Edited version of private ruling

Authorisation Number: 1011857197860

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Ruling

Subject: Is compensation a non taxable capital payment

Question 1

Is the compensation payment you received a non-taxable capital payment?

Answer

No

This ruling applies for the following period:

The 2009-10 income year

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You are the owner of a property.

Another entity is the owner of an asset.

The asset goes through your property.

The asset is to be decommissioned.

You signed an agreement with the other entity in regards to the decommissioning the asset.

You received a compensation/settlement.

The agreement provides that the money was paid in full and final satisfaction of all claims of the owners in connection with the matters contemplated by the agreement and to assist with any on farm works and loss of benefit as a consequence of rationalisation and, if applicable, the purchase of the freehold of land.

Paragraph 1.C of the agreement states,

The Property is a serviced property within the Corporation's irrigation district, at the time of execution of the agreement, and the Corporation is required to provide the service of delivering X to the Owners or occupier of each serviced property in the district.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 160ZZL,

Income Tax Assessment Act 1997 Subsection 6-5(1),

Income Tax Assessment Act 1997 Section 6-10,

Income Tax Assessment Act 1997 Section 10-5,

Income Tax Assessment Act 1997 Section 102-5,

Income Tax Assessment Act 1997 Section 102-20,

Income Tax Assessment Act 1997 Section 104-25,

Income Tax Assessment Act 1997 Subsection 104-25(3),

Income Tax Assessment Act 1997 Section 108-5,

Income Tax Assessment Act 1997 Subsection 115-25(1),

Income Tax Assessment Act 1997 Paragraph 116-20(1)(a),

Income Tax Assessment Act 1997 Subsection 124-5(1),

Income Tax Assessment Act 1997 Section 124-70,

Income Tax Assessment Act 1997 Section 124-80 and

Income Tax Assessment Act 1997 Section 124-90

Income Tax Assessment Act 1997 Section 152-10.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Summary

The settlement payment for compensation that has been received is a capital gain and included in assessable income under section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Ordinary Income

Your assessable income includes income according to ordinary concepts (subsection 6-5(1) of the ITAA 1997).

For income tax purposes, a compensation amount generally bears the character of that which it intends to replace (F of CT v Dixon (1952) 86 CLR 540). A compensation receipt will be of an income nature where it replaces a revenue item and capital in nature where it replaces capital items.

Where compensation is received in settlement of an unliquidated claim covering both income and capital elements the whole amount will be treated as capital where it cannot be dissected into an income component and a capital component (Taxation Determination TD 93/58, McLaurin v. FC of T (1961) 104 CLR 381;(1961) 8 AITR 180; Allsop v. FC of T (1965) 113 CLR 341; (1965) 9 AITR 724).

In your case, you received an undissected lump sum.

The agreement between the other entity and you expressly states at paragraphs 4 (a) and 5 (b) that the payment is in full and final satisfaction of all claims of the owners in connection with the matters contemplated by the agreement and to assist with on farm works and loss of benefit as a consequence of rationalisation and, if applicable, the purchase of freehold land.

As no portion of the payment can be identified or quantified as replacing an income item the entire compensation payment is capital and is not assessable as ordinary income under section 6-5(1) of the ITAA 1997.

Capital Gains

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income also includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Section 10-5 of the ITAA 1997 lists those provisions about assessable income. The most relevant section in relation to your compensation settlement payment is section 102-5 of the ITAA 1997, which deals with capital gains.

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes the amount of any capital gains. Section 102-20 of the ITAA 1997 provides that a capital gain is made only if a Capital Gains Tax (CGT) event happens. A CGT event is generally something that happens in relation to a CGT asset. The most common CGT event occurs when a CGT asset is disposed of.
Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. The wide definition of asset in section 108-5 of the ITAA 1997 would include the right to be supplied with water.

Taxation Ruling (TR) 97/11 provides the Commissioner's view on the receipt of compensation receipts. Specifically, a 'look through' approach is required in order to ascertain the most appropriate underlying asset that the compensation relates to. Only if an underlying asset cannot be identified will the receipt be in respect of the right to seek compensation.

Clause 1 c of the agreement states that the other entity is required to provide the service of supplying X.

The compensation settlement payment that you have received is for a final settlement. The CGT asset to which your compensation settlement payment relates is the right to be supplied with X for the indefinite future.

According to section 104-25 of the ITAA 1997, CGT event C2 occurs in relation to cancellation, surrender and similar endings. You will make a capital gain if the capital proceeds from the ending of your right to be supplied with X are more than the cost base of the asset (subsection 104-25(3) of the ITAA 1997).

The capital proceeds from the CGT event is the total of the money you receive in respect of the event happening (paragraph 116-20(1)(a) of the ITAA 1997).

A capital gain will be made if the amount of the compensation settlement payment exceeds the incidental costs associated with receiving the payment. The net capital gain will form part of your assessable income in the year in which it is received.

Further issues for you to consider

Discount capital gain

Subsection 115-25(1) of the ITAA 1997 provides that a discount capital gain may apply if the CGT asset was acquired at least 12 months before the CGT event that resulted in the capital gain. As long as you have held the right to be supplied with water for more than 12 months, then you may be entitled to this discount.

Small business concessions

Small business concessions, including the small business rollover, may be available. This is beyond the scope of this ruling. If you require a ruling on the availability of these concessions, you may apply for another ruling, specifically providing information relating to your satisfaction of the basic conditions under section 152-10 of the ITAA 1997.