Edited version of your private ruling

Authorisation Number: 1011978551933

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Subject: capital gains tax - destruction of asset - insurance receipts

Question 1: Will the capital gains tax provisions apply to your insurance payments?

Answer: Yes

Question 2: Will planning costs incurred in relation to the rebuilding of the dwelling be viewed as capital expenditure?

Answer: Yes.

Question 3: Will you be able to choose the rollover in relation to the insurance payments when you incur expenses in relation to the rebuilding of the dwelling before 30 June 2012?

Answer: Yes.

This ruling applies for the following period:

Income year ended 30 June 2012

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

You purchased a holiday dwelling after 20 September 1985.

The dwelling was destroyed during a cyclone a number of years later.

The dwelling was insured and you received the following insurance payments:

· an amount for contents;

· an amount for the dwelling; and

· an amount for the costs involved to redesign the dwelling.

You have not used the dwelling to produce assessable income.

You and your family are devastated by the loss of your dwelling and are having difficulty dealing with the rebuilding process in the short term.

You intend rebuilding when you are able to address the issue, both mentally and physically.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Section 110-25

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

Income Tax Assessment Act 1997 Section 124-70

Income Tax Assessment Act 1997 Subsection 124-70(3)

Income Tax Assessment Act 1997 Section 124-75

Reasons for decision

Taxation treatment of compensation receipts

The structure of the capital gains tax (CGT) provisions under the Income Tax Assessment Act 1997 (ITAA 1997) requires that for those provisions to apply to compensation amounts, a CGT event must be identified. Generally, receipt of a compensation amount will give rise to one of the following CGT events:

A1 (disposal of a CGT asset);

C1 (loss or destruction of a CGT asset);

C2 (cancellation, surrender and similar endings);

D1 (creating contractual or other rights); or

H2 (receipt for event relating to CGT asset).

CGT event C1 happens if a CGT asset you own is lost or destroyed. The time that CGT event C1 happens is when you first receive compensation for the loss or destruction, for example the insurance receipt. You make a capital gain if the compensation is more than the assets cost base, or you make a capital loss if the compensation is less than the assets reduced cost base.

Taxation Ruling TR 95/35 (TR 95/35) provides the Commissioner's view on the taxation treatment of compensation receipts.

In the ruling, the Commissioner adopted an ``underlying asset'' approach (also known as a ``look-through'' approach) to determine the asset to which the compensation amount is most directly related. 

The underlying asset is 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.

If the underlying asset was acquired on or after 20 September 1985, a capital gain or capital loss may arise on the disposal or part disposal of an underlying asset.

If your property is damaged or destroyed in a disaster, you may receive an insurance payment. How this is treated for tax purposes depends on:

· the type of property (your home, other buildings, cars, personal property or work-related items); and

· whether or not the property is income-producing (for example, a rental property or business premises).

Insurance payouts received for destroyed or damaged items you used solely for your personal use, for example household goods are not taxable. However, the payout may need to be taken into account for capital gains tax purposes.

If a personal-use asset that was destroyed cost you more than $10,000 (or $500 if the property was a collectable such as a painting or jewellery), you will need to subtract the cost base from your insurance payout to work out whether you had a capital gain.

Capital losses on personal-use assets are disregarded, but you can make a capital loss on a collectable acquired for more than $500. These losses can only be used to reduce capital gains from collectables.

Application to your case

In your case, your holiday dwelling was destroyed by a cyclone and you received the following compensation amounts from your insurance company:

· an amount for the dwelling;

· an amount for the costs involved to redesign the dwelling; and

· an amount for contents.

On the facts of this case, it is considered that the amounts you received for the dwelling and the costs involved to redesign the dwelling have a direct and substantial link with the underlying asset, the dwelling, and not for any other asset such as the right to seek compensation. Therefore, these payments will be subject to the capital gains tax provisions.

You also received an insurance payment for the contents of the dwelling. As outlined above, insurance payments received in relation to destroyed or damaged personal use assets need to be considered for capital gains tax purposes.

Any of the assets covered under your contents insurance had a cost base of more than $10,000, or $500 for collectables, they will have to be accounted for under the CGT provisions. For those assets not meeting those requirements, any capital gain or capital loss made from the receipt of the insurance payment are disregarded.

Costs associated with preparing to build a dwelling

The cost base of a CGT asset is made up of five elements. These elements are located in section 110-25 of the ITAA 1997.

The fourth element of a CGT asset's cost base includes the capital expenditure incurred for the purpose, or the expected effect of which is to increase or preserve the asset's value.

Costs associated with planning to build would normally form part of the fourth element of the cost base of a property.

Application to your case

You intend rebuilding your holiday dwelling and anticipate incurring costs such as architectural fees associated with this undertaking.

Expenses incurred for architects fees, planning applications and building plans and approvals may be included in the fourth element of the cost base of an asset where they are expected to increase the value of your dwelling.

Rollover relief for compensation payments received for the destruction of an asset

In some circumstances, there are provisions in the ITAA 1997 that allow you to defer your capital gain until another CGT event happens in the future. This is known as rollover relief.

Section 124-70 of the ITAA 1997 provides you with the opportunity to choose rollover relief where a CGT asset you own, or part of it, is lost or destroyed.

In order for the rollover to apply, however, subsection 124-70(3) of the ITAA 1997 states that you must receive money or another CGT asset as compensation for the loss or destruction of the original asset, or as a result of an insurance policy. It is also noted that you must have made a capital gain from the event. That is, the amount of compensation or insurance monies you received is greater than the cost base of the asset (or part of the asset) at the time it was destroyed. If you realised a capital loss, then rollover relief is not available.

There are further requirements that need to be satisfied if you receive cash as a result of the asset being lost or destroyed. In order to be eligible for the rollover, you must use the cash to purchase another CGT asset, or if the original asset was damaged, on repairs to that asset as set out in section 124-75 of the ITAA 1997. This section also states that this expenditure must be incurred no earlier than one year before, or no later than one year after the end of the financial year in which CGT event C1 happens, or within such further time as the Commissioner allows in special circumstances.

Application to your case

From the information you have provided, you satisfy the conditions in section 124-70 of the ITAA 1997 for the rollover to apply because:

· your holiday dwelling was destroyed by a cyclone; and

· you received an insurance payment.

While you have met the conditions outlined in section 124-70 of the ITAA 1997, you must also meet the further requirements outlined in section 124-75 of the ITAA 1997 as you have received money in relation to the destruction of your dwelling.

Therefore, you must incur expenditure on repairs within the specified timeframes outlined in section 124-75 of the ITAA, or within such time as the Commissioner allows in special circumstances.

You will meet the requirements for the conditions outlined in section 124-75 of the ITAA if you incur expenditure on repairs within the stated timeframes, by June 2012, or the further time the Commissioner granted when he exercised his discretion in your favour.

Once either of these conditions have been met, you will be eligible to choose the rollover in relation to any capital gain made from the receipt of the insurance payments