Edited version of private advice

Authorisation Number: 1052166901908

Date of advice: 11 September 2023

Ruling

Subject: CGT - compensation

Question 1

Is the Compensation paid to the Taxpayer by the XXXXXX (the Secretary), as project authority for the XXX XXX under the Major Transport Projects Facilitation Act 2009, included in the calculation of the Taxpayer's net capital gain for an income year pursuant to section 102-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and not included in the net income of the Taxpayer under any other provision of the ITAA 1997 or the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No. A portion of the Compensation is included in the net income of the Taxpayer under section 6-5 of the ITAA 1997.

Question 2

If the answer to Question 1 is 'Yes', did the CGT event that happened in connection with the Compensation received by the Taxpayer happen in the income year ended 30 June 20NN?

Answer

Not applicable given the answer to Question 1 is 'No'. However, to the extent the Compensation constitutes capital and is not otherwise assessed as ordinary income, it represents capital proceeds relating to CGT events that happened to the Taxpayer in the years ended 30 June 20NN and 30 June 20RR.

Question 3

Is any penalty or shortfall interest charge (SIC) that might be imposed under the Taxation Administration Act 1953 (TAA) payable in connection with the Compensation received by the Taxpayer?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20NN

Year ended 30 June 20RR

Year ended 30 June 20BB

Year ended 30 June 20CC

Year ended 30 June 20DD

Year ended 30 June 20AA

Relevant facts and circumstances

The Taxpayer

1.    The Taxpayer is a resident of Australia for income tax purposes.

2.    The Taxpayer operates a number of stores (as franchisee) under individual licence and lease agreements with the franchisor.

3.    The Taxpayer treats each store as a stand-alone business.

Store A

4.    The franchisor granted a franchise to the Taxpayer to operate Store A from the Land on and from XX XXXX 20XX.

5.    In order to facilitate the Taxpayer's operation of Store A (as a franchisee) from the Land, the Taxpayer:

•         purchased assets (such as plant and equipment and stock) necessary to run Store A from the franchisor;

•         entered into a lease with the franchisor, being the registered proprietor of the Land, for a term of 20 years for the purpose of operating Store A (Lease); and

•         entered into a licence agreement with the franchisor pursuant to which the Taxpayer was granted an exclusive license to operate Store A for the duration of the lease (License).

6.    The Lease and Licence, each granted in 20XX for a term of 20 years, were integrated. The Land could only be occupied and used by the Taxpayer under the Lease to carry on the business in accordance with the Licence.

7.    In the case of the assignment of the Taxpayer's interest in the Lease, the Taxpayer (as lessee) remained personally liable for the performance of all obligations, covenants and agreements.

8.    The Licence and Lease did not confer on the Taxpayer any particular entitlements if the franchise granted to it was ended either by the Taxpayer voluntarily or by the franchisor.

The Land Acquisition and Compensation Act 1986 (Vic)

9.    Section 19 of the Land Acquisition and Compensation Act 1986 (Vic) (LACA) provides that, subject to the LACA, a person or body that is an 'Authority' for the purposes of the LACA may acquire an interest in land for the purposes of certain Acts by causing a notice declaring that interest to be acquired to be published in the Government Gazette.

10.  Subsection 24(1) of the LACA provides that, upon publication in the Government Gazette of a notice of acquisition:

(a)       the interest in land described in the notice vests in the Authority without transfer or conveyance freed and discharged from all taxpayers, restrictions, dedications, reservations, obligations, mortgages, encumbrances, contracts, licences, charges and rates of any kind; and

(b)       any interest that a person has in that land is divested or diminished to the extent necessary to give effect to this subsection.

11.  Where an interest in land is vested in the Authority pursuant to the LACA and the land acquired is used by a person as a principal place of business at the date of acquisition, subsection 26(2) of the LACA provides that the Authority will not enter into possession of the acquired land before the expiration of 3 months after the date of acquisition. That period of occupation may be extended further by agreement (subsection 26(6) of the LACA).

12.  Section 30 of the LACA 1986 provides that 'every person who, immediately before the publication of a notice of acquisition, had an interest in land that is divested or diminished by the acquisition of the interest to which that notice relates has a claim for compensation.'

13.  The LACA (under sections 31 and 36) makes provision for the acquiring Authority to make offers of compensation. Subsection 41(1) of the LACA provides that, except where otherwise provided in Part 4 of the LACA (dealing with the measure of compensation), in assessing the amount of compensation payable to a claimant in respect of an interest in land which is acquired under the LACA, regard must be had to several factors listed in that section. These are:

(a)           the market value of the interest on the date of acquisition;

(b)           any special value to the claimant on the date of acquisition;

(c)            any loss attributable to severance;

(d)           any loss attributable to disturbance;

(e)           the enhancement or depreciation in value of the interest of the claimant, at the date of acquisition, in other land adjoining or severed from the acquired land by reason of the implementation of the purpose for which the land was acquired;

(f)             any legal, valuation and other professional expenses necessarily incurred by the claimant by reason of the acquisition of the interest.

