Edited version of private advice

Authorisation Number: 1051572743297

Date of advice: 5 September 2019

Ruling

Subject: Compensation

Question 1

Will the portion of the compensation received for the compulsory acquisition of each property be regarded as capital proceeds for your capital gains tax (CGT) event A1 in accordance with section 116-20 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the portion of the compensation received for permanent damage to each property reduce the cost base of the property for any future capital gain?

Answer

Yes

Question 3

Will compensation received for the temporary disturbances of the businesses carried out on the properties be assessable as ordinary income under section 6-5 of the ITAA 1997 or assessable recoupments under Subdivision 20-A of the ITAA 1997?

Answer

Yes

Question 4

In determining the portion of the compensation that is the capital proceeds under section 116-20 of the ITAA 1997 for the compulsorily acquired land, is a value per hectare basis considered to be reasonable?

Answer

Withdrawn

Question 5

If the compensation received for the temporary disturbances is assessable income, are they assessable primary production income in accordance with subsection 392-80(2) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Part of each of your properties was compulsorily acquired.

You received compensation for the resumption of the land and temporary disturbances.

The compensation that you received for the resumption of the land took into account the estimated value of the land and the effect of severing the land on the remainder of the property.

The compensation for temporary disturbances takes into account potential expenses you may incur in your businesses because certain sections of the properties may not be accessible for a time as a result of the activity undertaken on the land.

Each property is used for primary production businesses.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 subsection 110-40(3)

Income Tax Assessment Act 1997 subsection 392-80(2)

Income Tax Assessment Act 1936 subsection 25(1)

Reasons for decision

All references made in these reasons for decision are to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

The portion of the compensation received for the compulsory acquisition of the property will be the capital proceeds for your CGT event A1 in accordance with section 116-20.

Detailed reasoning

Whether or not a particular receipt is ordinary income, statutory income or a capital receipt depends on its character in the hands of the recipient. For income tax purposes, a compensation amount generally bears the character of that which it is paid to replace.

Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) considers the CGT consequences for compensation receipts and relevantly, in relation to the disposal of an underlying asset it states at paragraph 4 that:

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset.

The underlying asset is identified using the 'look-through approach' in order to determine the asset to which the compensation amount most directly relates. Paragraph 70 of TR 95/35, provides that the underlying asset is identified by looking through to the transaction which generates the compensation receipt.

CGT event A1 happened when the resumed land was compulsorily acquired (Section 104-10). Under subsection 116-20(1), the capital proceeds from the CGT event is the total of:

(a)  the money you have received, or are entitled to receive, in respect of the event happening; and

(b)  the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

Paragraph 83 of TR 95/35 explains that:

If the compensation receipt relates to more than one relevant asset, the compensation needs to be apportioned between those assets. Similarly, if the amount is received for a number of heads of claim (e.g., lost profits, interest and punitive damages), the amount also needs to be apportioned between the items.

As the compensation received includes compensation in respect of the disposal of an underlying asset, being the resumed land, that portion of the compensation represents consideration received on the disposal of that asset and is capital proceeds for that CGT event.

Question 2

Summary

The portion of the compensation received for permanent damage for each property will reduce the cost base of the relevant property for any future capital gain.

Detailed reasoning

Paragraphs 6 and 7 of TR 95/35 provide that compensation received wholly in respect of permanent damage or reduction in value of a post-CGT underlying asset that is not disposed of represents a reduction in either the CGT cost base under either subsection 110-40(3) (for assets acquired before 7.30pm on 13 May 1997) or subsection 110-45(3) (for assets acquired after 7.30pm on 13 May 1997).

Paragraph 16 TR 95/35:

If the amount of compensation is received by the taxpayer partly for permanent damage suffered to, or a permanent reduction in the value of an underlying asset of the taxpayer, that part of the receipt which represents a recoupment of part of the total acquisition costs incurred in respect of the underlying asset reduces the total acquisition costs.

For the purposes of TR 95/35, permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or reduction in value that has permanent effect unless the taxpayer takes action to put it right

As the compensation takes into account the damage caused to the remaining land which has not been disposed of, any compensation received in respect of the permanent damage or reduction in value will reduce the cost base for any future capital gain.

Question 3

Summary

The compensation for temporary disturbances received is assessable under section 6-5 as ordinary income or under 6-10 as assessable recoupments in accordance with Subdivision 20-A.

Detailed reasoning

Subsection 6-5(1) provides that an amount is included in assessable income if it is income according to ordinary concepts.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts.

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? - explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income:

·         if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

·         to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

Assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10).

Subdivision 20-A provides that certain amounts received by way of insurance, indemnity or other recoupment are included as assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Subsection 20-20(2) provides that an amount received as a recoupment of a loss or outgoing is an assessable recoupment if:

(a)  you received the amount by way of insurance or indemnity; and

(b)  you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

The word indemnity is not defined in the legislation and so takes its ordinary meaning. According to the Macquarie Dictionary, Macmillan Publishers Australia, The Macquarie Dictionary Online, www.macquariedictionary.com.au, viewed 24 June 2019 this includes 'compensation for damage or loss sustained' and 'something paid by way of such compensation'.

The determination of the compensation for temporary disturbances provides for the potential expenses you may incur in your business because of the effect of activity undertaken on the land.

The compensation for temporary disturbances will be assessable under section 6-5 to the extent that it is ordinary income of the applicants.

To the extent that it is not ordinary income but satisfies the requirements of subsection 20-20(2) they will be assessable recoupments under Subdivision 20-A. Recoupments received in advance are only assessable in the year that the expenses being recouped are incurred.

Question 5

Summary

The compensation for temporary disturbances is assessable primary production income in accordance with subsection 392-80(2).

Detailed reasoning

Subsection 392-80(2) states that

Your assessable primary production income for the current year is the amount of your basic assessable income for the current year that was derived from, or resulted from, your carrying on a primary production business.

The Income Tax legislation does not provide guidance as to when an amount was derived from, or results from, someone carrying on a primary production business. However, the Explanatory Memorandum to the Income Tax Assessment Amendment Bill (No. 2) 1978, which first used the words 'assessable primary production income' in the corresponding provision in the ITAA 1936, indicates that the relationship between the income and the primary production business is to be close and direct rather than indirect or remote.

The definition of 'assessable primary production income' in the corresponding provision in the ITAA 1936 uses the phrase 'in consequence of the carrying on of a business of primary production'.

In TT89/25 and Commissioner of Taxation [1990] AATA 233 Dr Gerber observed:

The term "in consequence of " connotes causality - in this case whether the interest was "caused" to be derived as the "predominant" or "proximate" or "direct" result of the carrying on of the business of primary production. This is a question of fact.

The determination of the compensation for temporary disturbances provides for the potential expenses you may incur in your business because of the effect of activity undertaken on the land.

Each property is used in a primary production business. The compensation for temporary disturbances takes into account the disturbance to this usage of the property. There is a causative connection between the income derived and the primary production business being carried on.

Therefore, the compensation for temporary disturbances is assessable primary production income in accordance with subsection 392-80(2).

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