Edited version of your written advice

Authorisation Number: 1012870136217

Date of advice: 31 August 2015

Ruling

Subject: Compensation received on disposal of property

Question 1

Are solatium payments received by the Estate as part of the compensation included as part of the capital proceeds on disposal of the property which was compulsorily acquired?

Answer:

Yes

Question 2

As a consequence of question 1, is the solatium component of any capital gain or loss made by the legal personal representative (LPR) of the Estate disregarded on disposal of the property as the property was a pre-CGT asset and hence disregarded for you when the solatium component was distributed to you as a beneficiary of the Estate?

Answer:

Yes

Question 3

Was the solatium payment and replacement property cost compensation received directly by you as part of the compensation included as part of the capital proceeds on disposal of your rights in the property which were acquired by an entity?

Answer:

Yes

Question 4

As a consequence of question 3, were the solatium and replacement property cost compensation amounts disregarded for tax purposes by you on disposal of your rights in the property as those rights were a pre-CGT asset?

Answer:

Yes

This ruling applies for the following period(s)

Year ended 30 June 2009

The scheme commences on

1 July 2008

Relevant facts and circumstances

Prior to 1985, a property was acquired by your grandparent. The Land was used as a farm. The Land passed to your parent and their sibling and upon the death of your parent's sibling, half of the Land was sold with the balance being farmed and owned by your parent.

Later, your parent was registered as the sole proprietor of the Property and the Property was used for farming.

Sometime later, your parent leased the Property to a third party.

Your parent died prior to 20 September 1985 leaving a Will providing a life interest in the residue of their estate to their spouse and on their death, the residue of the estate to you and your sibling.

Later, the Property was leased until the Property was acquired by the government agencies.

The life tenant died prior to the year 2000.

Later an administrator was appointed to the estate by order of the Supreme Court. They were replaced by another administrator some 8 years later.

The Estate was fully administered by the 2007 calendar year (although the Estate had not distributed all its assets to the beneficiaries of the Estate). Legal interest in the Property did not pass to you due to the compulsory acquisitions of the Property by various government agencies.

By Notice of Acquisition in the early 2000's a government agency acquired part of the Property.

In the late 2000's, the Estate settled a claim it had against a government agency for the acquisition of that part of the Property for compensation for a total of $XX. It is possible to dissect the compensation into its constituent components, which include, inter alia, capital payments for the market value of the Property and solatium.

By Notice of Acquisition published in the late 2000's, another government agency acquired part of the remaining Property.

The Estate settled a claim it had against this government agency for an amount of $XX (made up of solatium and compensation for the value of the acquired property) plus an additional amount for legal and valuation expenses. The amount is capable of dissection into its constituent parts.

By Notice of Acquisition in the late 2000's, another government agency compulsorily acquired the interests of estate, your sibling and 'all other interests' (which includes your interest) in the Property pursuant to the Compensation Act. The government agency offered the claimants the sum of money by way of compensation.

Supreme Court Proceedings were issued for determination of the disputed claims for compensation in the acquisition.

Later, the government agency increased their offer of compensation to the Claimants, the increase arising from the discovery of an error in the prior survey plan conducted on the Property.

In compliance with Supreme Court Orders in the proceedings, the Claimants filed and served their respective Particulars of Claim. Over the course of a further period, amendments were made to the Particulars of Claim and the government agency filed and served Particulars of Offer but agreement could not be reached between the parties.

Since the Acquisition, there was a vast difference between the compensation sought by the Claimants and the compensation being offered.

In light of the vast difference between government agency and the Claimants, the proceedings were listed for a preliminary planning question hearing to determine the assessment of market value.

Judgement was given by the Supreme Court to the preliminary planning question in favour of the Claimants. It was then up to government agency to revise its offer of compensation.

Negotiations ensued between the parties from this time.

Eventually, the government agency and the Claimants agreed to settle all of the Claimants claims for compensation. It is possible to dissect the compensation into its constituent components which include, inter alia, compensation for the value of the property acquired, solatium payment and replacement property costs.

