Edited version of private advice

Authorisation Number: 1052033033413

Date of advice: 11 October 2022

Ruling

Subject: CGT - settlement proceeds

Question

Question 1

Are the proceeds received under the settlement agreement assessable as ordinary income?

Answer

No.

Question 2

Are the proceeds received under the settlement agreement assessable as a result of CGT event C2?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2022

Year ending 30 June 2023

The scheme commences on:

1 July 2021

Relevant facts and circumstances

The Plaintiffs commenced proceedings against the Defendants for three disputes:

1)            A retirement payment to the Plaintiffs

2)            Transfer of shareholdings

3)            The Defendant owed the Plaintiff a half-share in an asset

The Parties have agreed to fully and finally resolve the matters between them. In full and final settlement, the parties agree as follows:

a)            The Defendants will pay the Plaintiffs the Settlement Sum

b)            The Defendants agree to do all things necessary to transfer their shareholding to the Plaintiff

c)            The Plaintiffs indemnify the Defendant for any tax liability resulting from the transfer of the shareholding

d)            The Defendants irrevocably resigns as an appointor of the Trust

e)            The Defendants irrevocably agree and acknowledge that any unpaid beneficiary entitlements due to any of the Defendants as beneficiaries of the Trust are deemed to have been satisfied

f)             The parties agree to do all things necessary to obtain orders discontinuing the Proceeding and the Counterclaim.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 102-5

Reasons for decision

Summary

The compensation was not received in respect of an underlying asset, therefore the amount relates to the disposal of the right to seek compensation. The proceeds received under the settlement agreement are assessable as CGT event C2.

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states your assessable income includes income according to ordinary concepts (ordinary income).

Proceeds from the sale of a capital asset are generally not ordinary income, although they may be assessable statutory income under section 6-10 of the ITAA 1997, for example, they may be assessable under the capital gains tax (CGT) provisions of the ITAA 1997.

Section 108-5 of the ITAA 1997 states a CGT asset is any kind of property; or a legal or equitable right that is not property. Examples include land and buildings; shares in a company and units in a unit trust; options; debts owed to you; a right to enforce a contractual obligation; and foreign currency.

Section 104-25 of the ITAA 1997 explains that CGT event C2 happens if your ownership of an intangible asset ends by the asset being redeemed or cancelled; being released, discharged or satisfied; expiring; being abandoned, surrendered or forfeited; or if the asset is an option - being exercised; or if the asset is a convertible interest - being converted.

Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts (TR 95/35) provides the Commissioner's view on the CGT consequences for recipients of compensation amounts received. It states that a compensation receipt, or compensation, includes any amount 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.

TR 95/35 further explains 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 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 11 of TR 95/35 states if the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

TR 95/35 also explains 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. Paragraph 18 states if the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

Additionally, paragraph 188 states whether a receipt constitutes income or capital in the hands of the taxpayer depends on the circumstances of the receipt and the reasons why it was paid to the taxpayer.

In your case, the Deed of Settlement stated that in full and final settlement of the Proceeding, the parties agreed the Defendants will pay the Plaintiffs the Settlement Sum among other directions.

We do not consider the Settlement Sum to be ordinary income assessable under section 6-5 of the ITAA 1997. We also do not consider the compensation received is in respect of an underlying asset. Instead, we consider the Settlement Sum relates to the disposal, by the plaintiffs, of the right to seek compensation. The funds received are for release, discharge and satisfaction of the claims. Therefore, CGT event C2 occurred when the Settlement deed was executed by the plaintiffs and the proceeds will be assessable as statutory income.