Edited version of private advice

Authorisation Number: 1052009184745

Date of advice: 25 July 2022

Ruling

Subject: CGT and compensation receipts

Question 1

Are the payments received being the CCA Payments compensation for the permanent damage to, or permanent reduction in the value of the Land, therefore reducing the first cost base of the asset?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trustees are co-executors of the Estate of the Deceased.

An asset of the Estate is a property (Land).

A number of companies hold a 'petroleum authority' on the Land (Authority Holders).

The Deceased obtained the right to compensation from the Authority Holders when the Authority Holders obtained the Petroleum Authorities over the Land prior to death.

The Trustees of the Estate and the Authority Holders entered into a conduct and compensation agreement (CCA) during the year ended 30 June 20XX. The CCA was subsequently varied during the year ended 30 June 20XX (Variation).

The Variation:

(a)  Varied the compensation payable under the CCA; and

(b)  inserted a new special condition.

The Trustees and the Authority Holders entered into the CCA to compensate the Estate for the compensatable effects of carrying out activities on the land.

Compensatable effect is defined in the CCA as:

(a)  a compensatable effect as defined in either or both of the Petroleum Legislation and the Environmental Protection Act 1994 (Qld); and

(b)  any other effects or impacts specified as compensatable effects in the CCA.

The Estate is entitled to receive from the Authority Holders the following payments (CCA Payments) under the CCA (as subsequently varied by the Variation).

(a)  Upfront compensation payment

(b)  Construction compensation payment

(c)   Annual compensation payment

The Estate received the CCA Payments in the years ended 30 June 20XX, 30 June 20XX and 30 June 20XX.

The Trustees obtained a valuation for the Land.

The Trustees entered into a contract during the year ended 30 June 20XX for the sale of the Land for significantly less than the previous valuation amount.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 Division 110

Reasons for decision

Summary

As you did not dispose of all or part of the affected land at the time of entering into the CCAs or receiving the compensation payments there are no CGT consequences. The acquisition cost of the land will be reduced by the compensation payments received in relation to the land. That is, the first element of the cost base of the land is reduced by the compensation payments.

Detailed reasoning

Section 104-25 of the Income Tax Assessment Act 1997 outlines when a CGT event C2 happens. It states:

(1)  CGT event C2 happens if your ownership of an intangible * CGT asset ends by the asset:

(a)  being redeemed or cancelled; or

(b)  being released, discharged or satisfied; or

(c)   expiring; or

(d)  being abandoned, surrendered or forfeited; or

(e)  if the asset is an option-being exercised; or

(f)    if the asset is a convertible interest-being converted.

(2)  The time of the event is:

(a)  when you enter into the contract that results in the asset ending; or

(b)  if there is no contract-when the asset ends.

The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an asset for CGT purposes. 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.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling provides that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

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 asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying CGT asset, or part of an underlying CGT asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, the Commissioner considers that the amounts are not consideration for the disposal of any other asset, such as the right to seek compensation.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to an underlying asset of the taxpayer or for a permanent reduction in the value of an underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, then the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Accordingly, the total acquisition costs of the CGT asset should be reduced by the amount of the compensation. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset. If the compensation amount exceeds the total unindexed acquisition costs (including a deemed cost base) of the underlying asset, there are no CGT consequences in respect of the excess compensation amount.

The activities under the CCA resulted in permanent damage to, or a permanent reduction in the value of the land.

As you did not dispose of all or part of the affected land at the time of entering into the CCAs or receiving the compensation payments there are no CGT consequences. The acquisition cost of the land will be reduced by the compensation payments received in relation to the land. That is, the first element of the cost base of the land is reduced by the compensation payments.