The entire Property has now been acquired by various government agencies. As a consequence, the Property is no longer held by the Administrators of the Estate.

You have purchased some properties (the Replacement Properties) to replace the acquired asset. The properties include both farming and residential properties that are either already leased out or are intended to be leased out.

You state that the total value of the 'Replacement Properties' is less than the 120% threshold required by subsection 124-85(3) of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 128

Income Tax Assessment Act 1997 Section 128-15

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Section 97

Income Tax Assessment Act 1997 Section 102-15

Income Tax Assessment Act 1936 Section 99B

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 128-20

Income Tax Assessment Act 1997 Section 104-90

Income Tax Assessment Act 1997 Section 124-70

Income Tax Assessment Act 1997 Section 124-75

Income Tax Assessment Act 1997 Section 124-85

Reasons for decision

Effect of death

The capital gains tax provisions that deal with the effect of death are located in Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997).

When a person dies, the assets that make up their estate can:

• pass directly to a beneficiary (or beneficiaries), or

• pass directly to their legal personal representative (for example, their executor) who may dispose of the assets or pass them to the beneficiary (or beneficiaries).

A legal personal representative (LPR) can be either:

• the executor of a deceased estate (that is, a person appointed to wind up the estate in accordance with the will)

• an administrator appointed to wind up the estate if the person does not leave a will.

Subsection 128-15(1) and 128-15(2) of the ITAA 1997 explain that if a capital gains tax (CGT) asset you owned just before dying devolves to your legal representative or passes to a beneficiary in your estate, the legal personal representative, or beneficiary, is taken to have acquired the asset on the day you died.

A disposal by a deceased's legal personal representative or a beneficiary of a deceased estate of an asset owned by the deceased at death is not subject to CGT if the deceased died before 20 September 1985. This is because a deceased's legal personal representative or a beneficiary is deemed to have acquired the asset at the date of death no matter when probate or administration is granted or the asset is transmitted or transferred to the legal personal representative or beneficiary.

Equitable life and remainder interests

Taxation Ruling TR 2006/14 discusses the capital gains tax consequences of creating life and remainder interests in property.

Paragraph 7 of TR 2006/14 states:

This Ruling does not deal specifically with the treatment of pre-CGT acquired original assets or life and remainder interests. Any capital gain or loss arising from these assets is usually disregarded…

Importantly, a LPR will be treated as having acquired the original assets out of which life and remainder interest have been created, at the date of the deceased's death.

A remainder beneficiary under a will whose right to the assets is not subject to any contingency other than the death of the life beneficiary has a vested interest in the bequeathed assets but does not acquire possession of those assets until the death of the life beneficiary. A beneficiary who obtains a remainder interest in assets of a deceased estate under a will is also treated as acquiring those assets at the date of death, not at the date of death of the life tenant.

Paragraph 126 of TR 2006/14 confirms that the remainder beneficiaries are taken, under subsection 128-15(2) of the ITAA 1997, to have acquired estate assets at the date the deceased died. Therefore, if the deceased died before 20 September 1985, the asset is treated as a pre-CGT asset in the hands of the remainder beneficiary and so no capital gain or loss is recognised on ultimate disposal of the asset by the remainder beneficiary. This is the case even if the asset does not pass to the remainderman until the life tenant dies on or after 20 September 1985.

Capital gain made by the deceased estate and distributed to you

Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (property) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs.

Subsection 104-10(5) of the ITAA 1997 provides that a capital gain or capital loss will be disregarded if the asset was acquired before 20 September 1985 (pre-CGT).

Section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) defines 'net income' of a trust estate to be;

…the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions…

Section 995-1 of the ITAA 1997 provides that assessable income has the meaning given by sections 6-5, 6-10, 6-15, 17-10 and 17-30 and includes both 'ordinary income and 'statutory income'. According to section 102-5 of the ITAA 1997, assessable income includes your net capital gains (if any) for the income year.

