Private ruling: Income Tax - CGT - Involuntary disposal of land - Resumption and Revocation of pre-CGT land and Compensation.
Date of advice: 6 April 2017
Published: September 2017
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2010

Ruling: Q1: Did the later revocation of the resumption of land on a certain date mean that CGT event A1 did not previously happen? | A1: Yes. | Q2: Is the compensation amount received disregarded under the capital gains tax provisions because the now revoked resumption of land was pre-CGT land? | A2: No. | Q3: Is the right to compensation a discount capital gain? | A3: No.

Relevant facts and circumstances: A State government body (State) resumed land in Australia from two siblings, one sibling is now deceased, (siblings). The land was inherited by the siblings before 20 September 1985. It is pre-CGT land. The land was used for farming. The State issued an intention to resume land notice on a certain date. The land was resumed by the State. The State and the siblings' entered into an Agreement to enable the resumption. On signing the Agreement the State and the sibling's (the parties to the agreement) had not agreed to the amount of compensation payable for the taking of the subject land. The parties agreed to undertake negotiations in good faith to agree on an amount of compensation payable for the taking of the subject land. It is mentioned in the Background recitals' of the Agreement that the owners of the land were proposing to undertake a significant development on the land and that additional work would be required without the benefit of the land. At the time of the resumption planning and design for the land development had been completed and was undergoing the statutory public notification period. At this stage because of the probable pending resumption, all associated work ceased until after the official resumption became law. In consideration of the extent of the resumption, being 40% of the total site, a new town planning and engineering exercise was commenced after the resumption, utilising the much smaller site. A significant amount of money was incurred by you (siblings) for planning and design expenses after the date of the resumption. These expenses were in addition to a similar amount already spent on planning for the land development prior to the resumption. The Agreement provided for the ongoing maintenance of the land. The State agreed to maintain the land in a condition consistent with its location adjoining the future town centre, and in accordance with Local Government requirements, without fencing or barricading until such time that the land was required by the State for their development. The Agreement permitted the sibling's to continue farming activities on the subject land until the date specified in a Construction Notice. Not long after the resumption the siblings submitted a claim for compensation significantly higher in value than the amount of compensation that was advanced. The State commissioned and received a land valuation of a certain amount. When the State was requested to make an advance of compensation payment, it paid out (as is common) 80% of the valuation. The siblings' have not included any amounts in any income tax returns. The siblings' have not purchased any replacement asset. One sibling died last year. The sibling's spouse was appointed Executor of the Estate. You had not agreed about the final amount of compensation payable for the resumption of the land prior to the death of one of the siblings. The living sibling and the Executor of the Estate; and the State agreed that the resumption of the land may be revoked. The State and yourselves' entered into a Deed agreement to authorise the revocation of the resumption of land. The revocation of taking of land notice was gazetted sometime last year. The cost of the revocation of the resumption of land was at the States cost and the State was required to respond to any requests for information, requirements and notifications from the Registrar of Titles and notify you through your solicitors when the matter was finalised. When the State declared that they no longer required the resumed land, and were seeking a revocation the matter of the total compensation to be paid for the resumed land was in dispute and negotiations were ongoing. As a negotiated requirement of the revocation agreement, both parties agreed (and it was written in the Deed) that you could retain the advance of compensation paid in full and final satisfaction of any claim. The State did not take up occupation of the resumed land at any time. You remained in occupation of the resumed land since the date of resumption, pursuant to the Agreement. In the Deed it is acknowledged by the State that you incurred expenses associated with the design and planning of an alternate town centre master plan for the land development. The Deed does not specifically state or agree that any permanent damage was done to the land. The Deed states that the Deed and the Agreement constitute the entire agreement between the parties. In regard to the progress of the land development the actual physical development is still limited to planning and design work. The resumed/revoked land will be farmed in line with the rest of the future land development site.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 170(9D) | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Section 104-35 | Income Tax Assessment Act 1997 Section 106-5 | Income Tax Assessment Act 1997 Section 115-5 | Income Tax Assessment Act 1997 Section 115-25