14.  Relevantly, for the purposes of paragraph 41(1)(d) of the LACA, the expression "loss attributable to disturbance" is defined in section 40 of the LACA as:

... any pecuniary loss suffered by a claimant as the natural, direct and reasonable consequence of-

(a)           ...; and

(b)           the fact that an interest of the claimant in that land has been divested or diminished, being a pecuniary loss for which provision is not otherwise made in this Part.

15.  A claimant whose interest in land has been acquired may make a claim for solatium (pursuant to section 44 of the LACA) and/or call for an advance whilst still being able to make and pursue a claim for a larger amount of compensation (pursuant to section 51 of the LACA).

16.  Where advanced amounts paid exceed the amount of compensation determined under the LACA to be payable, the recipient of the advances is liable to repay the excess to the Authority (subsection 51(7) of the LACA).

17.  Subsection 89(1) of the LACA provides that on referral of a disputed claim for compensation to the Supreme Court of Victoria, the Court is to determine the amount of compensation to be paid and to make any orders necessary to give effect to that determination.

Acquisition of the Taxpayer's leasehold interest in the Land

18.  On XX XXXX 20NN (Date of Acquisition) the Secretary, being the project authority appointed in accordance with the Major Transport Projects Facilitation Act 2009 (Vic) for the XXX XXX Project, caused a Notice of Acquisition (Notice) to be published in the Government Gazette pursuant to the LACA and thereby declared that, by that Notice, it acquired the following interests in the Land (pursuant to sections 19 and 24 of the LACA):

The interest in fee simple of the registered proprietor ..., and all other interests in the land ...

19.  The Taxpayer's leasehold interest in the Land under the Lease (which had approximately 14 years to run as at the Date of Acquisition) was an 'interest in the land' within the ambit of the Notice.

20.  On the Date of Acquisition, and by reason of the Acquisition:

(a)           the Taxpayer was divested of its leasehold interest under the Land and the Lease vested in the Secretary (pursuant to section 24 of the LACA);

(b)           the Taxpayer became entitled to compensation from the Secretary for the divestment of the Lease (in accordance with section 30 of the LACA); and

(c)           the Licence was terminated (in accordance with clause 24 of the Licence Agreement).

21.  After the Date of Acquisition, and pursuant to new temporary agreements with the lessor (as licensor) and with the Secretary (as lessor) under subsection 26(6) of the LACA, the Taxpayer continued to occupy the Land and operate Store A, paying rent to the Secretary (with the exception of the first 3 months of the period beginning on the Date of Acquisition), until XX XXXX 20NN. The Taxpayer ceased carrying on Store A as of that date.

22.  On XX XXXX 20NN, the Secretary took vacant possession of the Land and subsequently demolished the building on it.

Compensation process and advances of compensation

23.  Following the Acquisition, the Secretary and the Taxpayer exchanged a series of offers and claims pursuant to the LACA in regard to the Taxpayer's claim for compensation. In particular:

(a)       The Secretary made an initial offer of compensation on XX XXXX 20NN for a sum of $XYZ that comprised an allowance for the cost of relocating the business and an allowance for legal fees.

(b)       The Taxpayer rejected the Secretary's initial offer on XX XXXX 20NN and submitted a claim for compensation of $XYZ (subject to adjustment to account for additional disturbance items, interest and professional expenses).

This amount was based on the first valuation report prepared for the taxpayer, who was instructed to assess the disturbance/pecuniary loss the Taxpayer suffered as the natural, direct and reasonable consequence of the Secretary's Acquisition based on, among other things, that:

•         the Taxpayer was unable to relocate the business to another comparable location;

•         the Acquisition of the Land resulted in the extinguishment of the Taxpayer's business; and

•         if the Acquisition didn't take place, the Taxpayer would have sought to extend its lease to operate the business from the Land for as long as possible.

The valuation report stated that the loss suffered by the Taxpayer as a result of the Acquisition relates to the extinguishment of the business and the cash flows that it would have generated over the remaining term of the Licence/Lease.

(c)       Following its receipt of an updated valuation report prepared for the taxpayer, on XX XXXX 20RR, the Taxpayer submitted an updated claim for compensation on the same date for $XYZ (subject to adjustment to account for additional disturbance items, interest and professional expenses).

(d)       The Taxpayer submitted a further updated claim for compensation on for $XYZ (subject to adjustment to account for additional disturbance items, interest and professional expenses).

This updated claim was merely adjusted to include additional professional expenses that the Taxpayer had incurred since its previous claim.

(e)       The Secretary made a second offer of compensation on XX XXXX 20RR for a sum of $XYZ comprising an amount of $ XYZ for loss of attributable to disturbance and an amount of $XYZ for legal, valuation and other professional expenses.

The loss attributable to disturbance reflected the losses suffered by the Taxpayer from the date the Secretary obtained vacant possession of the Land (i.e. business disturbance) of $XYZ; incorporated the estimated cost of relocation of $XYZ; and accepted the Taxpayer's disturbance claim of $XYZ for wasted expenditure.

