Private ruling: Capital gains tax - other - compensation
Published: November 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q3: If applicable, are you able to apply the small business concessions under Division 152 of the ITAA 1997 to reduce the capital gain? Advice/Answers No


Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 subparagraph 25(1)(d) | Income Tax Assessment Act 1997 subsection 25(2) | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 section 52-10 | Income Tax Assessment Act 1997 section 152-40

Reasons for decision: Summary: The lump sum payment is not income according to ordinary concepts and is not assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Income: Section 6-5 of the ITAA 1997 provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Other characteristics of income that have evolved from case law include receipts that: · are earned · are expected · are relied upon, and · have an element of periodicity, recurrence or regularity. | Detailed Reasoning - Application to your circumstance: The payment does not have the characteristics of ordinary income and was not earned by you and did not relate to services performed. The payment is also a one-off payment and does not have an element of recurrence or regularity. | Summary: Entering into the compensation agreement triggers the CGT event C2. The capital gain will be the difference between the incidental costs and the compensation received. | Detailed Reasoning - Capital gain: Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision are called statutory income. Generally, compensation and settlement payments which do not have the characteristics of income are capital in nature and are considered under the CGT provisions of the ITAA 1997. Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. If an asset has not been disposed of and has not been permanently damaged or permanently reduced in value by the happening event, the compensation will not have a direct and substantial link with the underlying asset. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. Permanent damage or reduction in value is defined in TR 95/35 as not meaning everlasting damage or reduced value, but as referring to damage or a reduction in value which will have a permanent effect unless some action is taken by the taxpayer to put it right. In your case, the compensation agreement provides for any affected parts of the land to be rehabilitated by the Tenement Holder. You have advised there is no permanent damage to the land. As there is no disposal of or permanent reduction in value of the underlying land, the compensation is received solely in respect of your right to seek compensation. The definition of a CGT asset in section 108-5 of the ITAA 1997 includes a legal or equitable right that is not property. The right to seek compensation is therefore an asset for the purposes of the CGT provisions. Section 104-25 of the ITAA 1997 discusses CGT event C2 which refers to cancellation, surrender and similar endings. Subparagraph 104-25(1)(d) of the ITAA 1997 states, in part, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being surrendered or forfeited. Subsection 104-25(2) of the ITAA 1997 states that the time of the event is: (a) when you enter into the contract which results in the asset ending; or (b) if there is no contract when the asset ends. Paragraph 157 of TR 95/35 states that the cost base of the right to seek compensation includes costs where there is a direct and substantial link between the expenditure and the arising of the right to seek compensation. Upon entering into the contract you surrender your right to seek future compensation. Therefore CGT event C2 happens at this time. The capital gain will be the difference between the incidental costs, which may include legal fees and charges incurred, and the compensation received. | Summary: No small business relief is available as the CGT asset is not inherently connected with the partnership business. | Detailed Reasoning - Small business concessions: To access the small business concessions the basic conditions for relief under section 152-10 of the ITAA 1997 must be satisfied. In addition to the basic conditions some of the concessions have extra conditions that must be satisfied for the concession to be available. One of the basic conditions is that the asset must be an active asset. Section 152-40 of the ITAA 1997 provides a CGT asset is an active asset where (a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by you, your affiliate; or another entity that is connected with you; or (b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you. As the words 'inherently connected' are not defined in the ITAA 1997, they must be interpreted in accordance with their ordinary meaning. The Macquarie Dictionary defines the word inherent as 'existing in something as a permanent and inseparable element, quality or attribute'. The section requires a connection to the normal course of operations of the business. Examples include patents, trademarks and licences. | Detailed Reasoning - Application to your circumstances: The receipt of the lump sum is a capital receipt and CGT event C2 occurred on the date you entered into the Conduct and compensation agreement. The payment for the disposal of your right to seek compensation did not relate to any underlying assets of the partnership business. It was not an asset used in the normal course of operations of the business. The contract is between the Tenement holder and you as the landowner and occupier. The payment of compensation is not in relation to loss of, or impact upon, your business, and is not inherently connected to the business. The right does not satisfy the requirement of an active asset. You therefore do not satisfy the basic requirements for small business relief under section 152-10 of the ITAA 1997. As such, you are not able to access the small businesses concessions. .

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Question 1: Will the receipt of compensation be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Question 2: Will the receipt of compensation be assessable as a capital gain under section 104-25 of the ITAA 1997? | Relevant facts: You are the owners and occupiers of the property. | In partnership, you operate a beef cattle farming business from this property. | A company (the tenement holder) has undertaken activity on the property. You have received compensation from the tenement holder. | You have provided a copy of the 'conduct and compensation agreement'. This agreement shows the tenement holder is to pay you a one off compensation payment 'for any loss or damage caused or to be caused by the Operations and to otherwise meet all its present and future compensation liability'. | The agreement further states that the tenement holder is required to repatriate any damage to the property at the conclusion of its Operations. You confirm there is no permanent damage to the property as a result of the Operations.