Edited version of your written advice

Authorisation Number: 1051494497065

Date of advice: 12 April 2019

Ruling

Subject: Are the payments assessable under Subdivision 20-A of the ITAA 1997?

Question 1

Is the arbitral payment award (including the associated interest component) made to a third party included in the CGT cost base of the right of Entity A to be indemnified, pursuant to subsection 110-25(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is the settlement payment made to a third party included in the CGT cost base of the right of Entity A to be indemnified, pursuant to subsection 110-25(2) of the ITAA 1997?

Answer

Yes

Question 3

Is any amount of the arbitral payment award (including the associated interest component) or settlement payment made to the third party by Entity B assessable to Entity A under Subdivision 20-A of the ITAA 1997?

Answer

No

Question 4

Is the payment of the repair costs by Entity A included in the CGT cost base of the right of Entity A to seek compensation, pursuant to subsection 110-25(2) of the ITAA 1997?

Answer

Yes

Question 5

Is any amount of the payment of the repair costs made by Entity B to Entity A assessable to Entity A under Subdivision 20-A of the ITAA 1997?

Answer

No

This ruling applies for the following period:

A specified period

The scheme commences on:

A specified date

Relevant facts and circumstances

Entity A owns and operates a business.

Entity A acquired the business from Entity B.

Part of the business is an underlying physical asset. Entity B originally had a contract with a third party contractor to construct that underlying physical asset.

Prior to Entity A acquiring the business, the third party made multiple claims against Entity B relating to the contract. These claims were not resolved at the time of acquisition.

At the time of acquisition, Entity A and Entity B entered into an indemnity agreement such that Entity B agreed to indemnify Entity A for the existing claims.

Post-acquisition Entity A incurred repair costs to remediate damage caused by the third party during the construction of the underlying physical asset. The repair costs were not incurred to repair any assets owned by Entity A. The repair costs were incurred to repair property owned by unrelated third parties.

The claims were settled separately under an arbitral decision and a settlement deed between the three parties.

As a result of the arbitral decision, Entity B made the payment in settlement of the arbitral claim to the third party directly (the ‘arbitral payment award’).

Upon settlement of the remaining claims under the settlement deed, Entity B made a settlement payment to the third party directly (the ‘settlement payment’).

Upon settlement of the repair costs claim under the settlement deed, Entity B directly reimbursed Entity A for the repair costs for damage caused by the third party, rather than Entity A invoicing the third party.

Relevant legislative provisions

Income Tax Assessment Act 1997, Subdivision 20-A

Income Tax Assessment Act 1997, Subsection 20-20(1)

Income Tax Assessment Act 1997, Subsection 20-20(2)

Income Tax Assessment Act 1997, Subsection 20-20(3)

Income Tax Assessment Act 1997, Subsection 20-25(1)

Income Tax Assessment Act 1997, Subsection 20-25(2)

Income Tax Assessment Act 1997, Subsection 20-30

Income Tax Assessment Act 1997, Section 40-185

Income Tax Assessment Act 1997, Section 108-5

Income Tax Assessment Act 1997, Subsection 110-25(1)

Income Tax Assessment Act 1997, Subsection 110-25(2)

Reasons for decision

Question 1

Summary

Yes, the arbitral payment award to the third party by Entity B is included in the CGT cost base of the right of Entity A to be indemnified under the indemnity agreement at subsection 110-25(2).

The arbitral payment award is considered to be a compensation payment corresponding to the right of Entity A to be indemnified by Entity B under the indemnity agreement. Such a right is considered to be a CGT asset and the compensation payment forms part of the cost base of that asset.

Detailed Reasoning

Section 110-25 is included in Part 3-1 which contains the capital gains and losses provisions. Section 110-25 provides the general rules about cost base. Subsection 110-25(1) states that the cost base of a Capital Gains Tax (CGT) asset consists of five elements. Subsection 110-25(2) provides that the first element is the total of:

(a) the money you paid, or are required to pay, in respect of acquiring it; and

(b) the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition).

The right to be indemnified as a CGT asset:

Prior to the acquisition of the business, disputes arose resulting in the third party making a number of claims against Entity B. Entity B sold the business to Entity A prior to the dispute proceedings being finalised. As a condition of the sale, Entity B provided an indemnity to Entity A in relation to the claims made by the third party.

