Edited version of private advice

Authorisation Number: 1052164421110

Date of advice: 4 September 2023

Ruling

Subject: CGT - compensation

Question 1

Is the Compensation Payment received by the taxpayer treated as a disturbance payment for the purposes of Class Ruling CR 2020/15 (CR 2020/15)?

Answer

No.

Question 2

Is the taxpayer's leasehold interest in the Property the most relevant CGT asset to which the Compensation Payment relates?

Answer

Yes.

Question 3

Did CGT event C1 under section 104-20 of the Income Tax Assessment Act 1997 (ITAA 1997) happen to the taxpayer in connection with the acquisition of its leasehold interest in the Property?

Answer

No. CGT event A1 under section 104-10 of the ITAA 1997 happened to the taxpayer in connection with the acquisition of its leasehold interest in the Property.

This ruling applies to the following periods

Year ended 30 June 2021

Year ended 30 June 2022

Relevant facts and circumstances

The taxpayer and its business at the Property

Multiple generations of the A family operated a family business. Mr and Mrs A had acquired the business from their parents in 20XX and have operated it since that time through their family company, the taxpayer.

The taxpayer is a resident for Australian tax purposes.

Since 19XX, the business had been carried on from the ground floor of the Property.

Under a lease commencing XX XX 20XX, the ground floor of the Property was being leased to the taxpayer by the Property owner.

The business also has an online presence.

The Land Acquisition (Just Terms Compensation) Act 1991 (NSW)

Subsection 19(1) of the Land Acquisition (Just Terms Compensation) Act 1991 (NSW) (LAJTCA) provides that an 'authority of the State' that is authorised to acquire land by compulsory process may, with the approval of the Governor, declare by notice published in the Gazette, that any land described in the notice is acquired by compulsory process.

For the purposes of the LAJTCA, the acquisition of land refers to either an acquisition of land or of any interest in land.

Subsection 20(1) of the LAJTCA provides that, upon publication in the Gazette of an acquisition notice, the land described in the notice is, by force of the LAJTCA, vested in the authority of the State acquiring the land (freed and discharged from all estates, interests, trusts, restrictions, dedications, reservations, easements, rights, charges, rates and contracts in, over or in connection with the land).

Section 34 of the LAJTCA generally entitles occupiers to remain in occupation of a property that is their principal place of business or residence for not less than 3 months after the date on which their interest in the land has been compulsorily acquired.

Section 37 of the LAJTCA provides that '[a]n owner of an interest in land which is divested, extinguished or diminished by an acquisition notice is entitled to be paid compensation in accordance with this Part by the authority of the State which acquired the land.'

To that end, a person who wishes to claim compensation must lodge a claim in accordance with section 39 of the LAJTCA with the relevant authority of the State or with the Valuer-General.

The LAJTCA (under section 42) requires the acquiring authority of the State to give a compensation notice to all former owners of the land who immediately before the acquisition had a registered interest in the land within 45 days after publication of the acquisition notice, setting out the amount of compensation offered, as to be determined by the Valuer-General.

Section 55 of the LAJTCA provides that, in determining the amount of compensation to which a person is entitled, regard must be had by the Valuer-General to several matters. These are:

(a)   the market value of the land on the date of acquisition,

(b)   any special value of the land to the person on the date of acquisition,

(c)    any loss attributable to severance,

(d)   any loss attributable to disturbance,

(e)   the disadvantage resulting from relocation,

(f)     any increase or decrease in the value of any other land of the person at the date of acquisition which adjoins or is severed from the acquired land by reason of the carrying out of, or the proposal to carry out, the public purpose for which the land was acquired.

Relevantly, for the purposes of paragraph 55(d) of the LAJTCA, the expression 'loss attributable to disturbance' is defined in section 59 of the LAJTCA to mean any of the following:

(a)   legal costs reasonably incurred by the persons entitled to compensation in connection with the compulsory acquisition of the land,

(b)   valuation fees of a qualified valuer reasonably incurred by those persons in connection with the compulsory acquisition of the land (but not fees calculated by reference to the value, as assessed by the valuer, of the land),

(c)    financial costs reasonably incurred in connection with the relocation of those persons (including legal costs but not including stamp duty or mortgage costs),

(d)   stamp duty costs reasonably incurred (or that might reasonably be incurred) by those persons in connection with the purchase of land for relocation (but not exceeding the amount that would be incurred for the purchase of land of equivalent value to the land compulsorily acquired),

(e)   financial costs reasonably incurred (or that might reasonably be incurred) by those persons in connection with the discharge of a mortgage and the execution of a new mortgage resulting from the relocation (but not exceeding the amount that would be incurred if the new mortgage secured the repayment of the balance owing in respect of the discharged mortgage),

(f)     any other financial costs reasonably incurred (or that might reasonably be incurred), relating to the actual use of the land, as a direct and natural consequence of the acquisition.

