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Edited version of private advice
Authorisation Number: 1012672526886
Ruling
Subject: Compensation payment
Questions and Answers:
1. Is the compensation payment of $X an assessable capital gain?
Yes
2. Do the legal costs involved in settlement of both the court applications form part of the cost base?
Yes
This ruling applies for the following period:
Year ended 30 June 2014
The scheme commenced on:
1 July 2013
Relevant facts and circumstances
You are the trustee for the deceased estate.
The deceased was in the business of buying land, subdividing and selling blocks of land which commenced prior to 20 September 1985.
One of the blocks of land, which formed part of trading stock, was dedicated to the crown as reserve for park and recreation. Despite being endorsed by the council before September 1985, the plan was registered without the dedication of land as reserve.
Prior to September 1985 title was issued for several blocks including the block in question in the name of the deceased and another person.
After September 1985, the title of the block of land in question was transferred into the name of the deceased.
You received a payment of $X, on behalf of the estate, in the relevant income year as compensation to settle disputes regarding court applications. The applications related to the block of land in question.
You have provided a letter from the estate's lawyers supporting the payment.
The estate incurred legal fees between 200X and the date the settlement was made in the relevant income year.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 104-25.
Income Tax Assessment Act 1997 Paragraph 108-5(1)(b).
Reasons for decision
You make a capital gain when a capital gains tax (CGT) event occurs and the capital proceeds from the disposal of the CGT asset is more than the cost base of the CGT asset. A CGT asset includes a right to enforce a contractual obligation.
Taxation Ruling TR 95/35 Capital gains: treatment of compensation receipts (TR 95/35) sets out the Commissioner's view in relation to the treatment of compensation receipts. Paragraph 11 of TR 95/35 states that if a compensation payment is not in relation to an underlying asset, it relates to the disposal of the right to seek compensation. Upon such disposal, CGT event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) occurs for the surrender of that right.
Paragraph 18 of TR 95/35 states that if the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.
In your case, you, as trustee for the deceased estate, received the amount $X in the relevant income year as compensation to settle the disputes. The applications related to the block of land in question.
CGT event C2 occurred when you entered into the contract that resulted in an asset ending, in this case giving up your right to seek compensation. The $X you received represents the capital proceeds of the CGT event. The amount is assessable as a capital gain to the estate.
Cost base
The cost base of the right to seek compensation is determined in accordance with the provisions of section 110-25 of the ITAA 1997. The consideration in respect of the acquisition of the right to seek compensation includes the total acquisition costs incurred as a result of which the right to seek compensation arose. Furthermore, paragraph 169 of TR 95/35 states that the cost base of the asset is the sum of money and the market value of any property given as consideration for the creation of the asset. This would include any legal expenses incurred in respect of pursuing your right to seek compensation. In your case, the estate incurred legal fees between 200X and the date the settlement was made in the relevant income year. These fees can be included in the calculation of the cost base.
Summary
You received a payment of $X, on behalf of the estate, in the relevant income year as compensation to settle the disputes, the underlying asset being the block of land in question. CGT event C2 occurred when you entered into a contract, giving up your right to seek compensation. The amount you received of $X is the capital proceeds of the CGT event. The legal costs incurred in connection with the disputes can be included in the calculation of the cost base.