Edited version of your written advice

Authorisation Number: 1051452347666

Date of advice: 8 November 2018

Ruling

Subject: Income tax: disturbance payments

Question 1

Is the amount received an undissected lump sum amount of a capital nature received by the trustee for its interest in the Store A?

Answer

No

Question 2

Do the provisions of subdivision 124-B ITAA 1997 apply to the entire amount received? Can I choose to obtain a roll-over under section 124-75(1) ITAA 1997 and utilize the Compensation Payment received to acquire another eligible CGT asset?

Answer

No

Question 3

Does the asset acquired me meet the requirements of a replacement CGT asset as set out in sections 124-75(2) and 124-75(4) ITAA 1997?

Answer

Not applicable given the answers to question 1 and 2 are No.

Question 4

Will the Commissioner exercise his discretion under paragraph 124-75(3)(b) of the ITAA 1997 to extend the one year period to acquire a replacement asset until the year ended 30 June 2019?

Answer

No

This ruling applies for the following period

1 July 2016 to 30 June 2018

The scheme commences on:

1 July 2016

Relevant facts and circumstances

● You are a resident of Australia for Australian income tax purposes.

● You currently own a number of stores.

● Importantly, you may only operate theses stores and any diversification into any other type of business interests is considered a breach of its licensing terms.

● On xyz date, you purchased Store A.

● The transaction involved you purchasing the assets (such as plant and equipment and stock) necessary to run Store A. You also entered into a xyz year lease agreement for the use of Store A premises.

Store A: the Compulsory Acquisition

● You were first approached by a government department (the Department) on xyz date. It was at this date that the you were first made aware of The Department’s intention to acquire Store A and was officially provided with two years notice of the compulsory acquisition of the Store A under the Land Acquisition (Just Terms Compensation) Act 1991 (Just Terms Act).

● You were served an acquisition notice under section 11 of the Just Terms Act and your interest in the Store A was compulsorily acquired on xyz date.

● In a Deed of Settlement, Release and Indemnity (the Deed), the terms of the compulsory acquisition were agreed, in particular the amount of compensation that you would be paid for its interest.

● Under the terms of the Deed, you were paid a compensation amount of $xyz as payment for your interest in Store A.

● The Department compulsorily acquired your interests in Store A by an acquisition notice in accordance with the Deed.

● You received the funds from The Department on xyz date.

● You did not relocate your business to other premises. Store A was compulsorily acquired by The Department and you were compensated for this acquisition by The Department.

● In the course of negotiating your compensation in the Deed, valuations of Store A were prepared by valuers representing The Department and valuers representing you.

Replacement Asset

● Subsequent to the completion of the Deed, you commenced negotiations for purchase of another store.

● The proceeds from the sale of Store A were used to fund the purchase of a replacement store.

● You are in the process of acquiring other suitable stores to utilise all the compensation received from the sale of Store A.

Relevant legislative provisions

Income Tax Assessment Act 1936

Income Tax Assessment Act 1997 (ITAA 1997)

Transport Administration Act 1988 (NSW)

Land Acquisition (Just Terms Compensation) Act 1991

Detailed reasoning

Question 1

Summary

We consider that the compensation amount is a disturbance payment within the meaning of Class Ruling CR 2017/4. The disturbance payment is assessable income under section 6-5 ITAA 1997. Any capital gain is reduced in accordance with section 118-20 ITAA 1997.

Detailed reasoning

Is the entire compensation capital in nature?

You received your compensation payment by a government department (The Department) in respect of the construction for the compulsory interest in your land by the Project on xyz date.

You are of the view that the entire compensation amount is capital in nature. You use the following cases to support your contention:

● McLaurin v FCT (1961) 104 CLR 381

● Allsop v FCT (1965) 113 CLR 341

● FCT v Northumberland Developments Co Pty Ltd (1995) 59 FCR 103

● Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337

The Commissioner’s view on the income tax treatment for Income tax: disturbance payments by the Department in respect of the construction of the Project are articulated in Class Ruling CR 2017/4 (CR 2017/4).