Acquisition of the taxpayer's leasehold interest in the Property

Sydney Metro is constituted as a corporation and is declared to be a NSW Government agency under section 38 of the Transport Administration Act 1988 (NSW).

On XX XX 20XX Sydney Metro, being the authority of the State authorised by the Transport Administration Act 1988 (NSW) for the construction of the Sydney Metro West underground railway connecting Greater Parramatta and the Sydney CBD, caused an acquisition notice to be published in the Gazette pursuant to the LAJTCA and thereby declared that, by that notice, it acquired by compulsory process the following (pursuant to section 19 of the LAJTCA):

All that piece of land situated in ....

By letter to the taxpayer dated XX XX 20XX, Sydney Metro notes, with reference to the acquisition notice published in the Gazette on the same date pursuant to which the taxpayer's leasehold interest in the Property was compulsorily acquired, that:

• Sydney Metro required vacant possession of the Property by no later than XX XX 20XX; and
• during the occupation of the Property on and from the date of acquisition, the taxpayer was required to pay rent on a weekly basis to Sydney Metro.

The taxpayer continued to trade online and, once it vacated the Property, temporarily relocated.

Compensation process

In accordance with section 39 of the LAJTCA, the taxpayer submitted a claim for compensation with Sydney Metro on XX XX 20XX.

The amount claimed was in accordance with a valuation report commissioned by the taxpayer and was prepared on the basis that the taxpayer had been unable to find a suitable property from which to operate the business and/or a property with similar attributes, resulting in the extinguishment of the business.

Walsh and Monaghan Pty Limited issued a Determination of Compensation report on behalf of the NSW Valuer-General (the Report) on XX XX 20XX. The Report:

• accepted that the taxpayer had not been able to find suitable alternate premises with the same attributes as the Property and that compensation based on an extinguishment basis was therefore warranted; and
• confirmed that no portion of the amount claimed by the taxpayer related to its efforts to relocate to a new premises.

The total compensation amount payable to the taxpayer set out in the Report was $xxxx.

In XX 20XX, the taxpayer received a compensation payment from Sydney Metro in the sum of $xxxx (the Compensation Payment) in connection with the compulsory acquisition of its leasehold interest in the Property.

By email dated XX XX 20XX, a representative from the NSW Valuer General's office informed Mr A as follows:

... The assessment of compensation from VG NSW is in fact for the extinguishment of your business, as certain tests in regard to relocations (backed by your efforts in being unable to identify suitable leasehold premises to the exposure offered at ..., together with the overwhelming length of time which your business had been at that address), did not support a relocation approach over that of extinguishment.

...

As a direct result of the acquisition of the land for the public purpose, upon which your leasehold business was located, extinguishment of that business was considered under s.59(1)(f)..........(f) any other financial costs reasonably incurred (or that might reasonably be incurred), relating to the actual use of the land, as a direct and natural consequence of the acquisition.

CR 2020/15

CR 2020/15[1] sets out the income tax consequences of disturbance payments made by Sydney Metro in connection with the construction of the Sydney Metro West underground railway and, broadly, applies to entities that:

• held a freehold interest, leasehold interest or sub-leasehold interest in, licence over, or right to occupy, land that is both used for commercial or retail (not residential) purposes and acquired by Sydney Metro for the purpose of, or in connection with, the construction of the Sydney Metro West underground railway; and
• received a disturbance payment from Sydney Metro in respect of the acquisition of their freehold interest, leasehold interest or sub-leasehold interest in, licence over or right to occupy, land.

A 'disturbance payment' for the purposes of CR 2020/15:

•         is limited to compensation for anticipated costs of relocating to new premises[2]; and

•         is calculated as an estimate of the expenses that the entity will incur in relocating to new premises[3], which include legal and consulting fees, removal fees, the costs of fitting out and furnishing new premises, increased rent and compensation for loss of profits as a result of relocating[4].

Reasons for decision

All subsequent legislative references are to the ITAA 1997, unless otherwise specified.

Question 1

Summary

The Compensation Payment is not a disturbance payment for the purposes of CR 2020/15.

Detailed reasoning

CR 2020/15 sets out the tax consequences of 'disturbance payments' made by Sydney Metro in connection with the construction of the Sydney Metro West underground railway.

Whilst the taxpayer held a leasehold interest in land (the Property) that was used for commercial or retail purposes and that leasehold interest was acquired by Sydney Metro in connection with the construction of the Sydney Metro West underground railway, the Commissioner is satisfied (based on a reading of all the correspondence relating to the compensation process between the taxpayer and Sydney Metro) that no portion of the Compensation Payment received by the taxpayer in respect of Sydney Metro's acquisition of the taxpayer's leasehold interest in the Property was compensation for costs to the taxpayer of relocating to new premises, i.e. a disturbance payment as contemplated for the purposes of CR 2020/15.