As per the indemnity agreement, Entity A has the right to be indemnified by Entity B unconditionally and irrevocably against any liability incurred by it in relation to the claims.

Subsequent to the resolution of the disputes, Entity B made the arbitral payment award directly to the third party in respect of the claims.

Taxation Ruling TR 95/35 – Income tax: capital gains: treatment of compensation receipts (TR 95/35) considers the tax treatment of compensation receipts. In particular, TR 95/35 considers whether an amount of compensation should be included in assessable income of the recipient under the former Part IIIA of the ITAA 1936. It states that a compensation receipt may be attributed from:

● Disposal of an underlying asset;

● Permanent damage to, or permanent reduction in the value of the underlying asset;

● Excessive consideration to acquire an asset;

● Right to seek compensation;

● Disposal of a notional asset.

Relevant in this case is whether the arbitral payment award (including the interest amount) is attributable to either the taxpayer’s right to seek compensation under the indemnity, or whether it is attributable to some permanent damage to or permanent reduction in the value of an underlying asset.

Paragraph 3 of TR 95/35 defines a ‘Right to seek compensation‘:

The right to seek compensation is an asset for the purposes of Part IIIA. The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.”

Paragraph 3 of TR 95/35 further provides that a ‘compensation receipt‘ may or may not be in relation to an underlying asset. For the purposes of applying TR 95/35, an ‘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 entity causing that damage or loss in value against any other entity.

In this case, in applying the look-through approach there is no underlying physical asset that is disposed of or has suffered permanent damage to or been permanently reduced in value as contemplated by TR 95/35. This is because the arbitral payment award from Entity B to the third party related to the matters under dispute. The arbitral payment award was not to compensate for the disposal of an underlying physical asset or for the permanent damage or reduction in value of any such asset, but rather is in settlement of the disputes as outlined in the facts.

Entity A is the entity with the right to be indemnified by Entity B in relation to any claim by the third party arising out of or in relation the disputes. The relevant decision maker awarded the third party an amount (inclusive of interest) in respect of the disputes. Under the indemnity, Entity B indemnifies Entity A for such claims and is obligated to pay the third party on behalf of Entity A. Accordingly, the right of Entity A to seek compensation and the corresponding award amount satisfy the definition of compensation for the purposes of TR 95/35.

The relevant indemnity agreement indemnifies Entity A for the purposes of the payment and places an obligation on Entity B for any amount payment in respect of that indemnity agreement. That is, if Entity A is required to pay an amount to the third party in respect of the indemnity agreement, Entity A has a right under the indemnity document to compel Entity B to meet the claim.

Section 108-5 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. This section notes that a right to enforce a contractual obligation is a CGT asset. Entity A’s right to be indemnified under the indemnity agreement is considered to be a right to enforce a contractual obligation for the purposes of section 108-5. Accordingly, the indemnity right of Entity A under the indemnity agreement to compel Entity B to make the arbitral payment award is a right to seek compensation for the purposes of TR 95/35 and is a CGT asset for the purposes of section 108-5.

The right to be indemnified pursuant to the indemnity agreement is considered to be an intangible CGT asset. A capital gain from CGT event C2 will arise if the capital proceeds from the ending of the right to be indemnified for the disputes are more than the right’s cost base (subsection 104-25(3)). Paragraph 91 of TR 95/35 provides that:

91. By paragraph 160M(3)(b), a change in the ownership of an asset (being a chose in action or any other right) occurs on the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset. If the relevant asset is the right to seek compensation, paragraph 160M(3)(b) applies on the receipt of the compensation following the granting by a Court of a judgment debt in favour of the taxpayer, or following a settlement entered into between the taxpayer and the defendant. There is a release, discharge or satisfaction of the right, and therefore a disposal of that right.

In accordance with paragraph 11 of TR 95/35, as the payment relates to the disposal by the taxpayer of the right to seek compensation, any capital gain arising on the disposal of that right is calculated using the cost base of that right. In reference to the antecedent cost base provisions in the Income Tax Assessment Act 1936 (ITAA 1936), paragraph 12 of TR 95/35 specifies that:

12: The cost base of the right to seek compensation is determined in accordance with the provisions of section 160ZH. The consideration in respect of the acquisition of the right to seek compensation, for the purposes of paragraph 160ZH(1)(a), includes the total acquisition costs incurred as a result of which the right to seek compensation arose.