(f)        The Secretary made a third offer of compensation on XX XXXX 20BB (following its receipt of further advice from the Valuer-General Victoria) for a sum of $XYZ, comprising an amount of $$XYZ for loss attributable to disturbance and an amount of $XYZ for legal, valuation and other professional expenses.

24.  Subject to there being no delay by or on the Taxpayer's part, the second and third offers made by the Secretary further noted that interest would be paid on the balance of compensation payable from the date of any agreement to the date of settlement, in accordance with subsection 53(2) of the LACA.

25.  As permitted by section 51 of the LACA, the Taxpayer called for and received a number of advances equal to the amount of compensation offered by the Secretary at the time in respect of the Taxpayer's leasehold interest in the Land, whilst still making and pursuing a claim for a larger amount of compensation. These were:

•         an advance of $XYZ (equal to the Secretary's initial offer), received on XX XXXX 20NN

•         an advance of $XYZ (equal to the Secretary's second offer less the first advance paid), received on XX XXXX 20BB; and

•         an advance of $XYZ (equal to the Secretary's third offer less the first and second advance paid), received on XX XXXX 20BB,

equating to a total of $XYZ.

Heads of compensation claimed

26.  The Taxpayer's updated claim for compensation of $XYZ, submitted on XX XXXX 20RR and subject to further adjustment, was comprised of the following:

Table 1

Table 1: Taxpayer's updated claim for compensation

The Proceeding

27.  On XX XXXX 20BB the Taxpayer informed the Secretary of its rejection of the Secretary's third offer for compensation dated and that their disputed claim would be referred to a Victorian Victoria.

28.  On the same date, the Taxpayer filed a Notice of Referral by which it commenced proceedings in a Victorian Court (the Proceeding).

Settlement of the dispute

29.  Subsequent to the commencement of the Proceeding, the Taxpayer and the Secretary continued to negotiate in an effort to resolve the disputed claim out of Court, including by participating in mediation.

30.  On XX XXXX 20DD, the Taxpayer and the Secretary entered into a Deed of Settlement and Release (Settlement Deed). By execution of the Settlement Deed, the parties agreed to settle the Proceeding and the Taxpayer's entitlement to compensation in accordance with terms of the Settlement Deed.

31.  The Settlement Deed provides as follows:

1.    Subject to any other written agreement between the parties, in full and final settlement of all issues arising directly or indirectly in relation to the Acquisition and the Proceeding, the parties agree to:

(a)           payment of lump sum of $... (Compensation) by the Secretary to the Claimant as compensation under the Act for the Acquisition, including for all related loss or damage, costs and expenses (other than those set out in paragraph 1(b) below) which has or may be sustained by the Claimant, as a natural, direct and reasonable consequence of the Acquisition, in accordance with the provisions of the Act. This includes all claims and entitlements under section 41 (including loss attributable to disturbance under sub-section(1)(d), section 44 and interest arising under section 53(2) of the Act or otherwise;

(b)           payment of a lump sum of $... by the Secretary to the Claimant as compensation for the professional expenses incurred by the Claimant in accordance with the provisions of section 41(1)(f) of the Act and any costs of the Proceeding incurred by the Claimant (Expenses Amount).^[[5]]

2.    The parties acknowledge and agree that the Secretary has paid the Claimant the Advances in the total amount of $... pursuant to section 51 of the Act on account of the Compensation, and that it forms part of that Compensation. Accordingly an amount of $... (the Final Settlement Amount) remains payable by the Secretary to the Claimant in accordance with this Deed, being the sum of the balance of the Compensation and all of the Expenses Amount.

3.    The Secretary must pay the Final Settlement Amount to the Claimant within 30 days of execution of this Deed by both parties...

32.  After the Settlement Deed was executed, the Secretary paid $XYZ to the Taxpayer as required pursuant to clause 7 of the Settlement Deed, being the difference between the advances received and the settled sum (i.e. the sum of the Compensation and the Expenses Amount).

Treatment of the advances in the tax returns of the Taxpayer

33.  On XX XXXX 20RR after its receipt of the first advance of $XYZ from the Secretary and before its receipt of the subsequent advances, the Taxpayer submitted a private ruling application (Application) to the ATO via a tax agent.

34.  The Application notified the ATO:

(a)           that the Taxpayer had received the initial advance;

(b)           of the Secretary's first compensation offer and the Taxpayer's rejection of it; and

(c)           the Taxpayer's increased compensation claim.

35.  The Application presumed that the CGT rules applied to the initial advance and any further compensation to be received by the Taxpayer in respect of the Acquisition and, based on the fact that the Taxpayer and the Secretary believed that the business could be relocated at the time, requested that the Commissioner exercise his discretion to allow further time for the Taxpayer to take advantage of CGT replacement roll-over relief in Subdivision 124-B of the ITAA 1997 in respect of the capital gain made to date.