Section 97 of the ITAA 1936 provides that the assessable income of a beneficiary shall include;

i. the share of the net income of the trust estate, attributable to a period when the beneficiary was a resident; and

ii. the share of the net income of the trust estate, attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia.

Subsection 99B(1) of the ITAA 1936 explains that an amount, being property of a trust estate paid to a beneficiary, shall be included in the assessable income of the beneficiary, subject to subsection 99B(2).

Subsection 99B(2) of the ITAA 1936 provides that an amount paid to the beneficiary of the trust estate should be reduced by the amount that, if it had been derived by a taxpayer being a resident, would not have been included in the assessable income of that taxpayer of a year of income.

As the property is considered to have been acquired by the LPR before 20 September 1985, any capital gain made on disposal of the property will be disregarded. As the capital gain will be disregarded, it will not be included in the net income of the trust. As the capital gain does not form part of the net income of the trust estate, there is no amount to which the beneficiaries will be assessed under section 97 of the ITAA 1936. Therefore, Division 6E of the ITAA 1936 and subdivision 115-C of the ITAA 1997 do not have any application in assessing the beneficiaries on the capital gain from the disposal of the property.

On the cash distribution of the capital gain to beneficiaries, consideration must be given to section 99B of the ITAA 1936 as the beneficiaries are in receipt of trust income which has not previously been subject to tax.

It has already been established that a capital gain made on the disposal of a pre-CGT asset is disregarded. Therefore, should the gain have been derived by a beneficiary, the gain would also be disregarded. Accordingly, subsection 99B(2) would apply to ensure that no amount will be included in the assessable income of the beneficiary when the gain is distributed to them.

As such, any capital made by the estate on disposal of the property and/or interests in the property to the government agencies and distributed to you will be disregarded by both you and the estate.

Capital gain made by you

Subsection 108-5(1) of the ITAA 1997 explains that a CGT asset is;

1) any kind of property, or

2) a legal or equitable right that is not property

To avoid doubt, subsection 108-5(2) of the ITAA 1997 states that the following are CGT assets:

a) part of, or an interest in, an asset referred to in subsection (1)

b) goodwill or an interest in it.

c) an interest in an asset of a partnership, and

d) an interest in a partnership that is not covered by paragraph (c)

Subsection 128-20(1) of the ITAA 1997 states that a CGT asset passes to a beneficiary in your estate if the beneficiary becomes the owner of the asset:

a) under your will, or that will as varied by a court order; or

b) by operation of an intestacy law, or such a law as varied by a court order; or

c) because it is appropriated to the beneficiary by your legal personal representative in satisfaction of a pecuniary legacy or some other interest or share in your estate; or

d) under a deed of arrangement if:

i. the beneficiary entered into the deed to settle a claim to participate in the distribution of your estate; and

ii. any consideration given by the beneficiary for the asset consisted only of the variation or waiver of a claim to one or more other CGT assets that formed part of your estate

Subsection 128-15(1) and 128-15(2) of the ITAA 1997 explain that if a capital gains tax (CGT) asset you owned just before dying devolves to your legal representative or passes to a beneficiary in your estate, the legal personal representative, or beneficiary, is taken to have acquired the asset on the day you died.

In relation to any subsequent dealing in an equitable interest between a remainder owner and a third party (i.e. not the trustee), paragraph 73 explains;

CGT event E8 in section 104-90 happens if a remainder owner disposes of a post-CGT acquired interest in the capital of a trust (except a unit trust or a trust to which Division 128 applies) provided they:

• did not give any money or property to acquire their remainder interest; and

• did not acquire it by assignment.

The exception in that event for a 'trust to which Division 128 applies' will not apply unless:

a) the event involves an asset that the deceased owned when they died; and

b) the asset passes to a beneficiary of the estate in accordance with the rules in section 128-20 of the ITAA 1997 for the transmission of an asset through an estate.