Reasons for decision: Summary: CGT event A1 did not happen on a certain date some years ago because the later revocation of the resumption of land meant that the compulsory acquisition of land was void ab initio on a later date. | Detailed Reasoning - Detailed reasoning: Your land was compulsorily acquired some years ago when it was resumed by the State. Originally CGT event A1 did happen when the land was first resumed. Section 104-10(6) of the Income Tax Assessment Act 1997 (ITAA 1997) deals with compulsory acquisitions. It states that the timing of the CGT event is the earlier of; when the change of ownership happens or when compensation is paid. In your case it was when there was a change of ownership as evidenced by the Taking of Land Notices. You and the State revoked the compulsory acquisition by entering into the Deed sometime last year to authorise the revocation of the resumption of land. This meant the contract was null from the beginning. TR 94/29 Income tax: capital gains tax consequences of a contract for the sale of land falling through (TR 94/29) at paragraphs 21 to 23 states the ATO view when a contract falls through after completion: | Detailed Reasoning - 'Contract falling through after completion: 21. It is only in exceptional circumstances that a contract can fall through after completion. 22. As a general rule, once a contract has been completed, in the sense that the purchaser has paid the balance of the purchase monies and the vendor has delivered the transfer and the title deeds to the purchaser, any subsequent dealings in respect of the land will constitute a fresh disposal and acquisition. That is to say, if the parties to the original contract decide to put an end to the contract after completion there will be for CGT purposes a disposal of the land by the original purchaser and a re-acquisition of the land by the original vendor. 23. However, in some circumstances a contract may fall through after completion for reasons which will render the contract void from the beginning, that is, the contract is treated in law as never having come into existence. One example would be where the contract is set aside because of the fraud of one of the parties and the fraud is discovered after completion. In these types of cases the innocent party may rely on the fraud to have the contract of sale declared a nullity from the beginning. The position from a CGT point of view would then be that a change in the ownership of land is taken never to have occurred since the contract of sale was a nullity from the beginning….' The Revocation of Taking of Land Notices had the legal effect of voiding the resumption of land ab initio. This makes the compulsory acquisition a nullity from the beginning. It follows then that there has been no legal change in ownership nor any compensation paid for the acquisition. The parties (the State and the siblings) are restored to their pre-contract (Agreement) position. That part of the now revoked resumed land owned by the living sibling will remain pre-CGT land. The Executor of the Estate will acquire the deceased sibling's part of the revoked resumed land at its market value at the deceased's date of death, (therefore the land is no longer pre CGT land in the Estates hands). | Summary: The relevant asset for CGT purposes is the right to seek compensation. The compensation was not paid for disposal of the land, or for permanent damage to, or permanent reduction in the value of, the underlying asset, (pre-CGT land). Therefore the compensation amount received from the State is not disregarded under the capital gains tax provisions. The right to seek compensation was acquired after 20 September 1985. | Detailed Reasoning - Detailed reasoning: When a person receives an amount of compensation, it is necessary to consider the CGT consequences of receiving the amount. Fundamental to working out the CGT consequences is establishing what the compensation amount is paid for and to this end determining what the relevant asset is. When compensation is paid for the disposal of an underlying asset, for example land the ATO view is that the compensation receipt is consideration paid for the disposal of the land. Paragraph 4 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) states: '4. 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, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation.' When the land is pre-CGT land there are no CGT consequences for the taxpayer on receipt of the compensation. TR 95/35 at paragraphs 5 states: '5. It follows that if the underlying asset disposed of was acquired by the taxpayer before 20 September 1985, the receipt of the compensation has no CGT consequences for the taxpayer.' On signing the Agreement the compensation amount was going to be paid in relation to the taking of the subject land. An advance of compensation was paid. Had the resumption remained unrevoked any compensation paid for the resumption of the land was in relation to the taking of that land. However as a result of the revocation of the resumption of land there has been no disposal of the land, therefore the compensation is not consideration for the land. You were able to keep the advance of compensation paid as a result of the Deed. We therefore need to use the 'look-through approach' as per TR 95/35 to establish the underlying asset that triggered the payment of the compensation. Some relevant definitions of key terms used in TR 95/35 are: | Detailed Reasoning - 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 from the person or entity causing that damage or loss in value or against any other person or entity. If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset. | Detailed Reasoning - Look-through approach: The look-through approach 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 in this Ruling as the underlying asset approach. The character of the advance of compensation changed at the time the Deed was agreed to. The advance of compensation was no longer in relation to the taking of the land. The Deed created other rights because you did not have to return the advance of compensation. Ordinarily at common law it would have been expected that you would need to return the advance of compensation in relation to the land if other rights had not been created at the time the Deed was agreed to. The ATO view in this regard is stated in TR 94/29 at paragraph 27: '27. Thus a contract induced by fraud, mistake or misrepresentation is in some circumstances treated in law as never having come into existence. Here a contract is said to be rescinded ab initio (as from the beginning). All causes of action based on the existence of the contract would cease to exist. The parties would be restored to their pre-contract