Edited version of private advice

Authorisation Number: 1052110000032

Date of advice: 26 April 2023

Ruling

Subject: Assessability of ex-gratia payment

Question 1

Is the receipt of an ex-gratia payment, consideration for a taxable supply?

Answer

Yes.

Question 2

Will the receipt of the ex-gratia payment be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

Will the receipt of the ex-gratia payment result in a capital gain under section 102-5 of the ITAA 1997?

Answer

Yes, however any capital gain will be reduced to nil under section 118-20 of the ITAA 1997 as it is included as assessable income under another provision.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commence d on:

1 July 20XX

Relevant facts and circumstances

The Deceased was an artist.

The Executor of the Estate of the Deceased (the Estate), entered into a Deed with unrelated entities in relation to artwork of the deceased that had been acquired when the deceased was alive.

An ex-gratia payment has been made to the Estate under the Deed.

The Estate is in the business in selling the Deceased artwork.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 118-20

Reasons for decision

Taxable supply

GST is payable on any taxable supplies that you make. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) outlines the requirements of a taxable supply:

You make a taxable supply if:

(a)  you make the supply for consideration; and

(b)  the supply is made in the course or furtherance of an enterprise that you carry on; and

(c)   the supply is connected with the indirect tax zone; and

(d)  you are registered or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

To satisfy the first requirement, that you make "the supply for consideration", the ex-gratia payments must have a nexus to an identifiable supply. For GST purposes, a supply is defined very widely as "any form of supply whatsoever" and includes an entry (or release from) an obligation to do anything (section 9-10 of the GST Act).

The ATO view on what constitutes a supply is set out in Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9). In the ruling, it states that an entity will make a supply when it provides "something of value to another entity" (paragraph 71 of GSTR 2006/9).

The Deed states that the Estate will do certain things 'in consideration of receipt of the payment..." which includes providing the certificates of authenticity. As this is 'something of value to another entity', the payment has a sufficient nexus to a supply. Given the other requirements under section 9-5 of the GST Act are also met, the Estate will be making a taxable supply and the payment will be subject to GST.

Assessable Income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that are earned, are expected, are relied upon, and have an element of periodicity, recurrence, or regularity.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

The Estate is in the business of selling the Deceased's artwork. It follows that the compensation is ordinary income of the Estate under section 6-5 of the ITAA 1997 as it relates to the Estate's business activities of Dealing with the Deceased artwork.

Capital gains tax

Part 3-1 of the ITAA 1997 contains the general capital gains and capital loss provisions commonly referred to as the CGT provisions.

CGT event A1 happens of the dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997). You make a capital gain if the capital proceeds from the event are more than the assets cost base subsection 104-10(4) of the ITAA 1997.

While a payment may be characterised as ordinary income, a capital gain may still be made. However, an anti-overlap provision prevents income being assessed as both ordinary or statutory income and a capital gain, the latter being reduced to the extent it is assessed by the former (see section 118-20 of the ITAA 1997).

Taxation ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35), sets out the Commissioner's views on the capital gains tax (CGT) implications of compensation payments. The ruling states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset. A so called 'look-through' approach.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset of the taxpayer, the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation (paragraph 4 of TR 95/35).

Our view is that CGT event A1 occurred upon the signing of the Deed, as it represented the authentication of the previous disposal of the paintings. The settlement payment represents sale proceeds from the disposal. However, as the amount is considered ordinary income of the Estate under section 6-5 of the ITAA 1997, any CGT gain arising is reduced to nil under section 118-20 of the ITAA 1997.

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