Moreover, the requirement that the asset be owned by the deceased at their date of death precludes the exception from applying to life and remainder interests, as the ruling states at paragraph 11, that equitable life and remainder interests are created under the will by reference to assets owned by the deceased at their date of death.

Therefore in relation to CGT event E8, as stated in paragraph 80 of TR 2006/14:

…The exception to CGT event E8 will therefore apply if, during the administration of a deceased individual's estate, a beneficiary disposes of their interest in trust capital. The exception applies however only to the extent that trust assets owned by the deceased when they died might pass to the beneficiary…

In this case, your remainder equitable interest in the property is a CGT asset. The remainder interest is considered to have passed to you for the purposes of section 128-20 of the ITAA 1997 as it is an interest you have received under the will of the deceased. Further, you are taken to have acquired the interest pre-CGT as the deceased died before 20 September 1985 (section 128-15).

While, the interest did pass to you under the will of the deceased, the trust is no longer considered a 'trust to which Division 128 applies' as the estate had already been fully administered before you disposed of your remainder interest and therefore CGT event E8 will happen at the time of the disposal.

However, as the remainder interest is considered to be a pre-CGT interest in your hands, any capital gain made on the disposal of your interest will be disregarded.

Solatium payments

Subsection 44(1) of the Land Acquisition and Compensation Act 1986 (Vic) (the Compensation Act) discusses solatium payments. It provides that an amount may be paid by way of solatium to compensate a claimant for intangible and non-pecuniary disadvantages resulting from the acquisition.

Taxation Ruling TR 95/35 states that the CGT consequences of an award of damages depend on whether there is an underlying asset to which the damages have a direct and substantial link. Such a link may be established if there is a CGT asset which has been disposed of, permanently damaged or reduced in value by the circumstances which generates the right to compensation.

Paragraph 4 of TR 95/35 states that if a CGT event happens to an underlying asset then the compensation received is treated as capital proceeds. If the asset was a pre- CGT asset, or is otherwise exempt, the compensation generally has no CGT consequences. If the asset was a post- CGT asset, a capital gain or loss may arise from the CGT event.

Solatium payments received by the Estate

The Estate received solatium payments as part of the compensation for the compulsory acquisition of the property. The property, for CGT purposes, is the 'underlying asset'. Without the compulsory acquisition of the property the Estate would not have received the solatium payments. Therefore, the amounts the Estate received, by way of solatium are treated similarly to the amounts the Estate received for the value of the property.

Accordingly, as it has already been established that the compensation related to the disposal by the Estate of pre-CGT property, any capital gain made by the Estate will be disregarded and hence, disregarded for you, when the solatium component was distributed to you as beneficiary of the Estate.

Solatium payments received by you

You have received a solatium payment as part of the compensation for the compulsory acquisition of the property in which you had an equitable interest (your remainder interest). It has already been established that your remainder interest in the property is a pre-CGT interest in your hands and that any capital gain made on the disposal of your interest would be disregarded.

Similarly to the treatment of solatium payments for the Estate, you would not have received the solatium payment if not for the compulsory acquisition of the property. Therefore the solatium payments are treated in the same way as the amount received for the value of your interest.

Accordingly, the solatium payment is considered part of the compensation for the disposal of your pre-CGT interest in the property and any capital gain made on receipt of the solatium payment will be disregarded.

Replacement property costs

You have received an amount of money, described as replacement property costs, as part of the compensation received for the disposal of your pre-CGT interest in the property.

Similar to the solatium payments, the amount was received as part of the compensation for the compulsory acquisition of your interest in the property. Without the compulsory acquisition of the property you would not have received the payment. Therefore, the amount received by you, noted as replacement property costs, are treated similarly to the amounts you received for the value of your interest in the property.

Accordingly, the amount received as replacement property costs is considered part of the compensation for the disposal of your pre-CGT interest in the property and any capital gain made on receipt of the payment will be disregarded.