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Ruling

Subject: insurance proceeds - lost trading stock - destroyed depreciating assets - destroyed capital works

Question 1

Are the insurance proceeds received for lost trading stock included in assessable income?

Answer

Yes

Question 2

Are you entitled to claim a deduction for the written down value of depreciating assets that were destroyed?

Answer

No

Question 3

Will a balancing adjustment amount be included in your assessable income for depreciating assets that were destroyed, where the insurance amount received for the destruction of the asset exceeds its adjustable value?

Answer

Yes, the difference will be included in your assessable income.

Question 4

Will a balancing adjustment amount be included in your assessable income for depreciating assets that were destroyed, where the insurance amount received for the destruction of the asset does not exceed its adjustable value?

Answer

No, you will be entitled to deduct the difference.

Question 5

Are the insurance proceeds received for capital works that were destroyed included in your assessable income?

Answer

No

Question 6

Are you entitled to claim a balancing deduction for the undeducted construction expenditure of the capital works that were destroyed?

Answer

No; unless the insurance proceeds received for the destruction of the capital works did not exceed the undeducted construction expenditure for those capital works.

This ruling applies for the following period

1 July 2010 to 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You operated a business in leased premises.

Trading stock, depreciating assets and capital works were lost or destroyed in an insured event.

You made a claim against your insurance policy and received a payout for:

§ lost trading stock

§ destroyed depreciating assets, and

§ destroyed capital works.

An insurance assessor examined the damage, and accepted that your contents and stock had been lost or destroyed.

The owner of the leased premises does not intend to re-build and you were evicted shortly after the event.

You will not purchase replacement assets with the insurance proceeds received for depreciating assets destroyed.

You will not use the insurance proceeds received for destroyed capital works to rebuild those capital works.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 paragraph 20-20(2)(b)

Income Tax Assessment Act 1997 paragraph 40-85(1)(c)

Income Tax Assessment Act 1997 subsection 40-85(2)

Income Tax Assessment Act 1997 section 40-285

Income Tax Assessment Act 1997 paragraph 40-285(1)(b)

Income Tax Assessment Act 1997 paragraph 40-285(2)(b)

Income Tax Assessment Act 1997 section 40-295

Income Tax Assessment Act 1997 subsection 40-300(2)

Income Tax Assessment Act 1997 section 40-310

Income Tax Assessment Act 1997 section 43-40

Income Tax Assessment Act 1997 section 43-250

Income Tax Assessment Act 1997 section 43-255

Income Tax Assessment Act 1997 section 43-260

Income Tax Assessment Act 1997 section 70-115

Reasons for decision

Insurance proceeds and lost trading stock

There is a specific provision (section 70-115 of the Income Tax Assessment Act 1997) which includes in your assessable income an amount received by way of insurance or indemnity for a loss of trading stock. However, for section 70-115 to apply the amount received must not be assessable as ordinary income under section 6-5 of the ITAA 1997.

Ordinary income generally includes three categories, namely, income from rendering personal services, income from property, and income from carrying on a business.

In normal trade you purchased trading stock and then on-sold this stock to your customers, converting the stock into money. Buying and selling stock was part and parcel of your business activities. Similarly, you took out a contract of insurance to insure your stock against certain events. Insuring stock against such events is also considered to be part and parcel of your business activities. Albeit involuntarily; your stock was disposed of and converted into money.

As such, the insurance proceeds received for lost trading stock are considered to have been received in the ordinary course of carrying on your business and are included in your assessable income under section 6-5 of the ITAA 1997.

Insurance proceeds and depreciating assets

When you stop holding a depreciating asset, such as when it is destroyed, a balancing adjustment event occurs (section 40-295 of the ITAA 1997).

The amount of the balancing adjustment is calculated by comparing the asset's termination value with its adjustable value (section 40-285 of the ITAA 1997).

The termination value of a depreciating asset that is lost or destroyed is the amount or value received or receivable under an insurance policy or otherwise for the loss or destruction (item 8 in the table in subsection 40-300(2) of the ITAA 1997.

The adjustable value of an asset at a particular time is the opening adjustable value for that year plus any second element costs for the year, less its decline in value for the year up to that time (paragraph 40-85(1)(c) of the ITAA 1997).

The opening adjustable value of a depreciating asset for an income year is its adjustable value to you at the end of the previous income year (subsection 40-85(2) of the ITAA 1997).

