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Edited version of private ruling
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Ruling
Subject: Capital gains tax and compensation receipts
Question:
Will the lump sum payment you receive give rise to a capital gain in the income year ended 30 June 2011?
Answer: Yes.
This ruling applies for the following periods:
Year ending 30 June 2011
The scheme commenced on:
1 July 2010
Relevant facts and circumstances
In the income year ended 30 June 2011 you will be receiving a gross lump sum payment as settlement of a claim for compensation from a real estate agency, Company X.
You made the claim against Company X alleging misrepresentation, in that you were sold a property by Company X and you were not made aware of certain aspects of the property at the time of purchase.
You allege that you suffered loss and damage as a result of Company X's behaviour.
The losses you incurred as a result of Company X's alleged negligence relate to a number of different expenses, including capital loss on the sale, stamp duty and legal fees.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 102-20.
Income Tax Assessment Act 1997 Section 104-25.
Income Tax Assessment Act 1997 Section 108-5.
Reasons for decision
Capital gains tax (CGT)
Subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) defines a CGT asset as any kind of property or a legal or equitable right that is not property.
Section 102-20 of the ITAA 1997 states that you make a capital gain or capital loss if and only if a CGT event happens. CGT events are the different types of transactions or happenings which may result in a capital gain or a capital loss.
Section 104-25 of the ITAA 1997 states:
1. 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.
2. The time of the event is:
a) when you enter into the contract that results in the asset ending; or
b) if there is no contract - when the asset ends.
CGT and compensation receipts
The Commissioner's view in regards to the treatment of compensation receipts is set out in Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts.
According to TR 95/35, 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. Accordingly, any capital gain arising on the disposal of that right is calculated using the cost base of that right. If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.
CGT event C2 happens when a taxpayer disposes of a right to seek compensation as the right is an intangible asset that is discharged when the compensation is received.
TR 95/35 gives the following example (at paragraphs 283-285):
On 4 July 1989 Marty acquired a rental property. In January 1990 Marty decided to sell the property. On 15 March 1990 Waldo indicated to Marty that he was willing to buy the property for $200,000. On 20 March 1990 Marty engaged his solicitors, Legal Eagles, to act for him in the sale. Legal Eagles had also acted for Marty when he purchased the property. On 10 July 1990 contracts were exchanged with a requirement that the sale be settled one year later on 10 July 1991. The sale was not finalised on 10 July 1991 because of a delay in receiving a clearance from one of the local authorities. Waldo later exercised his right under the contract to repudiate the contract and claimed a refund of his deposit.
On 24 October 1991 Marty commenced legal action against Legal Eagles seeking damages for their negligence in not ensuring that the certificate was received by the proposed settlement date. On 20 December 1991 Legal Eagles advised Marty they were willing to negotiate a settlement. On 17 January 1992 Marty accepted and received compensation of $95,000 in settlement of his claim against Legal Eagles. At this date Marty had not sold the property.
Note: no part of the $95,000 represents a repayment of the deposit paid by Waldo.
Relevant asset: |
The right to seek compensation. The property is not the relevant asset as it was neither permanently damaged nor was its value permanently reduced by the actions of Legal Eagles. |
Acquired: |
July 1991 (when Legal Eagle's negligent action became apparent) |
Cost base: |
Nil acquisition cost plus legal costs |
Disposed of: |
January 1992 |
Consideration: |
$95,000 |
CGT consequences: |
Marty will be assessed in the 1992 income tax year on the net capital gain |
Application to your circumstances
In your case you are receiving a compensation payment in settlement of your claim against Company X. You made the claim against Company X alleging misrepresentation, in that you were sold a property by Company X and you were not made aware of certain aspects of the property at the time of purchase. You allege that you suffered loss and damage as a result of Company X's behaviour.
The losses you incurred as a result of Company X's alleged negligence relate to a number of different expenses, including capital loss on the sale, stamp duty and legal fees.
The payment is an undissected lump sum as it is one lump sum amount that covers all of the losses you incurred as a result of Company X's alleged negligence.
As in the example from TR 95/35 set out above, the relevant asset in your case is the right to seek compensation. It was acquired when Company X's alleged negligence became apparent. The cost base of the asset includes the legal and other incidental costs associated with your action against Company X. The asset will be disposed of when you accept and receive the compensation payment in settlement of your claim against Company X. The consideration you will receive will be the payment amount. You will be assessed on the net capital gain in the income year ending 30 June 2011 as it is the year in which you receive the payment.