It is noted that paragraph 160ZH(1)(a) is the antecedent of section 110-25(2)(a) of the ITAA 1997.

In determining the cost base of a right to seek compensation, paragraphs 94 and 95 of TR 95/35 state:

94. The cost base of a right to seek compensation must be determined in accordance with section 160ZH. Paragraph 160ZH(1)(a) includes in the cost base any consideration in respect of the acquisition of the right. The expression 'consideration in respect of the acquisition of an asset' is defined in subsection 160ZH(4). …

95. The use of the word 'is' rather than 'includes' in subsection 160ZH(4) gives the expression 'consideration in respect of the acquisition of an asset' an exhaustive definition. The word 'is' in its context there has the meaning 'means'. Accordingly, money, property or money and property will only fall within the cost base for the purposes of paragraph 160ZH(1)(a) if it is paid or given by the taxpayer in respect of the acquisition of the asset within the terms of paragraph 160ZH(4)(a), (b) or (c).

TR 95/35, at paragraphs 98-104, takes a wide view as to what is 'consideration in respect of the acquisition of an asset'. Paragraphs 104 and 105 provide as follows:

104: If the right to seek compensation arises in respect of a monetary loss of the taxpayer (e.g., in respect of a claim for breach of contract, as a result of which the taxpayer must incur additional expenditure) the amount of that loss is included in the cost base of the right to seek compensation for that loss. It is an amount which the taxpayer has paid or is required to pay in respect of the acquisition of the right to seek compensation for having to incur the expenditure.

105: Similarly, if the taxpayer is insured under a contract of indemnity insurance and is liable to pay a claim covered by that policy (e.g., for a claim for negligent advice against the taxpayer), the amount of the claim paid by the taxpayer is included in the cost base of the taxpayer’s right to claim against the insurer for indemnity under the policy.

Example 18 of TR 95/35 provides illustrative guidance in circumstances where the relevant asset is the right to seek indemnity from an insurer under an insurance policy, concluding that the cost base of the asset will be the amount paid directly to the claimant by the insurer.

Similarly, in working out the cost base of the CGT asset (being the right of Entity A to seek compensation under the indemnity provided by the indemnity agreement) the amount paid by Entity B to the third party (being an amount paid directly from Entity B under the indemnity) will be included in Entity A’s cost base of that asset in accordance with subsection 110-25(2)(a).

As per paragraph 235 of TR 95/35, an award of compensation made to a taxpayer may include an amount of interest. Accordingly, the interest component of the amount paid by Entity B under the indemnity forms part of the cost base of the right of Entity A to seek compensation under the indemnity provided by the indemnity agreement under 110-25(2)(a).

Therefore, the arbitral payment award and associated interest to the third party by Entity B is included in the cost base of the right of Entity A to be indemnified under the indemnity agreement, pursuant to subsection 110-25(2).

Question 2

Summary

Yes, the settlement payment made to the third party by Entity B is included in the CGT cost base of the right of Entity A to be indemnified under the indemnity agreement at subsection 110-25(2).

The settlement payment is considered to be a compensation payment corresponding to the right of Entity A to be indemnified by Entity B under the indemnity agreement. Such a right is considered to be a CGT asset and the compensation payment forms part of the cost base of that asset.

Detailed Reasoning

As outlined in the Detailed Reasoning for Question 1 above, Section 110-25 is included in Part 3-1 which contains the capital gains and losses provisions. Section 110-25 contains the general rules about cost base. Subsection 110-25(1) states that the cost base of a CGT asset consists of five elements. Subsection 110-25(2) provides that the first element is the total of:

(a) the money you paid, or are required to pay, in respect of acquiring it; and

(b) the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition).

The right to be indemnified as a CGT asset:

As noted in the Detailed Reasoning for Question 1, Entity B sold the business to Entity A prior to the claims being finalised and provided an indemnity to Entity A in relation to some of the claims made by the third party, by entering into the indemnity agreement.

In resolution of all remaining claims the parties entered into a settlement agreement. Pursuant to the settlement agreement, a final settlement amount was agreed to and paid directly by Entity B to the third party in final settlement of all disputes and claims between the parties.

As outlined for Question 1, TR 95/35 considers the tax treatment of compensation receipts and whether an amount of compensation should be included in the assessable income of the recipient.

