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Ruling

Subject: Compensation payment - injurious affection

Question 1

Are the capital proceeds received in compensation assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No

Question 2

Are the capital proceeds received in compensation for the cancellation of your rights (an intangible asset), assessable under the capital gains tax provisions of the ITAA 1997?

Answer: Yes

Question 3

Is the interest received in conjunction with the compensation payment, assessable as ordinary income under section 6-5 of the ITAA 1997?

Answer: Yes

Question 4

Are the capital proceeds received in compensation otherwise assessable under any other provision of the ITAA 1936 or 1997.

Answer: Not applicable

This ruling applies for the following period

Year ended 30 June 2007

Year ended 30 June 2012

The scheme commenced on

1 July 2006

Relevant facts and circumstances

The Trust purchased land in the 1988-89 financial year.

The purpose of the purchase of the land was to conduct a non-primary production activity.

In the 2006-07 financial year the Trust applied for, and was refused, development approval for the construction of buildings on the land on the basis that the land was designated as being reserved for parks and recreation. The land was designated a Planning Control Area under a government act in the 1994-95 financial year to enable the land use to be controlled.

The Trust had also attempted to put the land to other uses, which included some primary production activities. However, further development was not undertaken due to the uncertainty surrounding whether the land would be re-purchased by the government due to the restrictions on the land relating to the designation of the area as a Planning Control Area.

Discussion ensued between the Trust and the government department regarding the repurchase of the land or compensation to be paid.

A claim was made for compensation and the government department agreed to the claim in which an amount would be paid to the Trust, being the difference between the land's unaffected value and the land's affected value.

The government declined the Trust's offer to sell the land to them. The land is retained by the Trust.

In the 2011-12 financial year a payment (by cheque) was made to the Trust for compensation and interest (the interest was calculated from the date of the development application refusal until payment of the compensation amount).

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 102-5

Income Tax Assessment Act 1997 Section 112-30

Income Tax Assessment Act 1997 Subsection 112-30(3)

Reasons for decision

Summary

The capital proceeds received in compensation are not assessable as ordinary income; however, the proceeds will be assessable under the capital gains tax provisions.

The compensation payment relating to the reduction in the value of your land was made due to limitations imposed on the use of the land by statute. This is considered to be a payment in compensation for the cancellation of your right to use your land for your particular purpose and CGT event C2 is taken to have occurred. The event is taken to have occurred on the date your development application was refused and will be treated similarly to the part disposal of the land. Accordingly, you will be assessed on the net capital gain arising from the event in the financial year in which your rights ended, that is, when the development application was refused.

The interest received in conjunction with the payment is considered a substitute for the loss of income and, accordingly, is assessable as ordinary income in the financial year in which it was received.

Detailed reasoning

You received a lump sum compensation payment from a government department. The payment was in compensation for the damage suffered to the value of your property due to the limitations imposed on what you can do with your land, after the designation of the land as a Planning Control Area. We will need to determine whether the payment:

· is assessable ordinary income under section 6-5 of the ITAA 1997 as it was income received from rendering personal services, income from property or, income from carrying on a business.

· is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to profit, or

· is assessable under the capital gains tax provisions.

Assessable as ordinary income

Income from personal services, property, or carrying on a business

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Compensation component

In your case, you have not earned the lump sum payment as it does not directly relate to services performed. It is not income from property or from carrying on a business as the trust is not involved in either of these activities. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. In addition, the payment is neither expected nor relied upon.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. The compensation payment you have received is not considered to be compensation for the loss of income, but compensation for the loss of a capital asset (your rights). Accordingly, the lump sum payment is not considered ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Interest component

However, the interest received in respect of the compensation payment is considered ordinary income. The interest was paid as recompense for the loss of the use of the capital proceeds during a period in which it would earn income, that is, the period from when your development application was refused until the date the compensation payment was made. This amount was a substitute for a loss of income that may have been earned had the compensation payment been made on the date the development application was refused.

Therefore, the interest component of the payment is considered ordinary income and is assessable under section 6-5 of the ITAA 1997 in the financial year in which it was received.

Income from an isolated transaction with a view to a profit

Taxation Ruling TR 92/3 discusses whether profits from isolated transactions are income and therefore assessable under section 6-5 of the ITAA 1997.

An isolated transaction refers to those transactions outside the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers. A profit from an isolated transaction is generally considered assessable income under section 6-5 of the ITAA 1997 if:

· in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income, and

· the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character (Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355, 82 ATC 4031, 12 ATR 692). Whether a particular transaction has a business or commercial character depends on the circumstances of the transaction.