36.  On XX XXXX 20BB, a representative of the ATO sent a detailed email in response to the Application, in which the ATO referred to the possibility that the initial advance might be an assessable disturbance payment under either sections 6-5 or 20-20 of the ITAA 1997, and not an assessable capital gain, and said it was premature to reach a conclusion on the point:

... as the Authority is still considering your client's claim for additional compensation, we do not yet know what the final compensation figure will be, and what that amount would be broken into (ie. any capital versus disturbance payment components, or a certain component of each). We would firstly need to know this information in order to determine whether your client is eligible for the roll-over under Subdivision 124-B of the ITAA 1997 before we could consider an extension of time request in respect of acquiring a replacement asset.

For this reason, we are unfortunately unable to provide a response to your client's request at this time.

37.  The ATO email of XX XXXX 20BB also noted the following option available to the Taxpayer:

You may choose to withdraw your client's request for the Commissioner to exercise his discretion to allow an extension of time to obtain a replacement asset, and subsequently submit an application for a PBR (or lodge an Objection to your client's [20NN] income tax assessment) as soon as a final compensation amount has been agreed to between your client and the Authority, and the make-up of that compensation amount is known.

38.  The Taxpayer consequently withdrew the Application under the understanding that, once the negotiations with the Authority are finalised, a new private ruling application would be lodged to confirm how the final total compensation should be taxed.

39.  The advances received by the Taxpayer in the 20NN and 20BB income years (i.e. advances 1 and 2 respectively) were treated as capital gains reduced by the CGT discount and replacement roll-over relief in the Taxpayer's tax returns for those income years. Reporting of the third advance received in the 20CC income year was deferred pending the outcome of the negotiations or the Proceeding and the current private ruling application.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95(2)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(6)

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 paragraph 104-25(1)(a)

Income Tax Assessment Act 1997 paragraph 104-25(1)(b)

Income Tax Assessment Act 1997 paragraph 104-25(2)(b)

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 109-5(2)

Income Tax Assessment Act 1997 section 115-5

Income Tax Assessment Act 1997 section 118-20

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

Income Tax Assessment Act 1997 subsection 118-20(2)

Income Tax Assessment Act 1997 section 995-1

Land Acquisition and Compensation Act 1986 (Vic) section 19

Land Acquisition and Compensation Act 1986 (Vic) section 24

Land Acquisition and Compensation Act 1986 (Vic) subsection 24(1)

Land Acquisition and Compensation Act 1986 (Vic) subsection 26(2)

Land Acquisition and Compensation Act 1986 (Vic) subsection 26(6)

Land Acquisition and Compensation Act 1986 (Vic) section 30

Land Acquisition and Compensation Act 1986 (Vic) section 31

Land Acquisition and Compensation Act 1986 (Vic) section 36

Land Acquisition and Compensation Act 1986 (Vic) Part 4

Land Acquisition and Compensation Act 1986 (Vic) section 40

Land Acquisition and Compensation Act 1986 (Vic) subsection 41(1)

Land Acquisition and Compensation Act 1986 (Vic) paragraph 41(1)(a)

Land Acquisition and Compensation Act 1986 (Vic) paragraph 41(1)(d)

Land Acquisition and Compensation Act 1986 (Vic) section 44

Land Acquisition and Compensation Act 1986 (Vic) section 51

Land Acquisition and Compensation Act 1986 (Vic) subsection 51(7)

Land Acquisition and Compensation Act 1986 (Vic) subsection 53(2)

Land Acquisition and Compensation Act 1986 (Vic) subsection 89(1)

Major Transport Projects Facilitation Act 2009 (Vic)

Taxation Administration Act 1953 subsection 280-100(1) of Schedule 1

Taxation Administration Act 1953 subsection 280-100(2) of Schedule 1

Taxation Administration Act 1953 subsection 280-160(1) of Schedule 1

Taxation Administration Act 1953 subsection 280-160(2) of Schedule 1

Taxation Administration Act 1953 Subdivision 284-B of Schedule 1

Taxation Administration Act 1953 section 284-15 of Schedule 1

Taxation Administration Act 1953 section 284-30 of Schedule 1

Taxation Administration Act 1953 subsection 284-75(1) of Schedule 1

Taxation Administration Act 1953 subsection 284-75(2) of Schedule 1

Taxation Administration Act 1953 subsection 284-75(5) of Schedule 1

Taxation Administration Act 1953 subsection 284-75(6) of Schedule 1

Taxation Administration Act 1953 section 284-90 of Schedule 1

Reasons for decision

Question 1

Summary

A portion of the Compensation is for lost profits and included in the net income of the Taxpayer under section 6-5 of the ITAA 1997[6].

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 receipt of a lump sum compensation/settlement payment is assessable as ordinary income where the payment is compensation for loss of income only, or to the extent that a portion of the lump sum payment is identifiable and quantifiable as income.

Therefore, where a lump sum compensation payment covers loss under multiple heads that are both income and capital in nature, apportionment is required if the sum can be dissected into the component parts. To that end, where the taxpayer allocates amounts between different assets on a reasonable basis, the ATO will generally accept that basis of allocation.