CR 2017/4

You are a class of entity to which CR 2017/4 applies per paragraph 3, as you held a leasehold interest or sub-leasehold interest in, licence over or right to occupy, land (other than an estate in fee simple in the affected parcel of land) that

● is used for commercial or retail (not residential) purposes, and

● is acquired, or will be acquired, by the Department for the purpose of, or in connection with, the construction of the Project (the Project),

You received a payment of compensation of your in interest in the land through negotiation with The Department. CR 2017/4 paragraph 17 explains the taxation treatment in these circumstances as follows:

‘Whether interests in, or rights over, land are acquired or extinguished by means of negotiation or compulsory acquisition, The Department will pay the affected entity an amount consisting of at least two components:

(a) the market value of the interest in, or right over, land, and

(b) compensation for anticipated costs to the affected entity of relocating to new premises (a disturbance payment).’

While you received an amount for your leasehold interest, you specifically contend that the compensation amount is wholly for your leasehold and license being compulsory acquired by The Department. You, further contended:

‘The fact that section 55 prescribes various factors that the Valuer General may consider, does not change the fact that the underlying asset for which compensation is being paid is the interest in land. Under the provisions of the Just Terms Act, The Department cannot compensate me anything other than the Interest in Land. Thus, the payment made to me cannot be a ‘disturbance payment’.

…

‘The Settlement Deed does not provide any further breakdown. In order to apply CR 2017/4, some attribution would have to be undertaken to allocate some of the undissected settlement sum to a disturbance payment. The Settlement Deed provides no indication that any amount was allocated to or paid as a disturbance payment.’

…

‘The Settlement Deed provides no indication that any amount was allocated to or paid as a disturbance payment.’

We do not agree with your contentions. You originally acquired Store A with a xyz year lease and licence agreement. As part of this transaction, you acquired plant and equipment and entered into a leasehold and licence agreement.

It is difficult to accept that the value of the leasehold interest had increased significantly such that it was equal to $xyz at xyz date when the Deed of Settlement was entered into with The Department, at a time when there was no prospect of any business being conducted at the premises.

You had no present intention to sell Store A prior to it being compulsory acquired by The Department.

We consider that the compensation amounts to be for lost profits for extinguishing Store A, and would be treated as a disturbance payment that was negotiated between you and The Department as contemplated by paragraph 21 of CR 2017/4.

CR2017/4 provides guidance as to how the disturbance payment should be treated. CR 2017/4 paragraphs 23 -25 inclusively states

‘23. A disturbance payment, being a grant (within the definition of a ‘recoupment’ in subsection 20-25(1)), and to the extent that it is not ordinary income or statutory income because of another provision of the income tax legislation (subsection 20-20(1)), will be an assessable recoupment under subsection 20-20(3).

24. A part of the disturbance payment will be included in a relevant land holder’s assessable income under section 20-40 for several income years. The amount of assessable income in an income year will be equal to the amount the relevant land holder can deduct (in that same income year) under Division 40 for the decline in value of any depreciating asset acquired with the disturbance payment.

25. Any part of the disturbance payment that is compensation for loss of profits is not an assessable recoupment under section 20-20. It will form part of a relevant land holder’s ordinary income, which is included in their assessable income under section 6-5.’

We are of the view the disturbance payment received by you is assessable under section 6-5 ITAA 1997 in accordance with CR 2017/4 paragraph 25 as the compensation for the loss of profits for the extinguishment of Store A.

CGT consequences of the disturbance payments

CR 2017/4 also contemplates whether the disturbance payment can be subject to the CGT provisions in Parts 3-1 and 3-3 of the ITAA 1997 and how those provisions interact with section 6-5 ITAA 1997.CR 2017/4 paragraph 28 provides guidance in your circumstances as you negotiated your disturbance payment with The Department. CR 2017/4 paragraph 28 states:

‘Where The Department acquires interests in, or rights over, land by means of negotiation, the right to receive a disturbance payment will be acquired when the relevant land holder enters into a deed or other contract with The Department that gives rise to a contractual right to receive a specific amount (event number D1 in the table in subsection 109-5(2)).’

We are of the view that CGT event D1 is applicable in your circumstances as you negotiated with The Department your disturbance payment with The Department. CGT event D1 happened on the date you entered into the Deed of Settlement, which was dated xyz.

