Edited version of private ruling

Authorisation Number: 1011705482367

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Ruling

Subject: CGT consequences of insurance payment

Question 1

Did you make a capital gain or loss when you received an insurance payment for the destruction of the pole, light and associated wiring?

Answer

Yes.

Question 2

Is the cost base and reduced cost base of the property modified because of CGT event C1 happening to the pole, light and associated wiring?

Answer

Yes.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commenced on:

1 July 2009.

Relevant facts:

You own an income producing property.

You acquired the property after 20 September 1985.

A pole on the property fell down during a storm.

The pole was removed, you lodged an insurance claim and subsequently received an insurance payment.

The pole was already in existence when you acquired the property.

The pole was not a depreciating asset.

Neither the land nor the pole have been used for any purposes associated with research and development.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 102-5.

Income Tax Assessment Act 1997 Section 102-20.

Income Tax Assessment Act 1997 Section 104-5.

Income Tax Assessment Act 1997 Section 104-20.

Income Tax Assessment Act 1997 Section 108-5.

Income Tax Assessment Act 1997 Section 108-55.

Income Tax Assessment Act 1997 Section 110-25.

Income Tax Assessment Act 1997 Section 110-55.

Income Tax Assessment Act 1997 Section 112-30.

Income Tax Assessment Act 1997 Section 116-20.

Reasons for decision

Capital gains tax (CGT) - general

When a CGT event happens to a CGT asset you own, you will make a capital gain or loss, depending on whether or not the capital proceeds received from the CGT event are more or less than the asset's cost base or reduced cost base.

Where the capital proceeds are more than the cost base, a capital gain is made. You make a capital loss when the capital proceeds are less than the asset's reduced cost base.

Any assessable gain made from a CGT event is included in your assessable income in the income year in which the event happens.

Land (including vacant land, and land on which there are buildings and structures) acquired on or after 20 September 1985 is a CGT asset.

Buildings and structures on land - CGT assets in their own right, or part of a whole CGT asset?

Under the CGT provisions, a building or structure on land may be either:

· a separate CGT asset from the land, or

· part of a whole CGT asset (comprising the land, buildings and structures upon the land).

Section 108-55 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a building or structure on land you acquired on or after 20 September 1985 is a separate CGT asset from the land if the building or structure is:

· a depreciating asset, or

· if certain provisions of the tax law relating to research and development apply to the building or structure.

If the building or structure is not a separate CGT asset from the land because the provisions of section 108-55 of the ITAA 1997 do not apply, then it is simply considered to be 'part' of the whole asset.

Under the provisions of subsection 108-5(2) of the ITAA 1997, 'part' of a CGT asset can also be a CGT asset. Accordingly, it is possible for a CGT event to happen to part of an asset, but not to the whole asset. For example, you might dispose of part of a CGT asset but retain the remainder of the asset.

In your case you acquired the property after 20 September 1985. The pole was on the land when you acquired it. The pole was not a depreciating asset and neither the land nor the pole have been used for any purposes associated with research and development.

Accordingly, for CGT purposes, the pole was not a separate asset to the land but rather, a part of the whole CGT asset which comprised the land and the buildings and structures on it.

CGT even C1 - loss or destruction of part of a CGT asset

Section 104-20 of the ITAA 1997 provides that CGT event C1 happens if a CGT asset you own is lost or destroyed.

Taxation Determination TD 1999/79 discusses the meaning of the word 'destroyed' and notes that because the word is not defined in the tax law, we must consider its ordinary meaning in the context of CGT event C1.

According to The Macquarie Dictionary, [Multimedia], version 5.0.0, 1/10/01, the meaning of the word 'destroy' includes:

'to reduce to pieces or to a useless form; ruin; spoil; demolish'.

TD 1999/79 specifies that CGT event C1 can happen to a part of a CGT asset provided the part is wholly destroyed and not just damaged.

TD 1999/79 also specifies that the word 'destroyed' contemplates both voluntary and involuntary actions and notes that CGT event C1 would apply to a CGT asset (or a part of that asset) destroyed in an involuntary occurrence such as a natural disaster.

In these circumstances, the loss or destruction of the asset or its part constitutes a disposal of the asset or its part.

Generally, the time of the event is when compensation for the loss or destruction is received. If there is no compensation, the time of the event is when the loss is discovered or the damage occurs.

