Edited version of private advice

Authorisation Number: 1051634042535

Date of advice: 12 February 2020

Ruling

Subject: Compensation to settle a claim, real property leasing

Question 1

Is the settlement sum received assessable under the capital gains tax (CGT) provisions?

Answer 1

Yes

Question 2

Is the settlement sum received considered ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 2

No

Question 3

Is the settlement sum received exempt income under section 6-20 of ITAA 1997 or under Division 54 of ITAA 1997?

Answer 3

No

This ruling applies for the following period:

1 July 2018 to 30 June 2019

The scheme commences on:

1 January 2014

Relevant facts and circumstances

You as the Trustee for Family A Trust (the lessor) purchased the land and building known as the Property A (the property) after 20 September 1985.

Company A (the lessee) occupied the property at the time of purchase and the lessee signed a new lease agreement with the lessor upon settlement.

The lease agreement was for a specific period which was renewed with a new agreement at the end of the term for another specific period.

The lessor utilised the services of a property agent.

The last lease agreement between the parties for another period was not signed by the lessee; however the lessee commenced paying the monthly rental amount as was specified on the new lease agreement.

The lessee vacated the property over five years ago with no written notice given to the lessor. Upon departure, the lessee owed one month rental and some outgoings.

Upon inspection of the property following departure of the lessee, the lessor noticed some damages.

The lessor contacted the lessee to obtain restitution for the various breaches to the lease agreement, but was unsuccessful.

The lease agreement contained various clauses that are important in this situation.

The lessor sought legal representation and intended to proceed to court.

Recently, a Deed of Settlement and Release was signed whereby a settlement sum being an undissected amount was paid by the lessee.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 6-20

Income Tax Assessment Act 1997 Division 54

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

A payment or other benefit received by a taxpayer is assessable income if it is:

a) income in the ordinary sense of the word (ordinary income); or

b) an amount or benefit that through the operation of the provisions of the tax law is included in assessable income (statutory income).

Ordinary income

Subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income).

The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics.

Characteristics of ordinary income that have evolved from case law include receipts that:

a) are periodical, regular or recurrent;

b) are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and

c) are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient.

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

Statutory income - capital gains

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a legal or equitable right that is not property.

Taxation Ruling 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation.

Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the payment.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 to be the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related.

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

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. A C2 event can apply where there is a release or discharge of a right to seek compensation.

Exemptions

Section 6-20 of the ITAA 1997 provides that an amount of ordinary income is exempt income if it is made exempt from income tax by a provision of the ITAA 1997 or another Commonwealth law.

Division 54 of the ITAA 1997 provides an exemption for certain annuities and lump sums provided to personal injury victims under structured settlements or structured orders.

In your circumstances

The Commissioner considers that the amount received is not ordinary income and relate to the disposal of your right to seek compensation. The right to seek compensation was acquired at the time of the compensable event occurring. CGT event C2 happened when you accepted the offer of compensation.

The exemptions do not apply to your case as the amount received is not made exempt by any provision of the ITAA 1997 and is not as a result of being the victim of a personal injury.

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