Paragraph 49 of TR 92/3 provides that generally, a transaction has a business or commercial character if the transaction would constitute the carrying on of a business except that it does not occur as part of repetitious or recurring transactions.

In your case, you state you purchased the property before you were made aware of the designation of the area as a Planning Control Area which enabled the government department to control the use of the land in question. Therefore, it would not have been possible for you to enter into the transaction with the intent to make a profit from the receipt of compensation. In addition, you provide that the intention for the purchase of the land was for a private or domestic use or, for carrying on a business, the land was not acquired for the intention of making a profit on its later sale.

As such, we consider that you did not conduct a commercial transaction with a view to a profit and, accordingly, the profit is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Assessable under capital gains tax provisions

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income also includes statutory income. Statutory income is amounts that are not ordinary income but are included in assessable income by another provision. One such provision is section 102-5 of the ITAA 1997 which deals with capital gains.

Amounts received which are not direct compensation for loss of income, will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Taxation Rulings TR 95/35 and TR 97/3 discuss the capital gains treatment of compensation receipts. Taxation ruling TR 97/3 extends the application of TR 95/35 and should be read in conjunction with that ruling. TR 97/3 specifically deals with compensation received by landowners from public authorities. This ruling, therefore, will have direct application in this case.

Paragraph 12 and 13 of TR 97/3 state:

12. An amount of compensation may be received by a landowner in respect of a reduction in the value of land resulting from limitations on the owner's use of the land imposed by statute. For example, the Native Vegetation Act 1991 (SA), the object of which is to preserve, enhance and manage native vegetation, limits rights of certain landowners to clear their land.

13. These compensation receipts are treated in the same way as compensation for a compulsorily acquired easement. Here again, there is a loss of some of the rights of ownership of the land. The compensation is treated as consideration in respect of the disposal of those rights, that is, in respect of a part disposal of the underlying land.

In your case, you received compensation from the government department for the reduction in your land value due to the limitations imposed on the use of your land under the Metropolitan Region Town Planning Scheme Act 1959. The land has not been acquired by the department, and the Trust therefore retains ownership of the land.

We consider that while the ownership of the land has not changed, the receipt of monies from a public authority is for compensation resulting from limitations on the use of your land imposed by statute. Therefore, as per ruling TR 97/3, the compensation payment is considered to be in respect of the disposal of the right to use your land for a particular purpose and subsequently is treated similarly to a part disposal of the underlying land.

As such, CGT event C2, constituting a cancellation of rights (an intangible asset), has occurred. The timing of a C2 event is taken to have occurred (if there is no contract), when the asset ends. In your case, the cancellation of your rights to use your land for a particular purpose occurred in the 2006-07 financial year when your development application was rejected. This is, therefore, the date your intangible asset (your right) ended.

Accordingly, if the capital proceeds received in compensation exceed the cost base of the asset in question, you would be considered to have made a capital gain, and it will be assessable under the capital gains tax provisions.

Apportionment of cost base (CGT event happens to part of an asset)

Section 112-30 of the ITAA 1997 provides apportionment rules which can be used to calculate the cost base of an asset when a CGT event happens to some part of the asset. Subsection 112-30(3) of the ITAA 1997 provides the following formula:

In your case, as cancellation of your rights is treated similarly to the part disposal of the land, you should calculate the cost base of the asset (the rights that have been cancelled) in accordance with the apportionment rules as detailed above.

Calculation of net capital gain

Section 102-5 of the ITAA 1997 outlines a method statement for calculating a net capital gain. This amount is then included in the taxpayer's assessable income.

A net capital gain is essentially the result of the following process:

· the sum of the taxpayer's individual capital gains for the income year

· less any capital losses made in the income year and previously unapplied net capital losses from earlier income years

· adjusting for any concessions (such as the discount capital gain concession).

Once the net capital gain is calculated, it should be reported in the income tax return of the Trust in the year the CGT event occurred, which in this case is the 2006-07 financial year.

Further information to consider

You may be eligible to apply a discount to your capital gain which may substantially reduce the amount of the gain that is assessable. We suggest that you consider the information provided in Subdivision 115-A of the ITAA 1997 detailing discount capital gains and whether an entity can apply a discount to a capital gain (and the percentage that may be applied) and, also Subdivision 115-C which discusses rules applying to Trusts with net capital gains.