Edited version of your written advice

Authorisation Number: 1051440442361

Date of advice: 31 January 2019

Ruling

Subject: Compensation – compulsory acquisition of land – permanent damage – consequential loss – temporary disturbance

Question

Will the compensation received for the compulsory acquisition of your land be subject to the application of CGT event A1 in section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question

Will compensation received for permanent damage and loss to the land reduce the cost base of the land?

Answer

Yes.

Question

Will compensation received for temporary disturbance to your business operations carried out on the land be assessable as ordinary income under section 6-5 of the ITAA 1997 or be an assessable recoupment under section 20-20 of the ITAA 1997?

Answer

Yes.

Question

Will compensation received for consequential losses of your business operations carried out on the land be assessable as ordinary income under section 6-5 of the ITAA 1997 or an assessable recoupment under section 20-20 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You are a landowner.

You carry on a business on the land.

You have entered into an agreement to receive compensation for land that is being compulsorily acquired.

The compensation includes amounts for:

● the compulsorily acquired land

● the permanent damage or reduction in the value of your land

● temporary disturbances to your business operations, and

● consequential losses for your business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 section 110-40

Income Tax Assessment Act 1997 section 110-45

Reasons for decision

Summary

CGT event A1 happened when part of the land was compulsorily acquired. The compensation amount received for the part disposal of the land is capital proceeds for that CGT event.

In relation to the permanent damage/loss to the land, the cost base for the remaining land should be reduced by the amount of compensation paid for this component under section 110-40 or 110-45 of the ITAA 1997.

The amounts for temporary disturbances and consequential losses will be assessable under section 6-5 of the ITAA 1997 to the extent that they are ordinary income. To the extent that these amounts are not ordinary income, they will be assessable under Subdivision 20-A of the ITAA 1997.

Detailed reasoning

Subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts, however, a substantial body of case law exists which identifies likely characteristics.

Characteristics of ordinary income that have evolved from case law include receipts that:

a) are periodical, regular or recurrent;

b) are relied upon by the recipient for their regular expenditure and paid to them for that purpose; and

c) are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient.

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income also includes statutory income. Statutory income is amounts that are not ordinary income but are included in assessable income by another provision. These provisions include Subdivision 20-A of the ITAA 1997 which deals with assessable recoupments and section 102-5 which deals with net capital gains.

Ultimately, whether or not a particular receipt is ordinary income, statutory income or a capital receipt depends on its character in the hands of the recipient. For income tax purposes, a compensation amount generally bears the character of that which it is paid to replace.

Compensation for Compulsorily Acquired Land

Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes a net capital gain. A capital gain or loss is made only if a capital gains tax (CGT) event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

An interest in land or part of and is a CGT asset under section 108-5 of the ITAA 1997. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation receipts.

Paragraph 70 of TR 95/35 provides that in determining the most relevant asset for which the compensation has been received, it is often appropriate to adopt a ‘look-through’ approach to the transaction which generates the payment.

The ‘look-through’ approach is defined in paragraph 3 of TR 95/35 to be the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related.

If the compensation receipt relates to more than one asset, the compensation needs to be apportioned between those assets. Similarly, if the amount is received for a number of heads of claim (e.g., lost profits, interest and punitive damages), the amount also needs to be apportioned between the items.

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

Taxation Ruling TR 97/3 Income tax: capital gains: compensation received by landowners from public authorities provides guidance on the tax treatment of compensation received from a public authority for the compulsory acquisition of an easement. Paragraphs 5 to 8 of TR 97/3 provide as follows in relation to the tax treatment of compulsory easements:

5. The compensation received by a landowner from a public authority that compulsorily acquires an easement is not excluded from the scope of TR 95/35 by paragraph 2 of that Ruling which states that:

'This Ruling does not consider:

* …..

* amounts received for the grant of easements, profits a prendre and licences - these are covered in detail in Taxation Ruling IT 2561 and in Taxation Determinations TD 93/235 and TD 93/236'.

