Edited version of your written advice

Authorisation Number: 1051499571582

Date of advice: 4 April 2019

Ruling

Subject: CGT - compensation payment

Question 1

Will the Section One payment in relation to the compulsory acquisition of the lease over the property trigger capital gains tax (CGT) event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Where you acquire a suitable asset, can you apply the replacement asset roll-over rollover in Subdivision 124-B of the ITAA 1997 to any capital gain resulting from CGT event A1?

Answer

Yes.

Question 3

Can you apply the CGT small business rollover in Subdivision 152-E of the ITAA 1997 to all or part of the capital gain resulting from CGT event A1?

Answer

Yes.

Question 4

Are the Section Two, Three and Four payments capital proceeds for capital gains tax (CGT) event C2?

Answer

Yes, however any capital gain from this event will be reduced to the extent the amount is assessable under section 6-5 of the ITAA 1997 and section 20-20 of the ITAA 1997.

Question 5

Where you acquire a suitable asset, can you apply the replacement asset roll-over rollover in subdivision 124-B of the ITAA 1997 to any capital gain resulting from CGT event C2?

Answer

No.

Question 6

Can you apply the CGT small business rollover in subdivision 152-E of the ITAA 1997 to all or part of the capital gain resulting from CGT event C2?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

FF leased a Property.

The lease commenced in early 20XX. It was set to expire in early 20ZZ with an option to renew the lease.

In late 20XX FF received a notice of proposed acquisition from a government entity relating to the acquisition of the property.

As a result of the proposed acquisition, correspondence indicated that FF would be required to relocate from the Property prior to the expiry of the initial term of the Lease.

FF eventually found new premises.

Given that the business is new there was a fear due to the potential disruption of relocation and/or temporary closure.

FF devoted time and resources to secure the new property.

After multiple negotiations you were compensated in respect of the acquisition.

The compensation amounted to $XX.

The amount can be broken up in the following way:

● Section one - for the additional cost of rent between the two properties (Section One payment).

● Section two - for the legal and valuation costs incurred in connection with the compulsory acquisition (Section Two payment).

● Section three - for financial costs incurred in connection with the relocation (Section Three Payment).

● Section four - for financial costs as a direct consequences of the acquisition (Section Four payment)

FF has a turnover of less than $2 million.

FF has used the lease in the course of carrying on their business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 Section 104-197

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 110-35

Income Tax Assessment Act 1997 subsection 110-25(5)

Income Tax Assessment Act 1997 subsection 110-45(1B)

Income Tax Assessment Act 1997 subsection 118-20(1)

Income Tax Assessment Act 1997 subsection 118-20(1A)

Income Tax Assessment Act 1997 section 124-70

Income Tax Assessment Act 1997 section 124-75

Income Tax Assessment Act 1997 section 124-85

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 Subdivision 152-E

Reasons for decision

Question 1

Section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a CGT event A1 occurs when a CGT asset is disposed of. Generally, an asset is disposed of if a change of ownership occurs.

Taxation Ruling TR 2005/6 Income Tax: lease surrender receipts and payments addresses a number of situations involving lease surrender receipts and payments, establishing the Commissioner’s treatment of these payments.

Paragraph 10 of TR 2005/6 introduces the Commissioner's position on the most relevant CGT event in the event of lease surrender:

A lessee makes a capital gain from surrendering a lease acquired after 19 September 1985 as it is CGT event A1, to the extent that the surrender receipt exceeds the cost base of the lease.

In this case, as a result of entering into an agreement to receive the Section One payment as a part the compulsory acquisition of the lease, CGT event A1 will occur.

We do not consider that the Section One payment would constitute ordinary income.

Question 2

Division 124 of the ITAA 1997 allows for a replacement asset roll-over to defer the making of a capital gain or loss from a CGT event happening until a later CGT event in certain circumstances.

In particular, roll-over relief may be available where a CGT asset is compulsorily acquired, lost or destroyed (Subdivision 124-B of the ITAA 1997).

Relevant to your circumstances of a compulsorily acquired asset, the CGT asset must have been compulsorily acquired in the following circumstances:

a. by an Australian government agency (paragraph 124-70(1)(a) of the ITAA 1997), or

b. disposed of to an entity following the service of a notice advising that the asset will be compulsorily acquired if agreement cannot be reached for you to dispose of the asset to an entity (paragraph 124-70(1)(c) of the ITAA 1997).

You must receive money or another CGT asset (except a car, motor cycle or similar vehicle), or both:

a. as compensation for the event happening; or

b. under an insurance policy against the risk of loss or destruction of the original asset.