Relevant in this case is whether the amounts incorporated in the settlement payment (being amounts in final settlement of the claims) were attributable to either the taxpayer’s right to seek compensation under the indemnity agreement or whether the amounts were attributable to some permanent damage to or permanent reduction in the value of an underlying asset. In this case, in applying the look-through approach there is no underlying physical asset that is disposed of or has suffered permanent damage to or been permanently reduced in value as contemplated by TR 95/35. This is because the settlement payment was made in final settlement of the disputes and claims and not to compensate for the disposal of an underlying physical asset or for the permanent damage or reduction in value of any such asset, but in settlement of the remaining disputes and claims as outlined in the facts.

Entity A is the entity with the right to be indemnified by Entity B under the indemnity agreement. The settlement provided for the full and final settlement of all outstanding claims and disputes and directed Entity B to pay the third party a settlement payment in final settlement of those claims and disputes. The indemnification and corresponding settlement payment satisfy the definition of compensation for the purposes of TR 95/35.

Section 108-5 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. This section notes that a right to enforce a contractual obligation is a CGT asset. The relevant terms of the indemnity agreement indemnify Entity A for the purposes of the claims and place an obligation on Entity B for any amount payable. This indemnity is considered to be a right to enforce a contractual obligation for the purposes of section 108-5. The final settlement payment satisfies the definition of compensation receipt for the purposes of TR 95/35. Accordingly, the right of Entity A to be indemnified by Entity B under the indemnity agreement is a CGT asset for the purposes of section 108-5

The right to be indemnified pursuant to the indemnity agreement is classified as an intangible CGT asset. A capital gain from CGT event C2 will arise if the capital proceeds from the ending of the right to be indemnified under the indemnity agreement are more than the right’s cost base (subsection 104-25(3)). Paragraph 91 of TR 95/35 provides that:

91. By paragraph 160M(3)(b), a change in the ownership of an asset (being a chose in action or any other right) occurs on the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset. If the relevant asset is the right to seek compensation, paragraph 160M(3)(b) applies on the receipt of the compensation following the granting by a Court of a judgment debt in favour of the taxpayer, or following a settlement entered into between the taxpayer and the defendant. There is a release, discharge or satisfaction of the right, and therefore a disposal of that right.

For the reasons outlined in the Detailed Reasoning for Question 1, in working out the cost base of the CGT asset (being the right of Entity A to seek compensation under the indemnity agreement provided by the indemnity agreement) the settlement payment from Entity B to the third party in finalisation of the claims (being an amount paid directly from Entity B under the indemnity) will be included in Entity A’s cost base of that asset in accordance with subsection 110-25(2)(a).

Therefore, the settlement payment from Entity B to the third party is included in the cost base of the right of Entity A to be indemnified under the indemnity agreement, pursuant to subsection 110-25(2).

Question 3

Summary

The arbitral payment award and settlement payment (including the associated interest component) made to the third party by Entity B are not assessable recoupments for Entity A under Subdivision 20-A. This is because the amounts have not been and cannot be deducted by Entity A in the current year or in an earlier income year and therefore do not satisfy the requirement of an ‘assessable recoupment’ in paragraph 20-20(2)(b).

Detailed Reasoning

Subdivision 20-A provides the rules applying to amounts that are assessable recoupments. Subsection 20-25(1) states that a recoupment of a loss or outgoing includes:

a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

b) a grant in respect of the loss or outgoing.

Further, subsection 20-25(2) provides that if some other entity pays an amount for you in respect of a loss or outgoing that you incur, you are taken to receive the amount as recoupment of the loss or outgoing.

The arbitral payment award and settlement payment (including interest) were paid on Entity A‘s behalf pursuant to the indemnity provided under the indemnity agreement. Further, subsection 20-25(2) operates such that the payments made directly from Entity B to the third party are considered to be received by Entity A as recoupment.

For an amount received as a recoupment under an insurance or indemnity to be an ‘assessable recoupment‘, it must also satisfy subsection 20-20(2).

Subsection 20-20(2) provides:

An amount you have received as recoupment of a loss or outgoing is an assessable recoupment if:

a) You received the amount by way of insurance or indemnity; and

b) 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 in an earlier income year under any provision of this Act.

The arbitral payment award and settlement payment (including interest) are amounts received by way of insurance or indemnity for the purposes of paragraph 20-20(2)(a).