Where a lump sum compensation payment is an undissected lump sum, defined in paragraph 3 of Taxation Ruling TR 95/35[7] to mean an 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, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

Where the relevant asset is the right to seek compensation and a taxpayer receives compensation following a settlement entered by them, CGT event C2 under section 104-25 will happen to the taxpayer in respect of that asset.

However, the mere fact that compensation has been awarded as a lump sum and has not been dissected into its component elements is not sufficient to treat the whole receipt as one of capital where the facts and circumstances surrounding the receipt enable an apportionment of the lump sum payment on a reasonable basis into its constituent elements. Therefore, a sum received as compensation for the compulsory acquisition of property may be dissected or apportioned into capital and income elements if there is an appropriate basis for doing so.

The Compensation received by the Taxpayer from the Secretary following execution of the Settlement Deed compensates the Taxpayer for the closure and loss of Store A that the Taxpayer had been carrying on from the premises at the Land, such closure and loss having resulted from the compulsory divestment of the Taxpayer's leasehold interest in the Land (and the consequent automatic cancellation of the Licence with the lessor).

As noted in clause 1(a) of the Settlement Deed, and with the exception of the Expenses Amount set out in clause 1(b) of the Settlement Deed, the Compensation was agreed to be compensation under the LACA for the Secretary's Acquisition of the Taxpayer's leasehold interest in the Land, including for all related loss or damage, costs and expenses which has or may be sustained by the Taxpayer, as a natural, direct and reasonable consequence of the Acquisition.

Subsection 41(1) of the LACA provides that regard must be had to several factors when determining an amount that would justly compensate a person for the Acquisition of an interest in land. These are:

(a)           the market value of the interest on the date of acquisition;

(b)           any special value to the claimant on the date of acquisition;

(c)            any loss attributable to severance;

(d)           any loss attributable to disturbance;

(e)           the enhancement or depreciation in value of the interest of the claimant, at the date of acquisition, in other land adjoining or severed from the acquired land by reason of the implementation of the purpose for which the land was acquired;

(f)             any legal, valuation and other professional expenses necessarily incurred by the claimant by reason of the acquisition of the interest.

This provision indicates that compensation takes into account more than just the value of the interest in land, and extends to the surrounding circumstances of the compulsory acquisition.

The Taxpayer originally acquired Store A in XX XXXX 20XX for $ XYZ plus GST and stock value. As part of that Acquisition, the Taxpayer acquired plant and equipment and entered into the Lease and Licence for a period of 20 years.

It is difficult to accept, nor have any attempts been made by the Taxpayer to demonstrate, that the value of the Taxpayer's leasehold interest in the Land had increased significantly such that it was equal to or in the vicinity of $ XYZ (the amount of the Compensation) on the Date of Acquisition, at a time when there was no prospect of any business being conducted at the premises.

Therefore, while it is acknowledged that the Compensation includes a receipt of capital in the hands of the Taxpayer to the extent it constitutes compensation for the market value of the Taxpayer's leasehold interest in the Land (per paragraph 41(1)(a) of the LACA), as well as any other assets that were critical to the Taxpayer carrying on its business at the Land (such as the License), it also constitutes compensation for something other than the value of assets compulsorily acquired by the Secretary.

As the Taxpayer acquired the leasehold interest to operate Store A for approximately 20 years, the Taxpayer would have expected to generate significant future earnings or profits. This loss of future profits would be considered part of any loss attributable to disturbance, i.e. a pecuniary loss suffered by the Taxpayer as the natural, direct and reasonable consequence of the fact that the Taxpayer's leasehold interest has been divested (section 40 of the LACA).

It is therefore considered that the Compensation received by the Taxpayer was also for lost profits as a consequence of having no premises in or from which their business could be conducted.

It is not accepted that the Compensation, having been paid in satisfaction of claims of a capital nature and an income nature, was an undissected lump sum (and hence wholly capital) merely because it was awarded as a lump sum and had not been dissected into its component elements under the Settlement Deed.

On the facts and circumstances surrounding the negotiation of the Compensation components (refer to paragraphs above and Table 1), an apportionment of the lump sum payment[8] into constituent elements is possible on a reasonable basis. That is:

• to the extent the amount of compensation was received by the Taxpayer in respect of the disposal of the Lease and other assets lost by the Taxpayer in connection with the Acquisition, the compensation represented consideration received on the disposal of those assets, equal to the value of those assets at the time of the Acquisition; and
• to the extent the amount of compensation was not received by the Taxpayer in respect of the disposal of those assets (i.e. the disturbance payment that related to lost business valued in Table 1) the compensation was for lost profits.

CGT consequences relating to compensation for leasehold interest and licence

On the basis that the Compensation included a receipt of capital in the hands of the Taxpayer, 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).

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

CGT event A1 happened to the Taxpayer upon the disposal of its leasehold interest in the Land to the Secretary as the leasehold interest was divested from the Taxpayer and vested in the Secretary upon publication of the Notice in the Government Gazette pursuant to subsection 24(1) of the LACA.

