Edited version of private ruling

Authorisation Number: 1011660914948

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Ruling

Subject: Compensation receipt

1. Is an out of court settlement payment considered a 'compensation receipt' for the purposes of Taxation Ruling 95/35?

Yes.

2. Will the settlement payment form part of the consideration received for the sale of the land?

Yes.

3. Does the compensation receipt in respect of the right to seek compensation give rise to capital gains tax (CGT) event C2?

No.

This ruling applies for the following period

Year ending 30 June 2006.

The scheme commenced on

1 July 2005.

Relevant facts

You purchased xx acres of land.

One lot on the property contained a pit.

You sought permission from the government body to extract substance from the pit.

The government body advised that the pit had to be registered and provided an onerous list of requirements to obtain registration.

You advised the government body that it had already been used as a pit, therefore, the registration must be current, and approached the government body on several occasions with evidence that the pit had been used as such.

The government body denied that it was a registered pit, and due to the onerous registration process, you ceased efforts in relation to obtaining registration.

You subsequently sold the block at a much reduced value on the basis that there was not value in the pit due to it not being registered or able to be used.

A short time after the sale, you noticed the use of the pit.

You approached the government body and was advised that paperwork had been discovered confirming that it was a registered pit.

You commenced action against the government body.

The Statement of Claim provided indicates you claimed for damages, interest, costs and such further and other orders as the court sees fit and just.

An out of court settlement was reached and you received compensation. You received a global amount which wasn't dissected.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 110-25(5)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise specified.

The CGT provisions are set out in Part 3-1. Under the CGT provisions you will make a capital gain or loss only if a CGT event happens.

To determine if a CGT event happens in respect of a compensation payment it is necessary to consider the nature of the asset to which the compensation payment relates.

The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 (capital gains: treatment of compensation receipts). TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be:

· an underlying asset

· a right to seek compensation, or

· a notional asset in terms of section 104-155.

In determining which is the most relevant, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt.

In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as:

the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

TR 95/35 advises the following guidelines on the treatment of compensation for the disposal of an underlying asset.

4.       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. 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.

5.       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.

On the facts of your case, you incurred a loss in value of your land due to the government body's mistakes. They paid you $X to compensate you for your loss. The amount was a global settlement amount, there were no negotiations prior to your settlement conference and the settlement amount was not dissected.

The sum of $X forms part of the consideration for the sale of your land.

Any legal costs incurred form part of the fourth element of the cost base as per section 110-25(5).

Although the right to seek compensation was also disposed of, it is considered that the land is the more appropriate underlying asset. Therefore, CGT event C2 will not occur for the right to seek compensation.

Your net capital gain for the financial year will have to be recalculated to reflect the increase in consideration from $X to $Y and your income tax return will need to be amended to include the additional amount of capital gain.