Edited version of your written advice

Authorisation Number: 1051415990890

Date of advice: 22 August 2018

Ruling

Subject: Capital gains tax - compensation

Question 1

Does the entire amount of compensation received by the Company relate to the permanent reduction in value of the pre - CGT land held by the taxpayer?

Answer

No

Question 2

If the answer to Question 1 is no, are the payments eligible to be apportioned between compensation received by the Company in respect of damage or reduction in value of the land and payment for the Noise Easement?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 2015

Income year ended 30 June 2016

Income year ended 30 June 2017

The scheme commences on:

1 July 2014

Relevant facts and circumstances

The Company was incorporated in 19XX.

The Company was incorporated by the Shareholder with their former spouse and their parent.

In 19XX the Shareholder acquired their former spouses and their parent’s shares in the Company under an Order of the Relevant Court.

The Shareholder currently owns 100% of the shares in the Company.

In 20XX the Shareholder resigned as Director of the Company.

The Shareholder’s child and spouse were then appointed Directors of the Company.

The Company owns the property, which is comprised of farmland held on a number of titles and used for primary production activities.

The property was acquired by the Company prior to 20 September 1985.

Part of the property includes concessional blocks that were permitted by local Council to be subdivided into X acre lots. These blocks have panoramic views, potentially giving them higher values than mere farmland.

Construction began in the local area in 20XX.

A number of energy sources have now been installed in close proximity to the property including:

● X sources within 2km of the residence; and

● Y sources within 100ms of the boundary fence.

A number of the sources that comprise of the construction were erected in the incorrect position, placing Z energy sources closer to the property than allowed under the Development Application (DA).

Council restricts the construction of residences within 2km of an energy source, which affects the concessional blocks with subdivision potential located on the property.

State A Planning Assessment Commission (PAC) was engaged to review the impacts of the energy sources which were constructed in the wrong locations.

The PAC refused the Developer’s application for retrospective approval of the incorrectly placed energy sources due to the noise and visual impacts on neighbouring properties.

No modifications have occurred following this ruling.

The Shareholder has been opposed to natural farming for a number of years and established a local action group. The Shareholder and undertook media interviews focused on rural amenity and reduction in land values in opposition of the construction of the Energy source Farm.

The Shareholder has protested the incorrect positioning of the energy sources, with particular emphasis on the Z energy sources that have been constructed closer to the property than allowed under the DA.

The Company entered into a Deed for the settlement of the dispute with the company that constructed the Energy source Farm in 20XX (the Deed).

The Deed has listed the parties to the agreement as stated.

The Deed provides for the following payments to be made to the Landowner:

● An initial payment of $X,XXX,XXX (GST- exclusive), payable within XX days of the commencement date (Initial Payment).

● Energy source Payments of $XX,XXX per source (GST- exclusive) if no Order has been made requiring the relocation of the Z incorrectly placed energy sources by late 20XX (Energy source Payments).

● Energy source Payments of $XX,XXX per source (GST- exclusive) if no Order has been made requiring the relocation of the Z incorrectly placed energy sources by late 20XX.

All payments due to be paid, including Energy source Payments, have been paid in line with the schedule provided under the Deed.

The Deed acknowledges receipt of an “Agreed Letter” from the Shareholder and Director.

The Agreed Letter is addressed to the Minister for Planning and states that each of the relevant properties are now an ‘associated residence’ to the Energy source Farm and that they no longer:

● object to the Energy source Farm, or

● require or support the relocation of any energy sources which form part of the Energy source Farm from their current position.

The Deed reflects the content of the letter and imposes further conditions on the Parties which have been stated in this ruling.

The Deed states that the ‘Parties agree that the Initial Payment represents compensation for among other factors a Noise Easement’ and further provides that: the parties will ‘do all things necessary to have the Noise easement registered with Land and Properties Information on the title of the Properties’.

The Deed provides that the Landowner, Shareholder and Director release the Energy source Farm and any Proponent from all claims, which they may have against the Energy source Farm in respect of, or in relation to:

● the construction or operation of the Energy source Farm

● any impact of the Energy source Farm on the properties or on any other land owned by the Landowner, Shareholder and Director, including impacts relating to noise or sound pressure levels, traffic movements, visual amenity, emissions or construction;

● the conditions of the Project Approval

The compensation payment was negotiated verbally with the CEO of the Energy source Farm.

Compensation sought at the commencement of the negotiations have been outlined and the amounts have been stated in this ruling.

The total compensation you actually received is approximately XY% of the amount originally sought.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 section 116-40

Reasons for decision

Question 1

Does the entire amount of compensation received by the Company relate to the permanent reduction in value of the pre - CGT land held by the taxpayer?

Answer

No

Summary

The entire amount of compensation does not relate to the reduction in value of the land, because a portion of the payment relates to the Noise Easement granted under the Deed of Settlement which is a separate capital gains tax (CGT) asset. The compensation receipt must be apportioned on a reasonable basis between the reduction in value of the land, and disposal of the Noise Easement.

Detailed reasoning

The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 Capital gains: treatment of compensation receipts (TR 95/35).

A compensation receipt, or compensation, includes any amount received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not it is:

● in relation to any underlying asset;

● arising out of Court proceedings; or

● made up of dissected amounts.

Undissected amounts

An undissected lump sum compensation receipt is any amount of compensation received where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated.

It is likely that a lump sum compensation amount can be dissected using the information which was available at the time of making the compensation claim.