CGT event C2 under section 104-25 happens if your ownership of an intangible CGT asset ends. CGT event C2 happened to the Taxpayer's Licence upon its termination/cancellation (paragraph 104-25(1)(a)).

In accordance with section 115-5, any capital gain realised by the Taxpayer on the disposal of its leasehold interest in the Land or the termination of its Licence will be treated as a discount capital gain.

The anti-overlap rule in section 118-20 does not apply to these capital gains as no provision (apart from a provision in Part 3-1) includes an amount in the assessable income or exempt income of the Taxpayer because of these events.

Consequences relating to compensation for loss of profits

The concept of ordinary income includes compensation for loss of profits. As such, the part of the Compensation that is compensation for loss of profits will form part of the Taxpayer's ordinary income and be included in its assessable income under section 6-5.

The right to receive a payment is also subject to the CGT rules in Part 3-1.

The Taxpayer's right to receive compensation for loss of profits is a CGT asset (subsection 108-5(1)), acquired when the Secretary created in the Taxpayer the legal right to receive the compensation (event number D1 in table in subsection 109-5(2)). This happened on the Date of Acquisition.

CGT event C2 happened to the Taxpayer's right to receive compensation for loss of profits when the Taxpayer received the Compensation. This is because its right ended by discharge or satisfaction (paragraph 104-25(1)(b)).

The Taxpayer's capital proceeds from the ending consisted of the portion of the Compensation not in respect of the disposal of the Lease and other assets lost by the Taxpayer in connection with the Acquisition (paragraph 116-20(1)(a)).

The capital gain from CGT event C2 happening is equal to the amount by which those capital proceeds exceed the cost base of the right (subsection 104-25(3)).

However, the capital gain the Taxpayer made from CGT event C2 in respect of its right to receive compensation for loss of profits is reduced by the portion of the capital proceeds that is also included in the Taxpayer's assessable income under section 6-5 (subsection 118-20(1)). If the capital gain is less than the amount included in the Taxpayer's assessable income, the capital gain can only be reduced to zero (subsection 118-20(2)).

Question 2

Summary

To the extent the Compensation constitutes capital and is not otherwise assessed as ordinary income (for the reasons explained in response to Question 1), it represents capital proceeds relating to CGT events that happened to the Taxpayer in the years ended 30 June 20NN and 30 June 20RR.

Detailed Reasoning

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 LACA, being a Victorian statute (and a State law), it is an Australian law.

Accordingly, and despite the fact that the Compensation 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 Land to the Secretary was the Date of Acquisition, when the Secretary became the owner of the Lease. That date fell in the 20NN income year.

Where an intangible CGT asset is subject to CGT event C2, having ended without its owner having entered into a contract that results in its ending, paragraph 104-25(2)(b) provides that the time of the event is when the asset ends.

Accordingly, and despite the fact that the Compensation was paid at a later time, the time that CGT event C2 happened to the Taxpayer in respect of the termination of its Licence was the date on which the Taxpayer ceased carrying on its business (i.e. XX XXXX 20NN, in the 20RR income year).

To the extent the Compensation relates to compensation for loss of profits, it will be included in the calculation of the Taxpayer's assessable income under section 6-5 in the 20AA income year, being the year in which the Settlement Deed was executed and the Secretary completed its assessment of the Taxpayer's entitlement to compensation pursuant to section 30 of the LACA.

Question 3

Summary

No penalty that might be imposed under the TAA is payable in connection with the Compensation received by the Taxpayer. Any liability of the Taxpayer for SIC that arises under the TAA in respect of the 20NN and 20RR income years in connection with the Compensation received by the Taxpayer will be remitted in full.

Detailed reasoning

Administrative penalties

Subsection 284-75(1) of Schedule 1 to the TAA[9] broadly provides that you are liable to an administrative penalty if you (or your agent) make a statement to the Commissioner that is false or misleading in a material particular, whether because of things in it or omitted from it.

A statement to the Commissioner is anything that is disclosed for a purpose connected with a taxation law[10] and includes any communication or forms you lodge with the ATO such as a tax return.[11]

A statement is false if it is contrary to fact or wrong,[12] irrespective of whether or not it was made with the knowledge that it was false,[13] and may be false because of something contained in the statement or because something is omitted from the statement.[14] A statement is misleading if it creates a false impression, even if it is true.[15]

A material particular includes something that is likely to affect the calculation of your tax liability.[16]

The Taxpayer:

• is considered to have made a false or misleading statement in a material particular to the extent the Taxpayer understated its assessable income in its 20NN and 20RR tax returns by omitting any discounted capital gains it realised in connection with the Acquisition; and
• therefore, subject to the application of the exceptions discussed below, would be liable to an administrative penalty under subsection 284-75(1).

You are not liable to a penalty under subsection 284-75(1) if:

• you and (if relevant) your agent took reasonable care in connection with the making of the statement (subsection 284-75(5)); or
• the 'safe harbour' under subsection 284-75(6) applies to the statement.