CGT event C2

CR 2017/4 also provides commentary on CGT event C2 and how this provision operates. CR 2017/4 paragraphs 30-34 states:

‘30. CGT event C2 will happen to the right to receive a disturbance payment when a relevant land holder receives the disturbance payment (subsection 104-25(1)). This is because their right to receive the disturbance payment will end by the right being discharged or satisfied (paragraph 104-25(1)(b)).

31. The time of CGT event C2 is when a relevant land holder receives the disturbance payment (paragraph 104-25(2)(b)).

32. The capital proceeds will consist of the amount of the disturbance payment (paragraph 116-20(1)(a)).

33. The capital gain from CGT event C2 happening is equal to the amount by which the capital proceeds (the disturbance payment) exceed the cost base of the right (subsection 104-25(3)).

34. The cost base of the right will only include any incidental costs incurred by the relevant land holder to acquire the right to receive a disturbance payment, or that relate to CGT event C2 happening to the right (subsection 110-25(3) and section 110-35). This includes remuneration for the services of a surveyor, valuer, accountant, agent, consultant or legal adviser. However, any such expenditure will not form part of the cost base of the right to the extent of any amount received by a relevant land holder as recoupment (see paragraph 39) of it (subsection 110-45(3)). This includes, but is not limited to, receiving an amount as part of the disturbance payment to cover such expenditure.’

In accordance with the above we are of the CGT event C2 will happen when you receive the disturbance payment from The Department, which is xyz date.

Anti-overlap rule

The CGT anti-overlap provisions are explained in CR 2017/4 paragraph 35 as follows:

‘A capital gain that a relevant land holder makes from CGT event C2 in respect of the right to receive a disturbance payment, is reduced by the amount that is included in their assessable income for any income year under section 6-5 or section 20-40 (subsection 118-20(1)) – see paragraphs 24 and 25.’

CGT event C2 and the anti-overlap rule are further explained in CR 2017/4 paragraphs 45-48 as follows:

45. ‘The capital gain from CGT event C2 will be reduced to the extent that any part of the disturbance payment is included, either in the income year the disturbance payment is received or any subsequent income year, in a relevant land holder’s assessable income under section 6-5 or section 20-40 (subsection 118-20(1)).

46. In respect of section 20-40, this means that the capital gain must be reduced by the part of the disturbance payment that was used by the relevant land holder to acquire any depreciating asset, to the extent that the depreciating asset is used for a taxable purpose (defined in subsection 40-25(7) to include the purpose of producing assessable income). This will require the relevant land holder to forecast the future use of a depreciating asset, and seek an amendment of their assessment (within the time limits set by section 170 of the Income Tax Assessment Act 1936) for the income year in which the disturbance payment is received if the actual use of the depreciating asset in a subsequent income year is different from the forecast.

47. The capital gain is reduced by the amount included in the relevant land holder’s assessable income if the capital gain exceeds that assessable amount (subsection 118-20(3)).

48. If the capital gain is less than the amount included in the relevant land holder’s assessable income, the capital gain can only be reduced to zero (subsection 118-20(2)).’

As such, we are of the view that in accordance with section 118-20 of the ITAA 1997 that your capital gain will be reduced by (to the maximum amount of zero), as a result of any assessable received as a disturbance payment, which as explained above is assessable under section 6-5 of the ITAA 1997.

Just Terms Compensation Act

The notice of the compulsory acquisition of Store A was rendered under the Land Acquisition (Just Terms Compensation) Act 1991 (‘Just Terms Act’). You were served an acquisition notice under section 11 of the Just Terms Act and your interest in Store A was compulsorily acquired on xyz date.

You contend that the recitals acknowledge that my interest in land is the Leasehold and that on termination of these interests by compulsory acquisition, I must be compensated under the provisions of the Just Terms Act.

You further contend that the Deed confirms that the Compensation Payment represented the total amount of compensation (exclusive of GST) to which I am entitled in respect of the acquisition of the Leasehold. Thus the Deed appears to contemplate a payment for the Leasehold. There is no indication in the Deed that the Compensation Payment could represent consideration for any other CGT asset, such as loss of items of equipment, loss of leasehold improvements, etc.

You have also contended that the only compensation permissible under the Just Terms Act is compensation for the acquisition of the interest in land. You contend, that the fact that section 55 prescribes various factors that the Valuer General may consider, does not change the fact that the underlying asset for which compensation is being paid is the interest in land. Under the provisions of the Just Terms Act, the Department cannot compensate me for anything other than the Interest in Land. Thus, the payment made to me cannot be a ‘disturbance payment’.