Pursuant to paragraph 20-20(2)(b), recoupment of a loss or outgoing is only an assessable recoupment if the taxpayer can deduct an amount for the loss or outgoing for the current year, or has deducted or is able to deduct an amount for it for an earlier income year, under any provision of the ITAA 1997. The phrase "for the loss or outgoing" in paragraph 20-20(2)(b) of the ITAA 1997 requires a connection between the deduction and the loss or outgoing for which the taxpayer had been recouped (paragraph 11 of Taxation Determination TD 2006/31 considers the phrase 'for the loss or outgoing' in the context of subsection 20-20(3)). As per Questions 1 and 2, the relevant losses or outgoings for which Entity A was recouped relate to the claims and disputes relating to the original contract.

Relevant to this case is whether the payment is attributable to either Entity A’s right to seek compensation under the indemnity agreement, or whether they it is attributable to some permanent damage to / permanent reduction in the value of an underlying asset. As per the reasoning above for Questions 1 and 2, in applying the look-through approach there is no underlying physical asset that is disposed of or has suffered permanent damage to or been permanently reduced in value such that the payment is connected to the disposal of an underlying asset or for the permanent damage or reduction in value of any such asset. Rather, the payment was made in settlement of the disputes and covered by Entity A’s indemnity right.

No amount has been deducted by Entity A for income tax purposes in any income year in relation to the payment (including interest amount). The payments were not deductible to Entity A but rather form part of the cost base of the corresponding CGT asset, being the right to seek compensation under the indemnity agreement.

Accordingly, as the taxpayer has not and cannot deduct an amount for the loss or outgoing for which the indemnity proceeds are received as recoupment, the recoupment Entity A is taken to have received under section 20-25 is not an assessable recoupment under section 20-20 and is therefore not assessable to Entity A under Subdivision 20-A.

Question 4

Summary

Yes, the repair costs Entity A incurred, being the sum of money and market value of property given as consideration for the creation of the right to seek compensation under the original contract, are included in the CGT cost base of that right, pursuant to subsection 110-25(2).

The payment in settlement of repair costs is considered to be a compensation receipt corresponding to the right of Entity A to seek compensation from the third party under the original contract. Such a right is considered to be a CGT asset. The consideration on disposal of the right to seek compensation for repair costs is the payment for repair costs made by Entity B to Entity A pursuant to the terms of the settlement.

Detailed Reasoning

Post the acquisition of the business by Entity A, Entity A incurred repair costs in rectifying various defects to the works undertaken by the contractor under the original contract. The costs were to repair property owned by unrelated third parties. The repair costs were not incurred to repair the underlying asset itself.

The original contract between Entity B and the third party contained a right of Entity B to claim recovery against the third party for works to correct defects.

Initially Entity A rectified the defects itself then claimed recovery from the third party contractor. However, this was not pursued and the balance of the amount recoverable was addressed under the settlement such that Entity B would directly pay an amount to Entity A in finalisation of the repair costs claim.

As outlined in the Detailed Reasoning for Question 1 above, TR 95/35 considers the tax treatment of compensation receipts and whether an amount of compensation should be included in the assessable income of the recipient.TR 95/35 provides (at paragraph 3) provides that 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.

Relevant in this case is whether the payments for the repair costs are for either Entity A’s right to seek compensation under the original contract or whether it is attributable to some permanent damage to or permanent reduction in the value of an underlying asset. In this case, in applying the look-through approach there is no underlying physical asset of Entity A that is disposed of or has suffered permanent damage to or been permanently reduced in value as contemplated by TR 95/35. The payment in final settlement of the repair costs is not to compensate for the disposal of an underlying asset or for the permanent damage or reduction in value of any such asset, but rather in settlement of the repair costs which were to remediate land and other property around the underlying asset owned by other parties and not incurred to repair the asset itself.

The right of Entity A to seek compensation from the third party was established by the relevant clause in the original contract. At settlement a nexus was demonstrated between the right to seek compensation created under the original contract entered into by Entity B and the disposal of the right to seek compensation by Entity A. Section 108-5 provides that a CGT asset is any kind of property or a legal or equitable right that is not property. This section notes that a right to enforce a contractual obligation is a CGT asset. Accordingly, Entity B’s (and its subsequent acquirer Entity A) right against the third party to claim recovery in relation to works to correct defects is a right to seek compensation and a CGT asset of Entity A for the purposes of section 108-5.