Taking 'reasonable care' in the context of making a statement to the Commissioner means giving appropriately serious attention to complying with the obligations imposed under a taxation law.[17] It requires an entity to make a reasonable and genuine attempt to lodge a tax return that is correct and if they are unsure of the correct tax treatment of an item, reasonable care requires them to make appropriate enquiries to arrive at the correct treatment.

Relevantly, in paragraph 10F of PSLA 2012/5, the Commissioner notes that one factor that is relevant to assessing reasonable care is 'whether any factors prevented the entity from seeking advice, understanding the requirements of the tax law or reporting correctly'.

A 'safe harbour' applies to the statement if:

(a)       you engaged a registered tax agent;

(b)       you gave the registered tax agent all of the relevant taxation information;

(c)       the registered tax agent made the statement; and

(d)       the false or misleading nature of the statement did not result from intentional disregard or recklessness by the agent.

For the purposes of subsection 284-75(5), the Taxpayer is considered to have taken reasonable care in making the false or misleading statement in its tax return for the 20NN and 20RR income years, with regard to the following:

• the Taxpayer gave appropriate serious attention to complying with its tax obligations in respect of the Acquisition, as demonstrated by its engagement of a tax agent to assist it with this matter and its subsequent submission of the Application seeking a private ruling from the Commissioner to confirm the extent of the assessability of the advance received by the Taxpayer at the time; and
• the Taxpayer was effectively prevented from reporting correctly given the Commissioner was not in a position at the time of the Application to provide the confirmation needed by the Taxpayer to assist it to report correctly, and it was agreed that the Taxpayer could re-engage with the Commissioner on this matter once a final compensation amount had been agreed to and the make-up of the compensation was known.

Further, for the purposes of the safe harbour exception in subsection 284-75(6), it is accepted that:

• the Taxpayer engaged a registered tax agent and gave it all relevant taxation information available at the time to make the statement to the ATO (in its tax return for the 20NN and 20RR income years);
• the agent made the statement (as proposed in the Application); and
• the false or misleading nature of the statement did not result from intentional disregard[18] or recklessness[19] by the agent.

The Taxpayer is therefore not liable to a penalty under subsection 284-75(1).

Broadly, subsection 284-75(2) imposes an administrative penalty where:

• a statement is made by an entity or its agent, which treats a relevant tax law as applying to a matter in a particular way that is not reasonably arguable; and
• a shortfall amount resulting from the statement exceeds the reasonably arguable threshold set out in section 284-90.

The reasonably arguable position test applies an objective standard involving an analysis of the law and application of the law to the relevant facts. It is not a question of whether an entity thinks or believes that its position is reasonably arguable, but simply whether it is reasonably arguable.[20]

The expression 'reasonably arguable' has the meaning given by section 284-15 which provides that a matter is reasonably arguable if it would be concluded in the circumstances, having regard to relevant authorities, that what is argued for is about as likely to be correct as incorrect, or is more likely to be correct than incorrect.

In other words, the position must be a contentious area of law, where the relevant law is unsettled or where, although the principles of the law are settled, there is a serious question about the application of those principles to the circumstances of the particular case.[21]

The Taxpayer is considered to have had a reasonably arguable position to the extent it omitted any capital gains it realised in connection with the Acquisition and understated its assessable income in its 20NN and 20RR tax returns. Therefore, the Taxpayer is not liable to an administrative penalty under subsection 284-75(2).

For completeness, it is noted that none of the other provisions in Subdivision 284-B that relate to the imposition of an administrative penalty are relevant to the facts and circumstances that are the subject of this ruling application and, accordingly, no penalty can be imposed under those provisions.

Interest charges

Subsection 280-100(1) explains that you are liable to SIC on an additional amount of income tax that you are liable to pay because the Commissioner amends your assessment for an income year.

Subsection 280-100(2) further explains that the liability to pay the SIC is for each day in the period:

• beginning at the start of the day on which income tax under your first assessment for that income year was due to be paid, or would have been due to be paid if there had been any; and
• ending at the end of the day before the day on which the Commissioner gave you notice of the amended assessment.

The Taxpayer will have a liability for SIC if:

• the Taxpayer obtains an amended assessment in respect of the 20NN and/or 20RR income year (to give effect to this ruling); and
• the amended assessment results in an additional amount of tax being payable.

Subsections 280-160(1) and (2) provide that the Commissioner may remit SIC if he considers it fair and reasonable to do so, provided that he must have regard to certain principles, including that remission should occur where the circumstances justify the Commonwealth bearing part or all of the cost of delayed payments.

Practice Statement Law Administration PS LA 2006/8 Remission of shortfall interest charge and general interest charge for shortfall periods (PS LA 2006/8) provides guidelines on the remission of the SIC accrued during the shortfall period (being the period described by subsection 280-100(2)).