There is therefore no expectation that the taxpayer assess any portion of the Compensation Payment in accordance with the tax treatment set out in CR 2020/15.

Question 2

Summary

The taxpayer's leasehold interest in the Property is the most relevant CGT asset to which the Compensation Payment relates.

Detailed reasoning

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. It is the character of the receipt in the hands of the taxpayer as recipient that must be determined.

The Compensation Payment received by the taxpayer from Sydney Metro in XX 20XX compensates the taxpayer for the loss it suffered as a result of the compulsory divestment of its leasehold interest in the Property, and is a receipt of capital in the hands of the taxpayer. As such, it is necessary to consider the application of the CGT rules in Part 3-1.

A taxpayer may make a capital gain or capital loss when a CGT event happens in respect of the CGT asset of the taxpayer (section 102-20).

A CGT asset is defined in section 108-5 to mean any kind of property, or any legal or equitable right that is not property, and includes an interest in property.

In the context of a compensation receipt received by a taxpayer in respect of a right to seek compensation, the most relevant asset in respect of which the compensation payment has been received is often appropriately determined by adopting a 'look-through' approach to the transaction or arrangement which generates the compensation receipt.[5]

The underlying asset, using the look-through approach, is commonly the asset that is disposed of and will generally be the most relevant asset to which an amount of compensation relates where the compensation receipt has a direct and substantial link with the underlying asset.[6]

The taxpayer's leasehold interest in the Property is a CGT asset under section 108-5 and, using the look-through approach, is the most relevant CGT asset to which the Compensation Payment relates.

Question 3

Summary

CGT event A1 under section 104-10 happened to the taxpayer in connection with the acquisition of its leasehold interest in the Property; not CGT event C1.

Detailed reasoning

CGT event C1 under section 104-20 happens if a CGT asset you own is lost or destroyed and, when compensation for the loss or destruction is received, the time of the event is when the compensation is received.

The word 'destroyed' in this context takes its ordinary meaning which includes 'to put an end to; extinguish', and contemplates involuntary actions (as well as voluntary), including the actions of others over which the owner of the CGT asset has no control.[7]

It is not considered that Sydney Metro's compulsory acquisition of the taxpayer's leasehold interest in the Property extinguished, and therefore destroyed, that CGT asset for the purposes of section 104-20. The leasehold interest previously held by the taxpayer merely vested in Sydney Metro upon publication of the acquisition notice in the Gazette pursuant to subsection 20(1) of the LAJTCA.

CGT event A1 under section 104-10 happens if you dispose of a CGT asset, i.e. where a change of beneficial ownership occurs from you to another entity, whether because of some act or event or by operation of law.

CGT event A1 is considered to have happened to the taxpayer upon publication of the acquisition notice in the Gazette. This is because publication of the acquisition notice caused ownership of the leasehold interest to vest in Sydney Metro (and therefore change from the taxpayer to Sydney Metro) by operation of law (pursuant to subsection 20(1) of the LAJTCA).

The capital gain from CGT event A1 happening is equal to the amount by which capital proceeds from the disposal exceed the cost base of the leasehold interest (subsection 104-10(4)).

The taxpayer's capital proceeds from the disposal consisted of the amount of the Compensation Payment (subsection 116-20(1)).

Where a CGT asset that is subject to CGT event A1 is acquired from you by an entity under a power of compulsory acquisition conferred by an Australian law, subsection 104-10(6) provides that the time of the event is the earliest of:

(a) when you received compensation from the entity; or

(b) when the entity became the asset's owner; or

(c) when the entity entered it under that power; or

(d) when the entity took possession under that power.

The term 'Australian law' is defined in section 995-1 to include a 'State law', also defined in section 995-1 to mean a law of a State. As the taxpayer's leasehold interest was acquired under a power of compulsory acquisition under the LAJTCA, being a NSW statute (and a State law), it is an Australian law.

Accordingly, and despite the fact that the Compensation Payment was paid at a later time, the time that CGT event A1 happened to the taxpayer in respect of the disposal of its leasehold interest in the Property to Sydney Metro was the date of acquisition, when Sydney Metro became the owner of the lease.

[1] Sydney Metro - disturbance payments in respect of the construction of the Sydney Metro West.

[2] At [28].

[3] At [30].

[4] At [31].

[5] Taxation Ruling TR 95/35, at [70].

[6] TR 95/35, at [82].

[7] Taxation Determination TD 1999/79, at [4].