Section 54(1) of the Just Terms Act provides that regard must be given to all the relevant matters [our emphasis] when determining an amount that would justly compensate a person for the acquisition of land.

Section 55 the Just Terms Act further provides the relevant matters to be considered when determining the amount of compensation:

(a) the market value of the land on the date of its acquisition,

(b) any special value of the land to the person on the date of its acquisition,

(c) any loss attributable to severance,

(d) any loss attributable to disturbance,

(e) the disadvantage resulting from relocation,

(f) any increase or decrease in the value of any other land of the person at the date of acquisition which adjoins or is severed from the acquired land by reason of the carrying out of, or the proposal to carry out, the public purpose for which the land was acquired.

The above provisions indicate that compensation takes into account more than just the value of the interest in land, and extends to the surrounding circumstances of the compulsory acquisition.

As you held a leasehold interest, subsection 55(a) of the Just Terms Act may be relevant if ‘the market value of the land’ includes any leasehold interest. However, it is unlikely that the leasehold has any value as it cannot be sold, disposed of, or encumbered under the terms of the lease. Further, the lease and licence are inextricably linked under the terms of the lease, and the permitted use under the lease only permits your store to operate at the site (thereby extinguishing any alternative use).

As such, the most relevant matter would be the loss attributable to disturbance in subsection 55(d) of the Just Terms Act. Section 59 of the Just Terms Act provides that this is intended to capture costs incurred from the compulsory acquisition, such as the legal costs, valuation fees and other financial costs.

As you acquired the leasehold interest to operate Store A, it would have expected to generate significant future earnings. This loss of future earnings would be considered part of the financial costs incurred from the actual use of the land as a direct and natural consequence of the acquisition (subsection 59(1)(f)) of the Just Terms Act. Therefore, we consider the compensation received by you was for lost earnings as a consequence of having no premises in which the business could be conducted.

Valuations

The valuations undertaken by both you and The Department support the position that the compensation amount is based on the loss attributable to disturbance and are consistent with the principles outlined in Bligh v Minister Administering Environmental Planning and Assessment Act [2011] NSW LEC 220.

The leasehold estate or Lessee interest is created by the terms of the lease rather than the underlying rights of real estate ownership. The lease interest is subject to the terms of a specific lease arrangement, expires within a specific timeframe. Lease interests are valued on the same general principles as freehold, but with the recognition of the differences created by the lease which may cause the interest to be unmarketable or restricted. Lease interests are often subject to restrictive covenants or alienation provisions. It is unlikely that the leasehold has any value as it cannot be sold, disposed of, or encumbered under the terms of the lease.

Further, the lease and licence are inextricably linked under the terms of the lease, and the permitted use under the lease only permits your Store (thereby extinguishing any alternative use). Any breach of the essential terms is deemed to be a breach of a fundamental term of the lease. The Lessor has the right to terminate the agreement on a breach or non-observation or non-performance of one of these terms.

Having regards to the valuations you have provided us, we consider the compensation received by you was for lost earnings as a consequence of having no premises in which the business could be conducted. We consider the valuations support the fact the whole compensation amount you received was a disturbance payment within the meaning of CR 2017/4.

Taxation Ruling TR 95/35

You are the view that the settlement deed does not suggest any breakdown or apportionment of the lump sum settlement amount of $xyz represents capital proceeds in respect of the disposal of the Leasehold as assessable under section 104-10 ITAA 1997 as a result of CGT event A1. As such, the $xyz should be treated as an undissected lump sum in accordance with the ATO treatment in TR 1995/35.’

The ‘look-through approach’ is defined at Paragraph 3 of TR 95/35 as:

‘The look-through approach is 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. It is also referred to in this Ruling as the underlying asset approach.’

The Compensation receipt is defined at Paragraph 3 of TR 95/35 as:

‘A compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

* in relation to any underlying asset;

* arising out of Court proceedings; or

* made up of dissected amounts.’

The Underlying asset is defined at Paragraph 3 of TR 95/35 as:

‘The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation.’

