Edited version of private advice

Authorisation Number: 1052411874016

Date of advice: 24 June 2025

Ruling

Subject: Compensation payment - lump sum

Question 1

Will any compensation from the Public Acquisition Overlay (PAO) be included as capital proceeds on the sale of the property (the Property)?

Answer 1

Yes.

Question 2

Does the Property satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 2

Yes.

Question 3

When you work out the net value of your capital gains tax (CGT) assets for the purposes of section 152-15 of the ITAA 1997 can you disregard the market value attributable to the main residence and adjacent land of the Property just before you entered into the contract to sell the Property?

Answer 3

Yes.

Question 4

When you work out the net value of your CGT assets for the purposes of section 152-15 of the ITAA 1997 can you disregard the market value attributable to the remaining land (in excess of the dwelling and adjacent land) of the Property just before you entered into the contract to sell the Property?

Answer 4

No.

Question 5

When you work out the net value of your CGT assets for the purpose of section 152-15 of the ITAA 1997 can you disregard any market value attributable to your rights to obtain compensation following the settlement of the sale of the Property?

Answer 5

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You jointly purchased vacant land (the Property) over 15 years ago.

You subsequently built a dwelling on the Property and it became your main residence. It has continuously been your main residence since then.

You conducted farming activities in partnership on the Property for over 7 years. You conducted these farming activities on the Property during this period on parts of the property aside from the dwelling on the land and the immediately adjacent land.

You acquired, maintained, and used a significant level of plant and equipment items in connection with the farming activities.

You undertook these farming activities during this period with an intention to make a profit and carried out the activities in a business-like manner. You kept accounting records and filed partnership income tax returns for these years. You held an ABN for the farming activities.

You ceased conducting farming activities.

You have not used the Property for income producing purposes since you ceased farming activities. Since then, it has been used as your main residence and a lifestyle property.

The Government issued a PAO over the Property to reserve it for a major new public road and rail transport project. This PAO grants the government the right to compulsorily acquire the Property from you at any time for the purposes of this project.

You were advised you could continue to use the land for any existing approved use however any subsequent development of the land could be the subject of a council planning permit.

When you sold your property, you had rights to monetary compensation from the government if you suffered an economic loss on the sale due to the PAO in place over the Property.

Specifically, the legislation gives you a right to monetary compensation for the loss on sale amount which is broadly the difference in what you sold the property for in open market transaction and what you might have sold the property for in open transaction had the property not been subject of the PAO.

The relevant rights of the compensation rest solely with you as the owners of the land when the PAO over the land came into effect and are not transferrable to any buyer of the land.

You are only permitted to make such a claim following the settlement of the sale of the property. The claim must be supported by a professional valuation stating what the property could have sold for in an open market arm's length sale assuming the property had not been encumbered by the PAO.

You entered into a contract to sell the Property to an arm's length buyer who was fully informed as to the existence of the PAO over the land and the practical limitations that might present their future enjoyment of the land.

Prior to selling the Property, you commissioned a property valuation. This valuation provided two separate valuations of the Property - one valuation on the assumption that the property was not subject to the PAO (referred to as the 'Unaffected Estimate'), and the other valuation reflecting the impaired value of the property subject to the PAO (referred to as the 'Affected Value' estimate).

The actual sale price you obtained on the sale of the Property was significantly lower than the Unaffected Estimate valuation estimate.

You have now engaged lawyers to make a claim for compensation in relation to the economic loss you realised on the sale of the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 118-120

Income Tax Assessment Act 1997 section 328-110

Reasons for decision

Question 1

Section 116-20 of the ITAA 1997 states that the 'capital proceeds' from a CGT event includes 'the money you have received, or are entitled to receive, in respect of the event happening'.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the CGT implications for compensation receipts. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 as follows:

The 'look-through' approach is 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. It is also referred to in this Ruling as the underlying asset approach.

In your case, you are entitled to the compensation for the reduction in sale proceeds received on the sale of the land because of the PAO.

Applying the 'look-through' approach, the most relevant asset to which the PAO compensation directly relates is the Property. Also, the PAO compensation is only payable to you once you have suffered a financial loss, being the reduced sale proceeds on a sale, so it is clear that the PAO compensation will be received in the course of the same 'continuum of events' as the sale of the Property.

Consequently, the PAO compensation will be additional capital proceeds for the sale of the Property.

Question 2

Sections 152-35 and 152-40 of the ITAA 1997 discuss the active asset test. A CGT asset satisfies the active asset test if:

•                you have owned the asset for 15 years or less and the asset was an active asset of yours for at least half of the test period, or

•                you have owned the asset for more than 15 years and the asset was an active asset of yours for at least 7.5 years during the test period.

The test period begins when you acquired the asset and ends at the earlier of:

(i)             the CGT event, and

(ii)            if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

The term 'active asset' is defined at section 152-40 of the ITAA 1997. Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a given time if, at that time, you own it and:

•                it is used (or held ready for use) in the course of carrying on a business by you, your affiliate or an entity connected with you (paragraph 152-40(1)(a) of the ITAA 1997); or

•                it is an intangible asset that is inherently connected with a business that is carried on by you, your affiliate, or an entity connected with you (paragraph 152-40(1)(b) of the ITAA 1997).

