ATO ID 2008/147: Capital gains tax: vendor cancellation of contract - compensation payment - preserving ownership rights
Date of decision: 4 November 2008
Year of income: Year ended 30 June 2009
Business line: Private Groups and High Wealth Individuals

Issue
Can the taxpayer include in the fifth element of the cost base under subsection 110-25(6) of the Income Tax Assessment Act 1997 (ITAA 1997) and the reduced cost base under subsection 110-55(2) of the ITAA 1997 of a CGT asset they own, an amount of damages paid to a potential purchaser upon the potential purchaser's acceptance of the termination of a contract to sell the asset following repudiation of the contract by the taxpayer?

Decision
Yes. The payment of damages can be included as part of the fifth element of cost base of the CGT asset under subsection 110-25(6) of the ITAA 1997 and the fifth element of the reduced cost base of the CGT asset under subsection 110-55(2) of the ITAA 1997.

Facts
The taxpayer entered into a contract for the sale of a CGT asset. Subsequently they changed their mind and asked the potential purchaser to agree to terminate the contract. The potential purchaser agreed to terminate the contract upon the payment by the taxpayer of an amount of damages.

Reasons for decision
Summary: The fifth element of the cost base, under subsection 110-25(6) of the ITAA 1997, is capital expenditure that you incurred to establish, preserve or defend your title to the asset or a right over the asset. The Macquarie Dictionary , 2005, 4th edn, The Macquarie Library Pty Ltd, NSW defines 'preserve' to include ' 4. to keep possession of; retain.' The expenditure (the amount of damages) was incurred so that the taxpayer could retain title to the CGT asset. It was the amount paid so that the potential purchaser would agree to termination of the contract as opposed to enforcing the taxpayer's performance of the contract. The effect of termination was that the title to the CGT asset remained with the taxpayer. Accordingly, the expenditure is included in the fifth element of the cost base of the CGT asset. Subsection 110-55(2) of the ITAA 1997 provides that all of the elements (except the third one) of the reduced cost base are the same as those for the cost base. The expenditure is thus included in the fifth element of the reduced cost base of the CGT asset.

Legislative references: Income Tax Assessment Act 1997 subsection 110-25(6) subsection 110-55(2)
Subject references: Breach of contract Capital gains tax CGT cost base CGT reduced cost base Contract law Law, litigation & legislation