Private ruling: Capital gain tax
Published: July 2013
Ruling period: Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2013

Ruling: Q1: Is the compensation amount payable to you under an agreement between yourself and another party assessable under the capital gains tax provisions? | A1: No.

Relevant facts and circumstances: You and your spouse jointly own a property (your property). Your property is a post-CGT asset. The property includes your main residence and has never been used to produce assessable income. Your property joins, or is near, mining operations. Your property has been affected and will continue to be affected by the mining operations. In the relevant financial year you entered into a compensation deed with the mine operators to compensate for the direct or indirect impacts of the mining operations on the property, including the diminution in value. The deed purports to be the full and final compensation for the mining operations. The compensation amount is un-dissected and is payable in instalments.

Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 6-10

Reasons for decision: Summary: The capital gains tax (CGT) treatment of compensation receipts are considered in Taxation Ruling TR 95/35. The CGT consequences of an award of damages depends on whether there is an underlying asset that damages have a direct and substantial link 'by looking through the transaction that gave rise to the compensation receipt to the most relevant asset relating to the receipt' (paragraph 76 of TR 95/35). In Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd and Graeme McDonald 93 ATC 4418; (1993) 25 ATR 192, Harper J suggested that the compensation receipt should be linked to the underlying asset in determining whether the plaintiff had received any capital gain. The ATO view is that where there is loss or destruction of the underlying asset that is why the compensation is received, rather than for the disposal of any rights arising from that loss or destruction. Only if the insurance or settlement proceeds do not relate to the disposal of part or all of any underlying asset is it necessary to consider the policy rights or the right to seek compensation as the relevant asset (paragraph 77 TR 95/35). The standard compensation agreements consist of an upfront payment and future ongoing payments reflective of the damages to underlying assets. If the payment relates to permanent damage to, or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (that is, you reduce the cost base and reduced cost base by the amount of the compensation). The total acquisition costs of the post-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, in the case of a post-CGT underlying asset, 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 (paragraph 7 TR 95/35). For example, where there is an upfront lump sum payment paid by the statutory authority party to the claimant in relation to clearing land and the constructing of a dam. The consideration received is treated in respect of the underlying asset, the land. The cost base of the land is reduced to the extent of the consideration and any gain or loss will crystallise at the later time when the land is sold. | Detailed Reasoning - Conclusion: Compensation received by a land owner in relation to the damage of and reduction in value of an underlying asset will be treated as a reduction of the cost base. If the compensation amount exceeds the total acquisition costs of the property, there are no CGT consequences in respect of the excess compensation amount. The cost base of the land is reduced to the extent of the consideration and any gain or loss will crystallise at the later time when the land is sold.