Edited version of private advice

Authorisation Number: 1052233057059

Date of advice: 20 March 2024

Ruling

Subject: CGT events - compensation

Question

Is the lump sum payment you received in relation to a final liquidation dividend assessable under the Capital Gains Tax (CGT) provisions?

Answer

Yes. Section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that CGT event C2 happens on the ending of the right to seek compensation. The payment received is an ending of this right and is therefore a capital receipt and the capital gain is assessed under the CGT provisions.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

In XX 20XX, you purchased one of X townhouses (the Property).

The purchase price of the Property was $XXX,XXX.XX.

You paid a 10% deposit for the Property, totalling $XX,XXX.XX.

A builder (the Builder) was contracted to construct the townhouses.

In 20XX, the Builder had not commenced construction.

In XX 20XX, the Builder went into administration.

You received a refund of the $XX,XXX.XX deposit, plus an interest amount totalling $X,XXX.XX.

You incurred legal costs to the amount of $X,XXX.XX.

On XX XX 20XX, you received a first and final liquidation dividend.

The liquidation dividend amount was $XX,XXX.XX.

The Property has been sold.

The liquidation dividends were derived from the sale of the Property.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1997section 102-25

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-35

Reasons for decision

CGT event C2

Under section 108-5 of the ITAA 1997, an asset for CGT purposes is any form of property or a legal or equitable right that is not property. Under section 102-20, you make a capital gain or capital loss as a result of a CGT event. Section 104-25 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

a)    Being redeemed or cancelled; or

b)    Being released, discharged or satisfied; or

c)    Expiring; or

d)    Being abandoned, surrendered or forfeited; or

e)    If the asset is an option - being exercised; or

f)     If the asset is a convertible interest - being converted.

The timing of the event is when you enter into the contract that results in the asset ending or if there is no contract, when the asset ends.

Taxation Determination TD 2001/27 Income tax: capital gains: how do parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ('ITAA 1997') treat:

a)    A final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the Income Tax Assessment Act 1936 ('ITAA 1936') to be a dividend; and

b)    An interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1)?

Considers how Parts 3-1 and 3-3 of the ITAA 1997 treat a final liquidation distribution, where all or part of it is deemed by subsection 47(2) of the ITAA 1936, to be a dividend.

The full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's share in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2. After the winding-up of a company, CGT event C2 happens to the shares when the company ceases to exist in accordance with the Corporations Act 2001.

At common law, a distribution to a shareholder by a liquidator is capital, not income, in the hands of the shareholder since it is a realisation of the shareholder's interest in the company.

Compensation receipts

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses taxpayers that receive an amount as compensation. It considers the CGT consequences for the receipt of the amount, and whether the amounts are included in the assessable income of the recipient under Part IIIA of the ITAA 1936.

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

If the underlying asset was acquired by the taxpayer on or after 20 September 1985, a capital gain or loss may arise on the disposal.

Legal fees and compensation

You sought a compensation amount to cover losses and bring the project to completion. The legal fees you incurred were in the course of taking action to receive compensation. These expenses are an outgoing of a capital nature and are not deductible under section 8-1 of the ITAA 1997.

As the expenditure is a capital expense, you need to determine if the expenditure can form part of the cost base of the residential property.

Section 110-25 of the ITAA 1997 provides the general rules regarding cost base, consisting of:

a)    Acquisition costs

b)    Incidental costs

c)    Non-capital ownership costs which are not deductible elsewhere

d)    Amounts which increase or preserve the value of the asset

e)    Amounts incurred in establishing, preserving or defending your title to the asset, or right over the asset.

The legal fees you incurred, connect with the proceedings, and may be included in the cost base of the asset as incidental costs in terms of subsection 110-25(3) and section 110-35 of the ITAA 1997.

Application to your circumstances

You received a compensation amount for a breach of contract. You had a right to seek compensation for the asset and that right was disposed of when the final liquidation dividends were paid to you. CGT event C2 happens on the ending of the right to seek compensation. The payment received is an ending of this right and is therefore a capital receipt and the capital gain is assessed under the CGT provisions.

The legal fees you have incurred are considered incidental costs in the course of taking action to receive the compensation amount and can be applied to the cost base of the asset.

CGT event C2 allows for the CGT 50% discount, you are eligible to apply the discount where you have owned the property for more than 12 months.

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