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Ruling

Subject: compensation payment

Question 1

Is the payment received as compensation for loss of future income from your business activity, assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income?

Answer:

Yes.

Question 2

Can you spread the payment received as compensation for loss of income (for the next five years) from your primary production business activity, over a five year period?

Answer:

No.

Question 3

Is the payment received as compensation for replacement assets (which were destroyed), assessable under the capital gains tax (CGT) provisions of the ITAA 1997.

Answer:

Yes.

Question 4

Are you entitled to apply the 50% discount to the capital gain made from the proceeds received in compensation for the destruction of your CGT asset?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You conduct a business activity under a partnership structure.

A disease was detected in your plants.

A government department was brought in to eradicate the disease, which involved the destruction of some of the plants.

You have provided a copy of your submission for compensation, which details the calculations undertaken to arrive at the compensation figure. The figures have been divided between loss of income and the cost of replacement plants.

You received a compensation payment for the stage 1 of removal and destruction of infected plants (the payment being calculated for the income loss over the period of 60 months).

You received a second compensation payment for the stage 2 of removal and destruction of commercial plants on the property in an attempt to stop the spread of the disease (the payment being calculated for the income loss over the period of 60 months).

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Section 385-135

Income Tax Assessment Act 1997 Section 385-130

Income Tax Assessment Act 1997 Section 385-105

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-20

Income Tax Assessment Act 1997 Section 115-25

Income Tax Assessment Act 1997 Section 106-5

Reasons for decision

Compensation payment - assessable as ordinary income

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.

The compensation received was not income from rendering personal services, income from property or, income from carrying on a business. The payment is also a one off payment and thus it does not have an element of recurrence or regularity.

A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of income, then it will be regarded as ordinary income. 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.

In your case, you received compensation for the loss of future income from the destroyed plants as well as compensation to replace the plants that were destroyed.

Therefore, the payments relating to loss of future income will be assessed as ordinary income, whereas the payment for the loss of the capital asset (the replacement of the plants themselves) will be considered a capital receipt and will be assessed under the capital gains tax provisions.

The compensation amount for the loss of future income, as provided in your calculation, is ordinary income and will be assessable under section 6-5 of the ITAA 1997.

Compensation payment - deferred over a five year period

According to section 995-1 of the ITAA 1997, carrying on a business of primary production includes cultivating or propagating plants, fungi, or their products or parts (including seeds, spores, bulbs and similar things), in any physical environment.

Special provisions apply to abnormal receipts of primary production producers relating to double wool clips (section 385-135 of the ITAA 1997), insurance recoveries for live stock and timber (section 385-130 of the ITAA 1997), and the forced disposal or death of live stock (section 385-105 of the ITAA 1997). In some cases the provisions allow for income received to be spread, for assessment purposes, over a 5 year period.

In your case, you carry on a business of primary production, however, the income received in compensation does not relate to wool clips or, an insurance recovery for the loss of live stock and timber, or, the forced disposal or death of live stock.

Therefore, none of the specials provisions for abnormal receipts, mentioned above, are applicable to you. Accordingly, you can not spread the compensation payment relating to the loss of income over more than one income year and the payment for loss of income, therefore, is assessable in the financial year in which it was received.

Compensation payment - assessable under capital gains tax provisions

Capital gains tax (CGT) is the tax you pay on certain gains you make. You make a capital gain or capital loss as a result of a CGT event happening to an asset in which you have an ownership interest (section 102-20 of the ITAA 1997).

A CGT asset is any kind of property; or a legal or equitable right that is not property (section 108-5 of the ITAA 1997). As such, the plants are considered a CGT asset.

Taxation Ruling TR 95/35 which deals with capital gains treatment of compensation receipts provides that in determining which is the most relevant asset, it is appropriate to adopt a look-through approach to the transaction or arrangement which generates the compensation receipt.

Paragraph 4 of TR 95/35 provides that if an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. Disposal for the purposes of the Ruling includes loss or destruction of the asset.

CGT event C1

CGT event C1 happens if a CGT asset is lost or destroyed (section 104-20 of the ITAA 1997). If compensation is received for the loss or destruction of the CGT asset, the time of CGT event C1 is when the compensation is first received. If no compensation is received, CGT event C1 happens when the loss is discovered or the destruction occurred.

A capital gain from CGT event C1 is made if the capital proceeds from the loss or destruction of the asset are more than its cost base. If the capital proceeds are less than the reduced cost base of the asset, a capital loss is made.

In your case, the most relevant asset is the plants that were destroyed. You have received compensation to replace the destroyed asset. As such, CGT event C1 is taken to have occurred on the date the compensation was first received.

CGT 50% discount

A 50% discount may be applied to a discount capital gain realised by an individual. In order to be considered a discount capital gain, the asset that gave rise to the capital gain must have been owned for a period of at least 12 months prior to the CGT event (section 115-25 of the ITAA 1997).

In your case, you state that the plants have been in existence for more than one year. Accordingly, as the asset (plants) has been held for more than 12 months the 50% discount can be applied to your capital gain.

Calculation of capital gain or loss for a partnership

Section 106-5 of the ITAA 1997 discusses capital gains in relation to partnerships. It provides that any capital gain from a CGT event happening to a partnership asset is made by the partners individually, with each partner's gain calculated by reference to the partnership agreement, or partnership law if there is no agreement. Each partner has a separate cost base for the partner's interest in the CGT asset of the partnership. The gain is calculated by allocating an appropriate share of the capital proceeds from the event against the individual's cost base for the asset.