Private ruling: Settlement payment
Published: April 2015
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Should the amount received as a settlement payment under the Deed of Release in the dispute between the landlord and tenant be considered on capital account? | A1: Yes.

Relevant facts and circumstances: You are the legal tenant of premises. You have claimed the landlord entered these premises, breaching the lease agreement and removed, destroyed and/or disposed of your property located in those premises and that you have and/or will suffer loss and/or damage as a result of the landlord's actions, which is denied by the landlord. You and the landlord entered into a Deed of Settlement and Release in relation to the above claims. This resulted in a settlement payment being made to you.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Section 104-25

Reasons for decision: Summary: Whether a receipt constitutes income or capital turns on its character in the hands of the taxpayer as the recipient of the amount and this depends on the circumstances of the receipt and the reasons why it was paid to the taxpayer: ( FC of T v Slaven 84 ATC 4077). The principle applied in respect to compensation receipts is the substitution principle and this says that the nature of the compensation payment depends on what it is replacing. If the receipt is a substitute for loss of income the compensation receipt is considered income, but if it is for the loss of a capital asset it is capital in the hands of the recipient. The payment, however, must be looked at in the overall context in which it is paid. In accordance with section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997), a Capital Gains Tax (CGT) asset is: (a) any kind of property, or (b) a legal or equitable right that is not property The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensation for damages or injury. A right to seek compensation is an asset for capital gains tax purposes. The right to seek compensation is acquired at the time of the wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged ( TR 95/35 paragraph 3). When you receive an amount of money as a result of a judgement from a court action or you receive an amount of money for settling your dispute out of court, you are disposing of an asset which is the right to seek compensation and CGT event C2 occurs. CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset (subsection 104-25(1) of the ITAA 1997): (a) being redeemed or cancelled; or (b) being released, discharged or satisfied; or (c) expiring; or (d) being abandoned, surrendered or forfeited. Subsection 104-25(1) of the ITAA 1997 applies on the receipt of the compensation following the granting by a court of a judgement in favour of the taxpayer, or following a settlement entered into between the taxpayer and the defendant. There is a release, discharge or satisfaction of the right, and therefore the disposal of that right. In your case, the settlement payment received was compensation for loss and/or damage to personal property and for a breach of conditions of a lease. This cannot be regarded as a substitute for loss of income so cannot be assessable as a receipt of ordinary income. The receipt of the settlement payment is viewed as being a substitute for the loss of a capital asset, which was your right to seek compensation; therefore CGT event C2 has occurred. It follows that the settlement amount is a capital receipt.