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Ruling

Subject: compulsory acquisition

Questions:

1. Is the compensation amount received, calculated having regard to market value and disturbance, assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No.

2. Is the compensation amount received, calculated having regard to market value and disturbance, assessable as a capital gain?

Answer: Yes.

3. Are the proceeds to be returned in the 2011-12 financial year?

Answer: Yes.

4. Where the compensation is capital, do you pass the basic tests for the small business CGT concessions?

Answer: Yes.

5. Are the redevelopment costs on capital account?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You and your spouse purchased a rural property (the property) a number of years ago. The following year, you and your spouse had constructed your private residence and established a business on the property. The business has operated since 1999 and is a small business for CGT purposes.

You were informed by a public authority that they wished to acquire part of the property from you under a power of compulsory acquisition. The public authority informed you that, as per your previous discussions and correspondence, they agreed to purchase the property.

The total purchase price was to be in full satisfaction of all claims arising from the acquisition in accordance with the applicable Australian law. The compensation you received was calculated having regard to the market value and disturbance of the land. The portion for disturbance was made up of valuation fees, conveyancing fees and allowance for fill.

The public authority and its agents had the right of entry from the date the contracts were exchanged.

Contracts were exchanged in and the property entered under this power the following month. Settlement and payment occurred in the month after that.

You had to undertake some minor earthworks and build some additional fencing due to the public authority encroachment on land incorporating existing business activities. In the same year, you had a development application approved in principle by the local council for future business related expansion.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Section 43-10

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-10

Reasons for decision

The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation.

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. It is not considered income received in the course of carrying on of a business and is therefore not assessable under section 6-5 of the ITAA 1997.

Taxation Ruling TR 95/35 describes how to treat compensation receipts. Where compensation is received, you need to look at what asset has been disposed of.

As discussed above, 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', the Commissioner will treat the compensation as consideration for that disposal (CGT event A1).

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 there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

In your case, you have received compensation for compulsory acquisition of your land. The amount you received was calculated having regard to the market value of the land compulsorily acquired and the disturbance of your business due to the acquisition of the land. Using the 'look through approach' we consider that the 'right to seek compensation' leads directly from the loss of part of your land and is the 'underlying asset' for CGT purposes. Therefore, the full amount of compensation received is treated as the total consideration received for the disposal of the land.

The time of such a disposal is specifically set out by subsection 104-10(6) of the ITAA 1997 as the earliest of:

· when the taxpayer received compensation from the entity;

· when the entity becomes the asset's owner;

· when the entity entered it under that power; or

· when the entity took possession under that power.

In your case, the amount of compensation to be received was negotiated during a certain financial year. However, under the agreement, the public authority and its agents had the right of entry from the date the contracts were exchanged. Contracts were exchanged early in the following year and the property entered under this power in the following month. The public authority became the owner of the parcel of land, and compensation paid, during the month following that. The earliest of these events is in the 2011-12 financial year, therefore that is the year in which the proceeds need to be returned.

CGT Small business concessions

A capital gain may be reduced or disregarded under Division 152 of the ITAA 1997 if the basic conditions in section 152-10 of the ITAA 1997 are satisfied for the gain. These conditions are as follows:

1. A CGT event happens in relation to a CGT asset in an income year;

2. The event would have resulted in a gain;

3. You are a small business entity; and

4. The CGT asset satisfies the active asset test.

The active asset test is satisfied if you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period. The test period begins when you acquired the asset, and ends at the earlier of the CGT event, and when the business ceased, if the business in question ceased in the 12 months before the CGT event.

In your case, CGT event A1 happened to the land in the 2011-12 financial year and the disposal resulted in a gain. You were carrying on a business in the 2011-12 financial year and you were a small business entity. The land has been held for over 14 years. The land has been used in the business for approximately 13 years.

Conclusion:

Based on the above, you satisfy all the basic conditions to gain access to the small business relief under section 152-10 of the ITAA 1997.

Capital expenditure

Expenses incurred to expand or improve you existing business structure are capital in nature and not deductible under section 8-1 of the ITAA 1997.

Under Division 43 of the ITAA 1997 you can deduct certain capital works expenditure incurred on income producing assets. Section 43-10 of the ITAA 1997 operates to allow a deduction for an amount of capital works used in a deductible way during the income year.

Alternatively, you may consider the CGT small business rollover exemption as part of the small business relief available under section 152-10 of the ITAA 1997.