Edited version of private advice

Authorisation Number: 1051884474554

Date of advice: 16 August 2021

Ruling

Subject: Deed of release - capital vs income

Question 1

Will receipt of a settlement payment under a deed of release be classified as ordinary income?

Answer

No. The amount received does not constitute assessable income according to ordinary concepts.

Question 2

Will receipt of a settlement payment under a deed of release be classified as capital?

Answer

Yes. The amount received does not constitute assessable income according to ordinary concepts. The payment received has the nature of exchanging the lump sum for the right to not pursue a 'chose in action'. The amount received constitutes a compensation payment for the intangible asset and is therefore capital.

This ruling applies for the following period:

Year ending 30 June 2021

The scheme commences on:

XX XXXX 2021

Relevant facts and circumstances

You purchased the business in 20XX

The business premises are located at XXXX.

Head lease of the property was between the Agency and XXXX.

XXXX entered into a sublease with the prior business owner. This sublease was subsequently transferred to you.

The Agency conducted a BCA audit and buildings condition report, which led to the Agency serving notice of breach to rectify. Administrators for XXXX notified the Agency they will not remedy the breaches.

The Agency terminated their head lease with XXXX. This has the consequence of terminating your sublease. The Agency issued a notice to advise of the termination of the sublease.

Under the deed of release and settlement, the Agency agreed to pay you a lump sum. This lump sum payment is in exchange under the various clauses of the deed for releasing the right to bring any claim in relation to this event.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(2)

Reasons for decision

Assessable income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes income according to ordinary concepts (ordinary income) derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

•                 are earned

•                 are expected

•                 are relied upon, and

•                 have an element of periodicity, recurrence or regularity.

Payments of salary and wages are examples of ordinary income.

Receipts that are not salary or wages but are paid as a substitute for salary or wages that would normally have been earned, expected and relied upon by a taxpayer are also assessable as ordinary income.

The general principle is that such payments take on the character of the salary or wages they replace. That is, if the substituted amount was an amount of ordinary income, the amount paid to compensate for the loss of that amount will also be ordinary income.

In your case, the payment was paid to you because you signed the Deed of Release and Settlement in which you agreed to give up your right to any claim or action. As the compensation payment is not compensating you for loss of income that would have been assessable income, the compensation payment is not assessable as income according to ordinary concepts.

Capital gain

You can only make a capital gain or capital loss if a CGT event happens to a CGT asset (subsection 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997)).

Subsection 108-5(1) of the ITAA 1997 defines a CGT asset to be any kind of property, or a legal or equitable right that is not property. CGT event C2 in section 104-25(1) of the ITAA 1997 happens if a taxpayer's ownership of an intangible CGT asset ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

The right to seek compensation is a particular asset for the purposes of CGT event C2. The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts.

In determining which is the most relevant asset, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt. In your situation, the amount of compensation received as a lump sum constitutes payment in exchange for releasing your right to pursue further action.

The Deed of Release and Settlement was executed and the settlement sum. The Agency did not provide you with any details as to how this amount was calculated. Under the Deed you agreed that the payment made was in final and full settlement of any and all claims you may have at any time.

Your circumstances are similar to that seen in example 8 of TR 95/35 and represent that the right to seek compensation is the relevant asset that has been disposed of. Accordingly, the $XXX amount constitutes the consideration paid for the release of this intangible asset. A C2 CGT Event has happened under section 104-25 of the ITAA 1997 upon execution of the Deed of Release and Settlement. You will need to report the capital gain you have made as a result of the CGT event.