Underlying asset

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

Compensation received by a taxpayer for the disposal or permanent damage or reduction in value of an asset has no CGT consequences if the underlying asset to which it relates was acquired by the taxpayer before 20 September 1985.

Right to seek compensation

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal of the right to seek compensation.

The right to seek compensation is the right of action arising at law or in equity on the occurrence of any breach of contract, personal injury or other compensable damage or injury. The right to seek compensation is an asset for CGT purposes.

In many cases there is both an underlying asset and a right to seek compensation. Determining the most relevant asset depends on whether the underlying asset has been permanently damaged or permanently reduced in value. If the underlying asset has not been affected in that way and there is no disposal or part disposal of the underlying asset, the compensation must be received for the surrender of the right to seek compensation.

Apportionment

If there is more than one underlying asset, the relevant asset is the asset which leads directly to the payment of the amount of compensation.

Where the total compensation is paid in relation to multiple assets, pre-CGT and post-CGT assets or for multiple reasons, the total compensation is to be apportioned between the assets, and each portion examined separately to determine the appropriate treatment.

Easement

Taxation Ruling IT 2561 Income tax: capital gains: grants of easements, profits a prendre and licences explains that an easement (or other comparable right) is an asset created at the time it is granted.

If the grant of the easement occurs on or after 20 September 1985, the CGT provisions apply on the disposal of the new asset. This applies even though the land the easement is granted over may have been acquired before 20 September 1985.

Application to your circumstances

Initial payment

The Initial Payment is a lump sum amount which can be attributed to a number of heads of claim, being:

● the Property becoming an “associated residence” to the Energy source Farm;

● the Parties to the agreement will no longer object to the Energy source Farm, or the relocation of energy sources, in any way;

● the Parties acknowledge they have been compensated for any impact to their property;

● the Parties release the Energy source Farm from all claims, and agree to lodge none further;

● the Parties will provide consent to all applications regarding the Energy source Farm, except for the construction of any new energy sources within 3km of the main residence;

● the Parties will execute and allow a Noise Easement to be registered in favour of the Energy source Farm.

No specified amount has been allocated to any of the heads of damage in the terms of the Deed.

During the course of your negotiations regarding the compensation payment, you submitted claims which attributed value to the various heads of damage.

While you did not ultimately receive the full amount of compensation sought, and do not have access to the reasoning of the Energy source Farm in consideration of the value attributed to the various claims, we consider that the Initial Payment is capable of being determined, valued or otherwise reasonably estimated.

Therefore, we do not consider the Initial Payment to be an undissected lump sum and the amount is not considered to have been received wholly in respect to the disposal of the right to seek compensation.

However, the full amount of the compensation received does not relate only to the reduction in value of the land caused by the construction of the Energy source Farm.

Easement

The Deed provides that part of the Initial Payment is compensation for the grant of a Noise Easement.

The Noise Easement is a separate CGT asset which came into existence (and was owned by you) immediately before it was granted to XYZ.

Because the easement was created after 20 September 1985, it is a post CGT asset.

When you granted the Noise Easement to XYZ, CGT event A1 occurred, and you are taken to have disposed of the asset at that time.

Therefore, the Noise Easement is the relevant underlying asset in respect to part of the Initial Payment.

Energy source payments

The Deed provides for the payment of ‘Energy source Payments’, conditional on no Order being made requiring the relocation of the energy sources by a certain dates specified in the Deed.

We consider that the most relevant underlying asset in relation to each of the energy source payments is the land, as the payment is directly related to the right of the Landowner take action to seek an Order requiring the relocation of the energy sources, due to their proximity and resulting impact on the land in contravention of the terms of the Development Approval.

Right to seek compensation

In your case, you are the legal owner of the property affected by the Energy source Farm.

You have entered into a Deed of settlement in respect of the construction of the Energy source Farm, and in particular the placement of certain energy sources in contravention of the terms of the DA.

The Landowner is entitled to payment of compensation under the terms of the Deed.

The Shareholder and Director are named as parties to the Deed, but are not owners of the land in their personal capacity. They are not entitled to receive the compensation under the terms of the Deed.

To the extent that the release relates to the Shareholder and Director, the payment can be attributed to the Shareholder’s interest in the land as the 100% shareholder of the Company, and The Director’s position in relation to the Company which owns the land. A reduction in value of the land held by the Company would be detrimental to each of their interests in these capacities.

Therefore, we do not consider that any portion of the compensation payment relates to the disposal of the right to seek compensation by the Shareholder or Director in their personal capacity.

Conclusion

The compensation received by the Company, other than that portion which can be attributed to the grant of the Noise Easement, has a direct and substantial link with the reduction in value the of the land caused by the incorrect placement of the energy sources.

Accordingly, it is considered that the amount of compensation which is not attributed to the Noise Easement is compensation for permanent damage or permanent reduction in the value of the land.

Question 2

If the answer to Question 1 is no, are the payments eligible to be apportioned between compensation received by the taxpayer in respect of damage or reduction in value of the land and payment for the Noise Easement?

Answer

Yes

Detailed reasoning

The effect of TR 95/35 as applied to the Income Tax Assessment Act 1997 (ITAA 1997) is that if compensation relates to a number of heads of claim, section 116-40 of the ITAA 1997 requires the taxpayer to apportion the compensation on a ‘reasonable basis’ to each of those claims.

In your case, part of the compensation received relates to the reduction in value of the underlying asset being the land, and part of it represents compensation or consideration for the disposal of the Noise Easement at the time it was granted.

The payment must therefore be apportioned on a reasonable basis between the reduction in value of the land and the grant of the Noise Easement.

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