If the termination value of the depreciating asset is more than its adjustable value, the difference is included in your assessable income in the income year in which the balancing adjustment event occurred (paragraph 40-285(1)(b) of the ITAA 1997).

If the termination value of the depreciating asset is less than its adjustable value, the difference is deductible in the income year in which the balancing adjustment event occurred (paragraph 40-285(2)(b) of the ITAA 1997).

In your case you received insurance proceeds for the loss of depreciating assets. Where the amount of insurance received (termination value) for a depreciating asset that was destroyed is more than the adjustable value of that asset, the difference is included in your assessable income. Where the amount of insurance received (termination value) for a depreciating asset that was destroyed is less than the adjustable value of that asset, you can deduct the difference.

Please note that if you receive an amount for 2 or more things that include a balancing adjustment event for a depreciating asset, you take into account as its termination value only that part of what you received that is reasonably attributable to the asset (section 40-310 of the ITAA 1997).

Insurance proceeds and capital works

The insurance proceeds you received to compensate you for the loss of capital works is not income from rendering personal services, income from property or income from carrying on a business. The payment is also a once and for all payment and therefore does not have an element of recurrence or regularity.

Additionally, the insurance proceeds were received for the loss of capital works and, therefore, take on the character of those capital works. As such, the payment is capital in nature.

Accordingly, the insurance proceeds you received to compensate you for the loss of capital works is not assessable income under section 6-5 of the ITAA 1997.

Your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).

Under paragraph 20-20(2)(b) of the ITAA 1997, recoupment of a loss or outgoing is only an assessable recoupment if the taxpayer can deduct an amount for the loss or outgoing for the current year, or has deducted or is able to deduct an amount for it for an earlier income year, under any provision of the ITAA 1997.

The phrase 'for the loss or outgoing' in paragraph 20-20(2)(b) of the ITAA 1997 requires a connection between the deduction and the loss or outgoing for which the taxpayer had been recouped (paragraph 11 of Taxation Determination TD 2006/31).

In your case, the relevant loss or outgoing which has been recouped is the destruction of the capital works. The 'loss or outgoing' referred to in paragraph 20-20(2)(b) of the ITAA 1997 is not limited to an amount expended or paid by you. As in the present case, it extends to a loss incurred as a result of the destruction of an asset.

Whilst you may have been able to deduct an amount in relation to the original construction of the capital works under section 43-40 of the ITAA 1997, this is not a deduction for the loss referred to in paragraph 20-20(2)(b) of the ITAA 1997. No deduction is available for the loss of the capital works.

Accordingly, as you cannot deduct an amount for the loss or outgoing for which the insurance proceeds are received as recoupment, the insurance proceeds received for the destruction of the capital works are not an assessable recoupment under section 20-20 of the ITAA 1997.

As the insurance proceeds paid to cover the cost of reconstructing the capital works that were destroyed are not ordinary or statutory income they are not included in your assessable income under any provision of the ITAA 1997.

Balancing deduction for destroyed capital works

You can deduct an amount (called a balancing deduction), if all, or part of your capital works are destroyed in an income year, and:

§ you have been allowed or can claim a capital works deduction for the capital works

§ the capital works were used for income producing purposes before they were destroyed

§ there is an amount of undeducted construction expenditure for the capital works (section 43-40 of the ITAA 1997).

The amount of the balancing deduction is calculated using the formula set out in section 43-250 of the ITAA 1997. Generally, the deduction is equal to the undeducted construction expenditure at the date of the destruction of the capital works less amounts you have received or have the right to receive for the destruction of the capital works, including an amount received under an insurance policy for the destruction of capital works (section 43-255 of the ITAA 1997).

If the insurance amounts received for the destruction of the capital works exceeded the undeducted construction expenditure for those capital works, the amount available as a deduction under section 43-40 of the ITAA 1997 is nil. However, if the insurance amount received for the destruction of the capital works did not exceed the undeducted construction expenditure for those capital works, you are entitled to a deduction for the undeducted construction expenditure of the destroyed capital works, less the insurance amount you received for the destruction of those capital works.

It should be noted that if an amount received in respect of the destruction of property relates to both capital works for which you are claiming the balancing deduction and to property the cost of which did not form part of your construction expenditure, you must apportion the amount received to the amount that is attributable to the capital works that were destroyed. The apportionment must be reasonable (section 43-260 of the ITAA 1997).