It is noted that Entity B paid the recoverable amounts for repair costs to Entity A. The right of Entity A to seek compensation from the third party contractor was established by the original contract. At settlement a nexus was established between the payment of the consideration and the disposal of the right to seek compensation. Accordingly, the amount received by Entity A from Entity B is consideration in respect of the right notwithstanding that under the terms of the settlement it was received from Entity B rather than directly from the third party.

For the reasons outlined in the Detailed Reasoning for Question 1, in working out the cost base of the CGT asset (being the right of Entity A to seek compensation for the repair costs under the original contract, the amounts paid by Entity B to Entity A for the repair costs, are the compensation receipts and the total amount of the liability for the purposes of TR 95/35. For the purposes of subsection 110-25(2), the amount of the repair costs may be included in the cost base of the CGT asset of the right of Entity A to seek compensation for repair costs.

Question 5

Summary

The payments made by Entity B to Entity A for the repair costs are not an assessable recoupment for Entity A under Subdivision 20-A. This is because the amounts are excluded from being an assessable recoupment by subsection 20-20(3) as Entity A cannot deduct an amount in relation to these payments in the current year or in an earlier income year.

Detailed Reasoning

Subdivision 20-A provides the rules applying to amounts that are assessable recoupments. Subsection 20-25(1) states that a recoupment of a loss or outgoing includes:

a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

b) a grant in respect of the loss or outgoing.

As per the Detailed Reasoning for Question 3, the payments made by Entity B to Entity A at settlement are considered to be received by Entity A as a reimbursement for repair costs incurred. Accordingly, the payments made by QGC to Entity A are a recoupment for the purposes of Subdivision 20-A.

The reimbursement for the repair costs was not paid under the indemnity agreement and were not a recoupment under an insurance or indemnity and subsection 20-20(2) will not apply.

Subsection 20-20(3), must therefore be considered in relation to the repair costs. Subsection 20-20(3) provides that:

An amount you have received as recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if:

a) you can deduct an amount for the loss or outgoing for the current year; or

b) you have deducted or can deduct an amount for the loss or outgoing for an earlier income year;

under a provision listed in section 20-30.

Under subsection 20-20(3), that recoupment is only an assessable recoupment if the taxpayer can deduct an amount for the loss or outgoing for the current year, or has deducted or can deduct an amount for it for an earlier income year, under a provision listed in section 20-30.

It is noted that no amounts paid or received by Entity A for the repair costs were recognised as capital expenditure or included in its balance sheet or profit or loss financial statements. Nor has Entity A deducted for income tax purposes in any income year any amounts for the repair costs.

Subsections 20-30(1) and 20-30(2) include tables that that show deductions under the ITAA 1997 and ITAA 1936 for which recoupments are assessable. Of those provisions listed, the only one that may potentially be of relevance is Division 40 of the ITAA 1997.

Division 40 relates to expenses for capital allowances. The repair costs were not incurred to repair the asset itself. Accordingly, the repair costs are not related to a depreciating asset held by Entity A.

Section 40-880 provides that certain capital expenditure, such as expenditure to commence of cease a business, may be deductible. Subsection 40-880(1) provides that:

The object of this section is to make certain business capital expenditure deductible over 5 years, or immediately in the case of some start-up expenses for small businesses, if:

(a) the expenditure is not otherwise taken into account; and

(b) a deduction is not denied by some other provision; and

(c) the business is, was or is proposed to be carried on for a taxable purpose.

However, paragraph 40-880(5) provides that:

You cannot deduct anything under this section for an amount of expenditure you incur to the extent that:

…

(f) it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event; or

…

As per the Detailed Reasoning outlined in Question 4 above, the repair costs paid by Entity A are included in the CGT cost base of the right of Entity A to seek compensation under the original contract pursuant to subsection 110-25(2) of the ITAA 1997. Accordingly, paragraph 40-880(5)(f) will prevent the repair costs from being deductible under 40-880. As neither Division 40 nor any other provision listed in section 20-30 is applicable to the repair costs, subsection 20-20(3) will not apply.

Therefore as subsection 20-20(3) will not apply, the recoupment payments made by Entity B to Entity A in reimbursement for the repair costs are not assessable recoupments under section 20-20 and will not be assessable to Entity A under Subdivision 20-A