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Edited version of your written advice
Authorisation Number: 1012705135597
Ruling
Subject: CGT
Question
Is the relevant asset for CGT purposes the right to seek compensation?
Answer: Yes
Is your right to seek compensation taxable Australian property?
Answer: No
This ruling applies for the following period
Year ended 30 June 2014
The scheme commenced on
1 July 2013
Relevant facts and circumstances
You have been a non-resident for tax purpose.
You are the owner of the Property.
You entered into a contract for the sale of the Property.
The Purchaser defaulted on the contract and refused to settle.
You undertook legal proceedings for damages (the difference between the contract price and the current market value of the Property). Damages were awarded to you but you needed to take further action to recover payment. You eventually received a sum of monies in settlement of your dispute.
Reasons for decision
In Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts, the Commissioner considers the capital gains tax consequences regarding the receipt of a compensation amount.
The ruling utilises the underlying asset / look through approach in determining which is the most relevant asset that generates the compensation receipt.
In first instance, it is necessary to determine the type of asset disposed in order to determine the most relevant CGT Event.
A compensation payment may relate to the disposal of, or permanent damage to, an underlying asset. The underlying asset is the most relevant asset to which the compensation amount is most directly related. For example, if you receive compensation for damage to a rental property, the most relevant asset (the underlying asset) is the rental property.
• If the payment relates to the disposal (in whole or part) of an underlying asset, the compensation is treated as additional capital proceeds for the disposal of that asset.
• If the payment relates to permanent damage to, or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (that is, you reduce the cost base and reduced cost base by the amount of the compensation).
• If the payment is not for an underlying asset, it relates to the disposal of the right to seek compensation. The capital gain or capital loss will be the difference between the incidental costs and the compensation received.
In this case, you entered into a contract with the Purchaser for the sale of the Property. The Purchaser defaulted and you undertook legal proceedings for damages for breach of contract with the court found in your favour.
As the Purchaser defaulted on the contract the Property was not disposed of. Also, there has been no permanent damage to, or permanent reduction in the value of the property as a result of the sale not proceeding.
Therefore, as the asset (the Property) was neither permanently damaged nor reduced in value, the relevant CGT asset in this case is the right to seek compensation.
Disposal of asset
CGT event C2 happens when compensation is paid to discharge or end a right. Section 104-25 of the ITAA 1997 states (where relevant):
(1) CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:
(a) being redeemed or cancelled; or
(b) being released, discharged or satisfied; or
In the current circumstances, your right to seek compensation would be regarded as an intangible CGT asset and the disposal of which results in CGT event C2 occurring.
Capital gains tax non-resident
A non-resident of Australia can make a capital gain or loss from a CGT event in certain circumstances under section 855-15 of the ITAA 1997. You are currently a non-resident for tax purposes and you were a non-resident at the time the CGT asset was created and disposed of.
As a non-resident you can only make a capital gain or loss if the asset is 'taxable Australian property'. The term 'taxable Australian property' is defined in the table in section 855-15 of the ITAA 1997 and covers five categories of assets.
Broadly, these categories are:
• taxable Australian real property which is held directly
• indirect Australian real property interests which are not covered by item 5 of the table in section 855-15 of the ITAA 1997
• CGT assets used in carrying on a business through a permanent establishment in Australia, and which are not covered by item 1, 2 or 5 of the table in section 855-15 of the ITAA 1997
• options or rights to acquire a CGT asset covered by item 1, 2 or 3 of the table in section 855-15 of the ITAA 1997 and
• CGT assets covered by subsection 104-165(3) of the ITAA 1997 (choosing to disregard a capital gain or capital loss on ceasing to be an Australian resident).
Your right to seek compensation does not fall into any of the above categories. Therefore any capital gain or loss you make from CGT even C2 is disregarded.
Therefore any capital gain or loss you make from CGT even C2 is disregarded.