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Ruling

Subject: Assessability of a compensation payment under the capital gains tax provisions

Question and answer:

Is the compensation amount payable to you under an agreement between yourself and another party assessable under the capital gains tax provisions?

Yes.

This ruling applies for the following period:

1 July 2012 to 30 June 2013.

The scheme commenced on:

1 July 2012.

Relevant facts and circumstances:

You and your spouse jointly own property (your property).

Your property is a post-CGT asset.

Your property joins, or is near, the mining operations of a mining company.

You entered into an agreement with the mining company under which you have agreed to receive a compensation amount payable in several instalments over a number of years because of the effect the mining operation will have on your property.

The compensation amount is undissected.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 116-20

Reasons for decision

Capital gains tax - general

You can only make a capital gain when a capital gains tax (CGT) event happens to a CGT asset that you own. The gain is made at the time of the CGT event.

In most cases, you must have acquired the asset on or after 20 September 1985 for the CGT provisions to apply to it.

Any assessable gain you make from a CGT event is included in your assessable income by section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

You make an assessable gain if the capital proceeds resulting from the CGT event are greater than the asset's cost base.

Subsection 116-20(1)(a) of the ITAA 1997 states that capital proceeds from a CGT event include:

· 'the money you have received, or are entitled to receive, in respect of the event happening'.

Where capital proceeds from a CGT event are payable by instalments over a period of time, subsection 116-20(1)(a) of the ITAA 1997 applies to bring the total amount payable to account in the year the CGT event happens. This is the case because the instalments constitute money or an entitlement to money and thus, the full amount receivable forms part of the consideration from the CGT event.

There are five elements that can make up the cost base of a CGT asset. These are:

· The first element: money or property given for the asset.

· The second element: incidental costs of acquiring the asset or that relate to the CGT event.

· The third element: costs of owning the asset.

· The fourth element: capital costs to increase or preserve the value of your asset or to install or move it.

· The fifth element: capital costs of preserving or defending your ownership of or rights to the asset.

There are numerous CGT events that may happen to a CGT asset and these include what is known as CGT event C2 (section 104-25 of the ITAA 1997). CGT event C2 happens when your ownership of an intangible CGT asset (such as a right to seek compensation) ends.

The time of a C2 event is generally when the contract that results in the asset ending is entered into.

Any assessable gain from a CGT event is divided between joint owners of the asset according to their legal interest in the asset.

CGT and receipts of undissected lump sum compensation amounts

Guidance on the application of the CGT provisions to receipts of compensation is provided by Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts.

Taxation Ruling TR 95/35 specifies that:

· when an undissected compensation amount is received, the whole amount is treated as being received for the disposal of a right to seek compensation,

· a right to seek compensation is a CGT asset,

· a right to seek compensation is ended (thereby giving rise to CGT event C2) when an arrangement to settle the matter is entered into,

· the normal cost base rules apply to determining the cost base of a right to seek compensation, and

· generally, there will be no acquisition cost for a right to seek compensation; however, legal and similar costs that are incurred in reaching an agreement to end a right to seek compensation are included in the cost base of the asset.

Conclusion and application to your facts

You signed an agreement accepting an undissected amount as compensation for the impact of a mining operation on your property.

Because the compensation amount was undissected, the whole amount is treated (for CGT purposes) as having being received for the disposal of your right to seek compensation.

A right to seek compensation is a CGT asset and CGT event C2 happened to your right to seek compensation on the day you signed the compensation deed. This was the day your right to seek compensation ended.

Because your property is a post-CGT asset (that is, the property was acquired on or after 20 September 1985), the right to seek compensation because of the nearby mining operation must also be a post-CGT asset. Accordingly, the CGT provisions apply to include in your assessable income any gain made from the ending of your right to seek compensation.

Your assessable gain from the ending of your right to seek compensation will be your share (according to your legal interest in the right to seek compensation) of the difference between the capital proceeds from the ending of that asset and the cost base of the asset.

The capital proceeds from the CGT event is the full amount of the compensation amount agreed to, regardless of the fact that the compensation amount is to be paid in instalments over several years.

The cost base of the asset will comprise any legal and other professional fees you may have incurred in entering into the compensation deed.