The term ‘undissected lump sum compensation receipt’ is defined at Paragraph 3 of TR 95/35 as:

‘An undissected lump sum compensation receipt is any amount of compensation received by the taxpayer where the components of the receipt have not been and cannot be determined or otherwise valued or reasonably estimated.’

The application of the look through approach is explained at paragraph 4 of TR 95/35 as

‘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’.

As stated previously, we are of the view the compensation is not attributable to the disposal of those underlying assets, but for loss of profits. The Commissioner’s views on the compensation payment are expressed in the more specific Class Ruling on compensation received from The Department, CR 2017/4. Accordingly, the compensation you received is not an undissected lump sum, but rather a disturbance payment assessable under section 6-5 ITAA 1997.

Question 2

Summary

You will not be entitled to choose a capital gains tax roll-over pursuant to Subdivision 124-B ITAA 1997 as we do not consider the amount of compensation received as an undissected lump sum, but a disturbance payment assessable under sec 6-5 ITAA1997 in accordance with Class Ruling CR 2017/4. As such, section 118-20 operates to reduce any capital gain so that you do not have a capital gain to which a rollover can be applied.

Detailed reasoning

Subdivision 124-B ITAA 1997 details the relevant provisions by which entities are entitled to capital gain roll-overs after the compulsory acquisition of their CGT assets.

Section 124-70 ITAA 1997 provides that a taxpayer may be able to choose a roll-over if a CGT asset is compulsorily acquired by an Australian government agency (the Event) and the compensation for the Event is money or another CGT asset or both.

As stated, in question 1, we do not consider the amount of compensation received to be an undissected lump sum, but rather a disturbance payment, assessable under sec 6-5 ITAA 1997 in accordance with CR 2017/4. Accordingly, you will not be entitled to choose a capital gain roll-over on the compensation amount as we do not consider the compensation payment to be for a CGT asset that would be eligible for a rollover pursuant to section 124-70 ITAA 1997.

Further, any capital gain that arises in relation to the ending of the right to receive payment, is reduced under the anti-overlap provisions in subsection 118-20(1)) ITAA 1997 so that there is no capital gain to which a rollover can be applied.

Question 3

Summary

Whether the purchase of the additional store meets the requirements in subsections 124-75(2) and 124-75(4) is not relevant, as we do not consider the amount of compensation received for Store A to be an undissected lump sum, but rather a disturbance payment in accordance with CR 2017/4. Accordingly, you will not be entitled to treat the purchase of the additional Store as a replacement CGT asset for the compulsory acquisition of Store A as you do not have an event giving rise to a roll-over per section 124-70 ITAA 1997.

Detailed reasoning

As explained in the detailed reasoning to Question 2 above, Subdivision 124-B ITAA 1997 provides entities with the ability to choose to obtain a capital gain roll-over after the compulsory acquisition of their CGT assets if they meet the specified requirements (including the those specified in subsections 124-75(2) and 124-75(4)) contained within the Subdivision.

As explained in the answer to question 1, we do not consider the amount of compensation received for the Store A is an undissected lump sum, but rather a disturbance payment in accordance with Class Ruling CR 2017/4. Accordingly, whether the purchase of the additional Store meets the requirements in subsection 124-75(2) and (4) is not relevant.

Question 4

Summary

You will not be granted the Commissioner discretion under Subsection 124-75(3) ITAA 1997 to allow extra to time to acquire the replacement CGT asset.

Detailed reasoning

Subsection 124-75(3) ITAA 1997 provides the Commissioner with a discretion to allow further time for acquiring the replacement CGT asset in special circumstances.

The term ‘special circumstances’ is not defined for the purposes of the ITAA 1997.

Taxation Determination TD 2000/40 Income tax: capital gains: what are 'special circumstances' for the purposes of subsection 124-75(3) of the Income Tax Assessment Act 1997? explains that whether special circumstances exist depends on the facts of each particular case and provides examples of what the Commissioner would consider appropriate circumstances.

As explained in Questions 1 to 3, we do not consider the amount of compensation received as an undissected lump sum, but rather a disturbance payment in accordance with Class Ruling CR 2017/4. Accordingly, you will not be entitled to choose a capital gain roll-over on the compensation amount. Therefore you will not be granted the Commissioner discretion under Subsection 124-75(3) of the ITAA 1997 to allow extra to time to acquire the replacement CGT asset as there is no replacement asset required.