position. It follows that any deposit or other moneys paid under the contract would need to be returned to the purchaser: see Johnson v. Agnew [1980] AC 367 in Voumard, The Sale of Land in Victoria , 4th edition at 462.' The Deed did a number of things. ● Agreed to the Revocation of resumption of the land. The resumption of land was void ab initio which had the effect of restoring the parties to their pre contract positon, CGT event A1 did not happen and the land reverted / retained its pre-CGT status; ● The parties agreed to the amount of compensation payable, the advance amount; ● The parties agreed that no further monies was payable on the revocation of the resumption and indemnified, released and discharged each other from any future claim; and ● Stated that the compensation paid was in satisfaction of ANY claim. Some further relevant definitions of key terms used in TR 95/35 are: | Detailed Reasoning - Right to seek compensation: 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 compensable damage or injury. A right to seek compensation is an asset for the purposes of Part IIIA. The right to seek compensation is acquired at the time of the compensable 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. | Detailed Reasoning - Permanent damage or reduction in value: Permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right. You believe that the compensation amount was paid as compensation for permanent damage to, or permanent reduction in the value of the underlying asset. You have also made the point that the damage does not need to be everlasting. You have said that you lost exclusive use of the land until the State revoked the resumption of land. This belief is not supported by the Agreement. The Agreement permitted you to continue farming activities on the land until you received a date specified in a Construction Notice. The State also agreed to maintain the land in a condition consistent with its location and in accordance with any Local Government requirements. In the Deed the State does not specifically acknowledge, admit or agree that there has been permanent damage to the Farm Land. The State says it never took up occupation of the land. This is supported by in the Background recitals of the Deed. There has been no change in the use of the land during the resumption and then revocation. There was no restriction on use; you were permitted to continue farming. There was no physical or legal impediment to prevent you from continuing your farming activities. The additional expenses incurred by you was in relation to amendments and additional planning works required to be carried out on adjacent land in relation to the land development business because that income producing activity did not have the benefit of the resumed land. The extent of the resumption was going to be 40% of the total site, therefore a new town planning and engineering exercise was commenced after the initial resumption date, utilising the much smaller site. Therefore the underlying asset is not the land, nor damage to it. The compensation has not been received wholly in respect of any permanent damage suffered to the underlying asset. The Deed creates a right to compensation; and states that the compensation is paid for ANY claim made by you in relation to the resumption of the land. The Deed provides compensation for all of the following: ● Any damage to the proposed profit making undertaking to develop the land. (Compensation for the altered design and planning that was required). ● For any permanent damage to the Farm Land. ● For the breach (revocation) and the resulting right to seek compensation (you would have had an entitlement to sue for damages had the revocation been enacted and no compensation paid to you). ● To surrender any current or future right to seek compensation. Paragraph 18 of TR 95/35 confirms the view that the relevant asset is the right to seek compensation when an undissected lump sum is received. | Detailed Reasoning - 'Undissected lump sum compensation amount: 18. If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation….' The compensation paid was to settle any claim that could be made by you. As per paragraph 34 of TR 95/35 the right to seek compensation is an asset for CGT purposes. There are CGT consequences on disposal of this asset According to paragraph 91 of TR 95/35, disposal occurs where there is a change of ownership, which is when the right to compensation is satisfied. You and your late sibling's spouse as Executor for your late sibling's estate, in the Deed surrendered the right seek to seek compensation. In your case it has been determined that the most relevant asset is the right to seek compensation and this asset was acquired after 20 September 1985, therefore on disposal a capital gain or loss will arise. | Summary: The right to seek compensation was both acquired and settled on the same day when the Deed was executed; therefore any capital gain is not a discount capital gain. | Detailed Reasoning - Detailed reasoning: For a capital gain to be a discount capital gain, section 115-25 of the ITAA 1997 states that the capital gain must be from a CGT event happening to a CGT asset that was acquired by an entity at least 12 months before the CGT event. TR 94/29 states at paragraph 18: '18. The right to sue is acquired at the time of breach of the contract. Disposal of the right to sue would arise upon settlement of the action or upon issue of a court order awarding damages in favour of the vendor. Where the right to sue arises after 25 June 1992 the new provisions of subsection 160M(6) introduced by the Taxation Laws Amendment Act (No 4) 1992 (TLAA (No 4) 1992) will apply as explained in paragraphs 65 and 66.' The Agreement created the right to compensation in relation to the taking of the land only. The Deed created and agreed to other rights to compensation not contemplated in the Agreement. The right to seek compensation was acquired on the date the Deed was executed. It was simultaneously discharged in the same Deed, CGT event C2 happened. Therefore the asset was not held for more than 12 months. The capital gain is not a discount capital gain.