Private ruling: Capital gains tax (CGT) and receipt of compensation
Date of advice: 24 May 2018
Published: July 2018
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 19XX

Ruling: Q1: Did capital gains tax (CGT) event C2 (in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997)) occur when you received your ownership interest in the Properties as a means of compensation? | A1: Yes.

Relevant facts and circumstances: You are the daughter of your father. Your father owned a building. On 20XX, the Office delivered a partial decision that you and your siblings were to receive ownership of the Properties. The transfer of property was to happen on the date of legal validity of the order. The partial decision contained the following facts: ON 19XX the Committee made a legally valid decision to deprive your father of ownership of the building. On 19XX the decision of the Committee was affirmed that from 19XX the ownership rights of your father were deleted. The City has used the Properties and charged rent or compensation from this time until 20XX. Your father passed on 19XX. At the time of his passing, your father had no valid Will. Upon your father’s passing, you and your siblings (the Applicants) became his heirs. On 19XX you and your siblings lodged an application to have the Properties returned to you as the rightful heirs of your father. On 20XX the Office heard an on-site investigation should be conducted of the Properties by all of the parties concerned. On 20XX the on-site investigation was held and the Properties determined. Between 20XX and 20XX the Office held hearings relating to the leases that were held by different parties within the Properties and as to when they were due to expire. On 20XX the Office received a submission from the lessees of the Properties (the Lessees) challenging the validity of the Applicants relationship to your father as the person deprived of the Properties. On 20XX before a hearing held by the Office, the Applicants contested the submission of the Lessees. At the same hearing, the City put it on record that all but one of the leases had now concluded and that they would not be seeking to renew them until a determination in the Applicants’ case had been made. On 20XX the City submitted to the hearing that it had not sought new leases after the expiry of the old in the Properties. On 20XX, the Court decreed that pursuant to the partial decision issued by the Office on 20XX, the conclusion of the matter on 20XX. This was that ownership of the Properties was to transfer to you and your siblings. The Law was enacted on 19XX.

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

Reasons for decision: Detailed Reasoning - Detailed reasoning: Paragraph 108-5(1)(b) of the ITAA 1997 provides that a CGT asset may be any kind of property; or legal or equitable right that is not property. A contractual right is an intangible right. Section 104-25 of the ITAA 1997 provides for CGT event C2 occurring certain conditions are met for an intangible CGT asset. One of the conditions is where the contractual right is released, discharged or satisfied. A capital gain will result from CGT event C2 if the proceeds received exceed the cost base of the asset. The Commissioner provides the view in paragraph 3 of Taxation Ruling 95/35 (TR 95/35) for key terms to do with the taxation ruling. Some of these are: ● Compensation receipt – includes any amount, whether money or property received by a taxpayer in respect of a right to seek compensation or a cause of action, or a proceeding instituted by the taxpayer in respect of that right or cause of action. ● Look-through approach – this is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to as the underlying asset approach. ● Underlying asset – The underlying asset is the asset that, using the ‘look-through’ approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation. Paragraph 4 of TR 95/35 provides that that if an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer, the compensation represents consideration received on the disposal of that asset. In these circumstances, the Commissioner considers that the amount is not compensation received for the disposal of any other asset, such as the right to seek compensation. At paragraph 11 of TR 95/35, the Commissioner’s view is that if the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. Accordingly, any capital gain arising on the disposal of that right is calculated using the cost base of that right. Paragraph 15 of TR 95/35 provides that if the compensation relates directly to more than one asset, it is necessary to determine the most relevant asset and to apportion the compensation between those assets. Paragraph 34 of TR 95/35 provides that the Commissioner considers the right to seek compensation an asset for the purposes of the CGT provisions. Paragraph 69 of TR 95/35 provides that the particular asset in respect of which compensation has been received by the taxpayer must be: ● an underlying asset; or ● a right to seek compensation; or ● a notional asset. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset, it is often appropriate to adopt a ‘look-through’ approach to the transaction or arrangement which generates the compensation receipt. The Commissioner regards this as the most appropriate basis on which to determine whether any capital gain arises on the disposal of any asset of the taxpayer. Paragraph 77 of TR 95/35 provides the view that the Commissioner considers that it is for the loss or destruction of the underlying asset that 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 right to seek compensation as the relevant asset. | Detailed Reasoning - Application to your circumstances: The Properties that were owned by your father were found to have been validly and legally seized by the then Government under a Law. The Office did not make a determination that the seizure had been null or void. At the time of your father’s passing, he had no valid Will and no legal or equitable ownership of the Properties. The right to have the Properties restored to your father or his heirs came about through the enactment of The Law. This law was enacted after your father’s passing. You and your siblings lodged a claim with the Government to have the Properties returned to you on 20XX. On 20XX you received an ownership interest in the Properties in satisfaction of your claim. You had no legal or equitable ownership of the Properties at the time they were seized. You did not possess a direct claim to have the Properties restored, but rather a derived claim, as the heir of your father. Ownership of the beneficial interest in the properties did not pass to you under the Will of your father. The seizure of the Properties in 19XX was held to be a legal exercise of power and has not since been declared as null or void. You were granted a right to compensation when the Government enacted the Law (which is a CGT event D1). In your case there is no underlying asset and CGT event C2 has occurred when ownership of the properties was transferred to you.