income years; or

(b) you received in an earlier income year an *assessable recoupment of a loss or outgoing of that kind (unless all of the recoupment has already been included in your assessable income for one or more earlier income years by this section or a *previous recoupment law).

(This section applies even if the recoupment was received before the first of those income years.)

(Items marked with an asterisk (*) are defined in the dictionary at section 995-1 of the ITAA 1997).

Accordingly, to the extent that expenses are deducted under Division 40, the disturbance payment will be included in the company’s assessable income in the income year it is received.

This means that the capital gain must be reduced by the part of the disturbance payment that was used by the company to acquire any depreciating asset to the extent that the depreciating asset is used for a taxable purpose. This will require the company to forecast the future use of a depreciating asset and seek an amendment of their assessment for the income year in which the disturbance payment is received if the actual use of the depreciating asset in a subsequent income year is different form the forecast.

Subsection 118-20(3) provides that the capital gain is reduced by the amount included in the company’s assessable income if the capital gain exceeds that assessable amount.

Subsection 118-20(2) provides that the capital gain is less than the amount included in the company’s assessable income, the capital gain can only be reduced to zero.

Issue 3

Question 1

Summary

The deed of indemnity makes it clear that no part of the compensation is consideration for a supply of surrendering the lease. The compensation relates to the loss suffered by the company on the extinguishment of its interest in the lease. Therefore, the payment from the council relates solely to compensation in relation to the loss you suffered on the extinguishment of your interest in the lease.

Detailed reasoning

Section 9-40 of the A New Tax System (Goods and Services Tax Act 1999 (GST Act) provides you must pay the GST payable on any taxable supply that you make.

One of the requirements of a taxable supply under section 9-5 of the GST Act is that you make the supply for consideration. Consideration includes any payment, or any act or forbearance, in connection with a supply of anything.

Section 9-10 of the GST Act provides that a supply is any form of supply whatsoever which includes, under paragraph 9-10(2)(d), a grant, assignment or surrender of real property.

It is arguable that the company made a supply, in accordance with section 9-10, when it agreed to surrender the lease. However, for any such supply to be a taxable supply, it must be made for consideration.

Whilst the company received the disturbance payment from the council, the deed states that the payment is ‘…full compensation for business disturbances associated with the proposed resumption of the Property under all heads in full and final settlement, satisfaction and discharge of any costs or expenses whatsoever incurred by the Claimant [the company].’

The deed makes it clear that no part of the compensation is consideration for a supply of surrendering the lease. The compensation relates to the loss suffered by the company on the extinguishment of its interest in the lease.

The deed also contains the following another clause that states the company agrees to accept the disturbance payment:

…as full compensation for business disturbances associated with the proposed resumption of the Property under all heads in full and final settlement, satisfaction and discharge of any costs or expenses whatsoever incurred by the Claimant [the company].

Therefore, it is also necessary to examine whether there is a nexus between the payment and any discontinuance supplies.

Paragraph 107 of Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements states:

In most instances, a 'discontinuance' supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement.

The release clause is a condition of the deed. However, as explained in paragraph 107 above, it is merely an inherent part of the legal machinery to add finality to the dispute. It is a condition of the settlement rather than being the subject of the settlement. Therefore, the payment from the council relates solely to compensation in relation to the loss you suffered on the extinguishment of your interest in the lease.

Accordingly, the requirement of paragraph 9-5(a) of the GST Act for there to be a supply for consideration is not satisfied. GST does not apply to the disturbance payment.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).