In circumstances where money is received for the compulsory acquisition of an asset, section 124-75 provides that you can choose to obtain a roll-over if:

a. you incur expenditure in acquiring another CGT asset, which is not a depreciating asset, or trading stock. (subsections 124-75(2) and (5) of the ITAA 1997)

b. at least some of the expenditure must be incurred no earlier than one year before the event happens or no later than one year after the end of the income year in which the event happens. The Commissioner can extend this time period in special circumstances. (subsection 124-75(3) of the ITAA 1997)

c. if the original asset was used in your business, installed ready for use, or in the process of being installed ready for use, just before the event happened, the replacement asset must be used in your business, or installed ready for use, for a reasonable time after it is acquired. (subsection 124-75(4) of the ITAA 1997)

d. if you are not carrying on a business, the replacement asset must be used for the same, or a similar purpose as the original asset for a reasonable period of time after it is acquired. (subsection 124-75(4) of the ITAA 1997)

Taxation Determination TD 94/77 states there is no restriction on the number of assets that can be acquired in replacement of an original asset. In order to fully defer the making of a capital gain from a CGT event, replacement assets must be purchased for an amount at least equivalent to all of the amounts received in compensation for the original assets.

In your case your rights associated with the lease of the property were compulsory acquired.

You received the Section One payment as compensation for that lease.

Where you acquire an appropriate asset that satisfies the requirements of section 124-75 of the ITAA 1997 you will be entitled to apply the replacement asset rollover contained in subdivision 124-B of the ITAA 1997.

Note: The extent of the rollover available depends on the amount you incur to acquire a replacement asset in accordance with section 124-85 of the ITAA 1997. More information on calculating the extent of the rollover available under subdivision 124-B of the ITAA 1997 can be found by searching QC 17204 on ato.gov.au.

Question 3

To qualify for the small business rollover in Subdivision 152-E of the ITAA 1997, you need to satisfy the basic conditions that apply to all the CGT small business concessions. You can choose to obtain a rollover even if you have not yet acquired a replacement asset or incurred expenditure on a capital improvement to an existing asset.

In this case you satisfy the basic conditions as you are a CGT small business entity and the lease satisfies the active asset test. Accordingly, you can choose to apply the small business rollover to defer all or part of the capital gain made from CGT event A1.

Note: Any capital gain deferred under the small business rollover will crystallise if one or more replacement assets is not acquired or if a capital improvement to one or more existing assets does not happen within the replacement asset period. You will also have a gain if the replacement asset or the asset to which you made a capital improvement is not an active asset and the all of the amount rolled over was not expended.

Further information on the consequences of choosing the small business rollover can be found by searching QC 52291 on ato.gov.au.

As the capital gain resulting from the A1 event is eligible for both of the rollovers, you may choose which rollover to apply (ATO Interpretative Decision ATO ID 2009/147).

Question 4

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if the ownership of an intangible CGT asset ends by the asset:

a) being redeemed or cancelled

b) being released, discharged or satisfied

c) expiring; or

d) being abandoned, surrendered or forfeited

The time of the event is when you enter into the contract that results in the asset ending or if there is no contract, when the asset ends.

As a result of the compulsory acquisition of your rights under the lease, you were entitled to compensation for the market value of your interest in the land (Section One payment) as well as compensation for additional costs you would incur in relocating to a new premises (Section Two, Three and Four payments).

Your right to receive compensation for the additional costs is a CGT asset. CGT event C2 occurred upon entering into an agreement for the Section Two, Three and Four payments as your right to receive those payments was extinguished.

Note: The part of the compensation that was paid in respect to the renovation and fitting out of the new premises will be considered an assessable recoupment to the extent that it relates to depreciating assets. The amount paid will be assessable under section 20-20 of the ITAA 1997.

The compensation that was paid in regards to loss of profits will be assessable under section 6-5 of the ITAA 1997 as it is considered ordinary income.

Section 118-20 of the ITAA 1997 reduces a capital gain to the extent the amount is included in your assessable income under another provision of the ITAA 1997. Accordingly, your capital gain from CGT event C2 will be reduced to the extent you need to include amounts under section 6-5 and 20-20 of the ITAA 1997.

Question 5

As stated above, in order to be eligible for the rollover relief under subdivision 124-B of the ITAA 1997, a CGT asset must be compulsorily acquired by a government agency or other appropriate entity.

In your case, while your lease over the property was compulsorily acquired, the right to receive compensation for additional costs (Section Two, Three and Four payments) was a separate CGT asset. This right to receive compensation was not compulsorily acquired. Accordingly the capital gain from CGT event C2 will not satisfy the requirements for the rollover under subdivision 124-B of the ITAA 1997.

Question 6

As stated above, to qualify for the small business rollover in Subdivision 152-E of the ITAA 1997, you need to satisfy the basic conditions that apply to all the CGT small business concessions.

In your case, the asset is the right to receive the compensation payment; an intangible asset. An intangible asset will be an active asset for the purposes of the basic conditions if it is inherently connected with the business.

We consider that the right to receive the compensation for additional costs was inherently connected with the business. Accordingly it will be an active asset.

As you satisfy all the other basic conditions, you may choose to apply the CGT small business rollover in subdivision 152-E of the ITAA 1997 to all or part of the capital gain resulting from CGT event C2.

As noted above, any capital gain deferred under the CGT small business rollover will crystallise at the end of the replacement asset period if certain requirements are not met.