6. A strict application of Part IIIA would require the compensation received from a public authority to be treated as consideration in respect of the disposal by the landowner of the right to compensation. However, TR 95/35 focuses on the asset to which the compensation receipt most directly relates. In the case of easements acquired under statute and the consequential disposal of the right to compensation, the most relevant asset is the landowner's pre-existing land with its rights of ownership including, for example, a right to exclude all others. This right to exclude all others is forfeited in part when the easement comes into existence. The loss of part of this right constitutes the disposal of part of the underlying asset (the land) for Part IIIA purposes (paragraph 160M(3)(b), subsection 160M(1) and section 160R).

7. Paragraph 4 of TR 95/35 states that:

"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. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation."

8. Applying this approach, an amount of compensation received by a landowner for the loss of part of the rights of ownership is accepted as being consideration received in respect of the part disposal of the underlying asset (the land). The amount is not consideration for disposal of the right to seek compensation.

In this case, it is considered that the payment received for the compulsorily acquired land is not assessable as ordinary income as it is not a product in a real sense of any employment, services or business carried on and it does not have the characteristics normally associated with ordinary income such as periodicity and reliance on the payments to meet regular expenditure.

The compensation for the compulsorily acquired land has been received in respect of the part disposal of the land (the underlying asset). It is not considered a disposal of the right to seek compensation. Accordingly, CGT event A1 happened when the land was compulsorily acquired (section 104-10 of the ITAA 1997). The compensation amount received for the part disposal of the land is capital proceeds for that CGT event.

Compensation for Permanent Loss to Land

Paragraph 6 of TR 95/35 provides that if an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Subsections 110-40(3) and 110-45(3) of the ITAA 1997 provide that expenditure does not form part of any element of the cost base to the extent of any amount you have received as recoupment of it, except so far as the amount is included in your assessable income.

Permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

In your case, the portion of the compensation payment relating to permanent damage to the land is not considered to be ordinary income nor is it considered to be capital proceeds from the disposal of the land or from any other CGT event. The amount is not included in your assessable income under any other provision. This amount was paid to compensate for the permanent damage to the land or the diminution in land value as a direct result of the placement of the rail corridor and associated railway structure on the land (the underlying asset). Accordingly, the total acquisition costs (the cost base) for the land should be reduced by the amount of compensation received for this component under subsection 110-40(3) or 110-45(3) of the ITAA 1997.

Compensation for Temporary Disturbances and Consequential Losses

To the extent that the compensation is paid to you for the temporary disturbances and consequential losses, the amounts received will either be assessable under section 6-5 of the ITAA 1997 or Subdivision 20-A of the ITAA 1997.

As noted above, subsection 6-5(1) of the ITAA 1997 provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). For example, if deductible expenditure is incurred in the course of carrying on a business, a reimbursement in respect of that expenditure is similarly derived in the course of business and is properly treated as part of its business proceeds (as it has the character of income).

Subdivision 20-A of the ITAA 1997 applies where a taxpayer has received an amount as recoupment of a deductible loss or outgoing. The effect of Subdivision 20-A is to include the recouped amount in your assessable income to the extent the loss or outgoing has or can be deducted.

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss or outgoing is an assessable recoupment if:

● you received the amount by way of insurance or indemnity, and

● you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it for an earlier income year, under any provision of this Act.

The word 'indemnity' is not defined in the ITAA 1997 and so it must take its ordinary meaning. According to the Macquarie Dictionary, 'indemnity’ is:

1. protection or security, as by insurance, against damage or loss.

2. compensation for damage or loss sustained.

3. something paid by way of such compensation.

Alternatively, an amount received by a taxpayer as recoupment of a loss or outgoing will be an assessable recoupment where the taxpayer did not receive the amount by way of insurance or indemnity, and an amount was deductible for the loss or outgoing (for the current year or for an earlier income year) under a provision listed in section 20-30 of the ITAA 1997.

The payments for temporary disturbances and consequential losses will be assessable under section 6-5 to the extent that they are ordinary income. The recoupments will be assessable once the related deductible expenses are incurred.

To the extent that the payments are not ordinary income, and instead have the character of an indemnity or fall within section 20-30 of the ITAA 1997, the payments will be assessable under subdivision 20-A of the ITAA 1997. Recoupments received in advance are only assessable in the year that the expenses are incurred (subsection 20-35(3) of the ITAA 1997). Section 20-40 of the ITAA 1997 provides where certain expenses are deductible over 2 or more years, the recoupments are assessable progressively over the period that the deductions are available.