In the case of the disposal of part of an asset, a capital gain results from CGT event C1 if the capital proceeds from the disposal are more than the cost base of the part of the asset disposed of. A capital loss will result if the capital proceeds are less than the reduced cost base of the part of the asset disposed of.

Considering the ordinary meaning of the word 'destroy', and the fact that after falling down during the storm, the pole was removed from the property, we consider that the pole was wholly destroyed by an involuntary occurrence.

Accordingly, CGT event C1 happened to the pole at the time you received the insurance payment.

Modifying the cost base of a CGT asset where CGT event C1 has taken place in respect of a part of the asset

Generally, when a person acquires a CGT asset the cost base and reduced cost base of the asset includes the cost of acquiring it, as well as certain other costs associated with acquiring, holding and disposing of the asset.

In all, there are five elements that make up the cost base of a CGT asset. These are:

· The first element: money or property given for the asset.

· The second element: incidental costs of acquiring the asset or that relate to the CGT event.

· The third element: costs of owning the asset.

· The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

· The fifth element: capital costs of preserving or defending your ownership of or rights to the asset.

The reduced cost base of a CGT asset has the same five elements as the cost base, except for the third element. The third element of the reduced cost base relates to balancing adjustments which do not apply to assets that are not depreciating assets.

However, in cases where part of a CGT asset is disposed of, the cost base/reduced cost base of the whole asset is modified in accordance with the apportionment rules in section 112-30 of the ITAA 1997. Specifically, subsection 112-30(2) of the ITAA 1997 states that:

The cost base and reduced cost base of a CGT asset is apportioned if a CGT event happens to some part of the asset, but not to the remainder of it.

To determine the amount by which the cost base/reduced cost base of the whole asset is modified, it is necessary to establish the cost base of the part of the asset disposed of.

Subsection 112-30(3) of the ITAA 1997 provides the following formula for establishing the cost base of part of a whole CGT asset:

Taxation Determination TD 2001/9 notes that in the above formula, the market value of the remainder of the asset is the market value of the asset after the disposal of the part.

The reduced cost base is worked out similarly.

Under the provisions of subsection 112-30(4) of the ITAA 1997, the remainder of the cost base/reduced cost base of the asset is attributed to the part of the asset that remains.

The following example is provided by section 112-30 of the ITAA 1997.

· A taxpayer acquires a truck for $24,000 and sells its motor for $9,000. The market value of the remainder of the truck after the disposal of the motor is $16,000.

· Using the formula above, the cost base of the motor (the part of the asset disposed of) is determined as follows:

$24,000 x $9,000 = $8,640
$9,000 + $16,000

· The cost base of the remainder of the truck is determined as follows:

$24,000 - $8,640 = $15,360

In your case, to apply the above formula, you will first need to determine the cost base of the whole asset, as well as the market value of the remainder of the asset at the time of the disposal of the pole. As previously stated, you are taken to have disposed of the pole at the time you received the insurance payment.

As far as the capital proceeds for the disposal of the pole is concerned, CGT Determination TD 31 (which discusses the treatment of insurance policy proceeds received in respect of lost or destroyed assets) states that where an asset, or part of an asset is lost or destroyed, any proceeds received by a taxpayer under an insurance policy in respect of the loss or destruction are taken to be amounts of money received "as a result of or in respect of" the disposal of the asset or part of that asset.

In your case, the insurance payment will be the capital proceeds for the disposal of the pole.

Conclusion

The pole was a part of the whole CGT asset comprising the land and the buildings and structures on it.

The pole was disposed of when you received the insurance payment. CGT event C1 happened to the pole at this time.

The capital proceeds from the CGT event was the insurance payment you received for the disposal.

You must use the formula above to determine whether you made a capital gain or loss on the disposal of the pole.

Before you can apply the formula, you will need to determine:

· the cost base of the whole asset, and

· the market value of the remainder of the asset at the time you received the insurance payment for the pole.

The cost base/reduced cost base of the property will be modified by deducting the cost base/reduced cost base of the pole (as determined by using the above formula) from the cost base/reduced cost base of the property.

Apportionment

Where a CGT asset is jointly owned by one or more individual, any capital gain or loss that results from the disposal of the asset is apportioned between each individual in line with their ownership interest. For example, where joint owners have an equal share in an asset, the capital gain or loss is apportioned equally between them.