PS LA 2006/8 states that the extent of any remission must take into account the individual circumstances of a case and the extent to which factors beyond the taxpayer's control were responsible for the size and duration of the shortfall (paragraph 5B).

PS LA 2006/8 also provides examples of particular circumstances in which remission may or may not be appropriate noting that those circumstances are not exhaustive and are not intended to limit the discretion to otherwise remit the SIC when it is fair and reasonable to do so.[22]

One such example, at paragraph 29 of PS LA 2006/8, reads as follows:

29. Taxpayer could not have been aware of shortfall when lodging return

29A. A shortfall amount may arise in situations where the taxpayer did not know and could not have known that a shortfall would arise when they lodged their original return or activity statement. This would occur where the return or activity statement is correct, and it is only future events that trigger the need to adjust a liability. Examples of this include:

•         Where a taxpayer becomes entitled to a receipt of compensation in a particular year, which may in some circumstances trigger an adjustment to capital proceeds and affect capital gains or losses in an earlier year's return

...

29B. Each case must be examined on its merits. In the above examples, it may be appropriate for you to grant full remission of interest charges related to the shortfall, usually on the condition that appropriate amendment requests are lodged within a reasonable time after the need to amend arises, if required.

Any liability of the Taxpayer for SIC in respect of a shortfall amount that arises in the 20NN or 20RR income year (in accordance with this ruling) is fairly and reasonably remitted in full on the following basis:

• following its receipt of the initial advance the Taxpayer, through its tax agent, notified the ATO of the relevant facts regarding the Acquisition and the (then) ongoing negotiations with the Secretary in respect of the quantification of the compensation amount, and expressly sought confirmation (via its Application) from the Commissioner of the manner in which the Taxpayer proposed to treat the initial advance in its tax return;
• a potential tax shortfall would reasonably be expected to have been in the contemplation of the ATO at the time it proposed that the Taxpayer should wait to seek a private ruling until the matter was resolved (and the entire compensation amount had been received);
• the Taxpayer could not have known that a shortfall would arise, or the extent of any shortfall that would arise, when it lodged the 20NN and 20RR tax returns; it was only until after the finalisation of settlement negotiations and the execution of the Settlement Deed during the 20AA income year that an assessment as to the characterisation of the Compensation could be made and the quantity of the sum to be assessed could be determined;
• the request for this ruling seeking such confirmation from the Commissioner was lodged within a reasonable timeframe after the execution of the Settlement Deed and the Taxpayer's receipt of the Compensation; and
• the Commonwealth has not suffered any prejudice in connection with any shortfall, including because the circumstances resulting in any shortfall were known to the ATO and the ultimate tax liability in connection with the Acquisition remained indeterminate until the Settlement Deed was executed, such that the capital proceeds in respect of CGT events happening to the Taxpayer in the 20NN and 20RR income years could not be quantified until just prior to submission of the application for this ruling.

[1] Based on the business loss valuation report prepared for the taxpayer.

[2] Relating to expenditure incurred by the Taxpayer to remodel the top floor of the building on the Land as an office/training area.

[3] The Taxpayer reserved the right to revise its claim in order to account for tax implications that arise on payment of the compensation.

[4] Cumulative professional expenses and adjustable on the incurrence of further fees.

[5] The receipt of the amount referred to as the 'Expenses Amount' in paragraph 1(b) of the Settlement Deed is not considered for the purposes of this ruling.

[6] All subsequent legislative references relating to Questions 1 and 2 are to the ITAA 1997, unless otherwise identified.

[7] Income tax: capital gains: treatment of compensation receipts.

[8] Note there was a separate lump sum payment of $XYZ that related directly to professional expenses, refer to clause 1(b) of the Settlement Deed (at paragraph 38 above).

[9] All subsequent legislative references relating to Question 3 are to Schedule 1 of the TAA.

[10] PS LA 2012/5 Administration of the false or misleading statement penalty - where there is a shortfall amount (PS LA 2012/5) at [5A].

[11] PS LA 2012/5 at [5B].

[12] PS LA 2012/5 at [7A].

[13] PS LA 2012/5 at [7D].

[14] PS LA 2012/5 at [7B].

[15] PS LA 2012/5 at [7E].

[16] PS LA 2012/5 at [7H].

[17] Miscellaneous Taxation Ruling MT 2008/1 Penalty relating to statements: meaning of reasonable care, recklessness and intentional disregard (MT 2008/1) at [27].

[18] Intentional disregard means that there must be actual knowledge that the statement made is false. To establish intentional disregard, the entity must understand the effect of the relevant legislation and how it operates in respect of the entity's affairs and make a deliberate choice to ignore the law.

[19] Recklessness is gross carelessness. It assumes that the behaviour in question shows disregard of, or indifference to, a risk that is foreseeable by a reasonable person.

[20] Miscellaneous Taxation Ruling MT 2008/2 Shortfall penalties: administrative penalty for taking a position that is not reasonably arguable (MT 2008/2) at [29].

[21] MT 2008/2 at [39].

[22] PS LA 2006/8 at [7A].