However, subsection 152-40(4) of the ITAA 1997 lists CGT assets that cannot be active assets. Under paragraph 152-40(4)(e) of the ITAA 1997, an asset whose main use is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. Such assets are excluded even if they are used in the course of carrying on a business. However, use of the asset by an affiliate or connected entity is treated as the use of the asset owner.

In this case, you owned your interests in the Property for over 20 years. The property is a CGT asset. You used the Property to operate a business in partnership for over 7 years. Consequently, the Property is an active asset as it has been used to carry on a business for more than 7 years and has not been mainly used to derive rent. Therefore, your interest in the Property satisfies the active asset test.

Questions 3 and 4

Section 152-15 of the ITAA 1997 provides that you satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a)           the net value of the CGT assets of yours;

(b)           the net value of the CGT assets of any entities connected with you;

(c)            the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b))

The 'net value of the CGT assets' of an entity is defined in section 152-20 of the ITAA 1997 as the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a)           the liabilities of the entity that are related to the assets; and

(b)           the following provisions made by the entity:

(i)             provisions for annual leave;

(ii)            provisions for long service leave;

(iii)           provisions for unearned income;

(iv)          provisions for tax liabilities

Subsection 152-20(2) of the ITAA 1997 further provides that, in working out the net value of the CGT assets of an entity, certain assets are to be disregarded:

(a)           disregard shares, units or other interests (except debt) in another entity that is connected with the first-mentioned entity or with an affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and

(b)           if the entity is an individual, disregard:

(i)             assets being used solely for the personal use and enjoyment of the individual, or the individual's affiliate (except a dwelling, or an ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120 of the ITAA 1997); and

(ii)            except for an amount included under subsection (2A), the market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and

(iii)           a right to, or to any part of, any allowance, annuity or capital amount payable out of a superannuation fund or an approved deposit fund; and

(iv)          a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and

(v)            a policy of insurance on the life of an individual.

A dwelling includes a building that consists wholly or mainly of residential accommodation and any land immediately under the building (subsection 118-115(1) of the ITAA 1997). Section 118-120 of the ITAA 1997 provides that the maximum area of adjacent land to a dwelling is 2 hectares, less the area of land immediately under the dwelling.

ATO ID 2011/37- Income Tax: CGT small business concessions: maximum net asset value test - disregarded assets - asset being used solely for personal use and enjoyment explains that the entire ownership period is taken into account when determining if the net value of a CGT asset is disregarded under subparagraph 152-20(2)(b)(i) of the ITAA 1997. It states if regard was had only to an asset's use at a single point in time, the result would not necessarily reflect the true nature of the use of the asset.

In your case, the value of the dwelling and adjacent land will be disregarded when working out the net value of CGT assets under paragraph 152-20(2)(ii) of the ITAA 1997. However, as per ATO ID 2011/37, when considering the remaining land, the non-personal use of the Property over its ownership period will mean the remaining land is not disregarded under subparagraph 152-20(2)(b)(i) of the ITAA 1997 and its value will be included when calculating the net value of your CGT assets.

Question 5

A 'CGT asset' is broadly defined in section 108-5 of the ITAA 1997 as 'any kind of property or a legal or equitable right that is not property'.

In Yanner v. Eaton (1999) 201 CLR 351; [1999] HCA 53 the High Court considered the meaning of property. In the joint judgment of Gleeson CJ, Kirby, Hayne and Gaudron JJ, their honours stated at paragraph 17:

... 'property' does not refer to a thing; it is a description of a legal relationship with a thing. It refers to a degree of power that is recognised in law as power permissibly exercised over the thing. The concept of property may be elusive. Usually it is treated as a bundle of rights.

The bundle of rights includes the right to use the property, to enjoy it, to exclude others from it, and to transfer it to someone else.

In this case we consider the PAO, and the contingent compensation rights that arise under the legislative scheme, should be viewed as part of the bundle of rights that is the land. The PAO imposes restrictions as to how the land can be used and your ability to sell. This includes the land being subject to a simplified acquisition process which could result in you being denied the right to develop and use your land in the way that you would otherwise be permitted under its existing zoning.

Also, the PAO creates rights to receive compensation, that attached to the land, that are triggered on various events occurring that result in you suffering a loss. This includes the sale to a party, other than the Government, for less than its market value (were the land not subject to the PAO).

While the compensation will be received after the sale of the land, these rights came into existence in 20XX when the PAO was placed over the land and existed at the time of the sale.

As discussed in question 1, we consider the compensation received under the PAO to be part of the proceeds for the disposal of the land under CGT event A1. Alternatively, the rights could be considered CGT assets in their own right.

However, in either instance the market value attributable to your rights to obtain compensation must be included when calculating the net value of your CGT assets just prior to the relevant CGT event.

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