Private ruling: CGT other - compensation
Date of advice: 11 December 2015
Published: February 2016
Ruling period: 2014-15 income year
Date scheme commenced: 1 July 2013

Ruling: Q1: Was the compensation payment that you received from the Solicitor received in respect of an underlying asset being your right to seek to receive a capital distribution from or participate in the Estate? | A1: No.

Relevant facts and circumstances: Some 20 years ago, the Deceased made the original Will leaving the entire Estate to several relatives and the Executor. A couple of years ago, the Deceased asked you if you would be willing to be the Executor of the Estate as the Deceased intended to prepare a new Will. A year later, the Deceased was ill and in hospital and requested the Solicitor to come to the hospital so that a new Will could be drawn up. The Solicitor went to the hospital and prepared hand written notes for the new Will and returned to the office to type it up. The Solicitor returned to the hospital the next morning with the newly prepared Will for signing, however, the Deceased had died earlier that morning before the new Will could be signed. The beneficiaries of the original Will submitted it for probate. You contested the original Will and sued the Solicitor for malpractice for not preparing the replacement Will in a timely manner. To settle the matter, the Estate of the Deceased paid an amount of compensation to you. The Solicitor made an out of court payment to you for a further sum of compensation to settle the malpractice claim. The Deed of Release is to be read with and form part of the description of the scheme for the purpose of this ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-1 and | Income Tax Assessment Act 1997 Part 3-3.

Reasons for decision: Summary: While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. The compensation payment you received from the Solicitor was not received in respect of an underlying asset being your right to seek to receive a capital distribution from or participate in the Estate. | Detailed Reasoning - Detailed reasoning: The term 'capital gains tax (CGT) asset' is defined in very broad terms as: • Any kind of property, or • A legal or equitable right that is not property. A part of, or an interest in, one of these CGT assets is itself a CGT asset. The particulars of a situation determine whether the relevant CGT asset is to be construed broadly or narrowly and whether a larger CGT asset is to be split into smaller components or separate CGT assets merged into a larger CGT asset. Where the issue relates to the seeking or the receipt of compensation, the other issue for consideration is whether or not the compensation will relate to an underlying CGT asset. Thus, the potential outcomes are: • The compensation may form part of the capital proceeds in relation to a CGT event that happens to the underlying CGT asset • The compensation may represent a return of part of the acquisition cost of the underlying CGT asset, or • The compensation payment may be independent of and not relate to any underlying CGT asset. Taxation Ruling TR 95/35 about the capital gains consequences that are applicable to compensation receipts provides some relevant definitions: | 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. | 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. | 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 - 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. Generally, permanent damage can only occur in respect of an asset that you already own. See, for example, paragraph 14 of Taxation Ruling TR 97/3 about compensation received from public authorities. Your situation The Deed of Release acknowledges that you had submitted a Statement of Cross-Claim seeking: • An order that the Note, or alternately the Unsigned Will, constituted the Deceased's last Will, or • In the alternative, that the Solicitor was negligent by failing to obtain a valid formal or informal Will from the Deceased and seek damages against the Solicitor. The Deed of Release also states: • The Parties deny liability to each other • The Parties have agreed on a without admission basis to the settlement and releases recorded in this Deed. The Deed of Release thus acknowledges that you were claiming to hold rights against two separate parties in relation to the matters that it was settling, being: • Rights against the Executor of the Deceased's Estate, and • Rights against the Solicitor. The alleged misdeed by the Solicitor has actually occurred just before or at the time the Deceased passed away. Therefore, this alleged misdeed has occurred before you could have had any rights against the Estate of the Deceased (or against the Executor) as the Estate did not exist as an entity at that time. As a result, it is difficult to see how the misdeed by the Solicitor could cause there to be a permanent reduction in the value of any rights you had to participate in the Estate before any of those rights had actually crystallised and come into existence. Further, the possibility of your other right being an underlying asset depends on its exact nature. The Deed of Release would appear to acknowledge that you had the right to seek to participate in the Estate, but it does not acknowledge that you had the right to actually participate in the Estate. Therefore, it is not possible to conclude that you possessed the right to participate in the Estate given that this was disputed by the Executor of the Estate and that it was never formally confirmed by the Court. For all of the foregoing reasons, it is considered that the right to seek compensation from the Solicitor is a separate CGT asset from the rights that you had to seek to participate in the Estate. Please note: if it had been concluded that both rights related to the one CGT asset, it is likely that the compensation from the Solicitor would have constituted additional capital proceeds in relation to its surrender, rather than a payment that reduced the cost base of that right as a continuing asset. How the capital gains provisions apply to the right to sue Taxation Ruling TR 95/35 provides guidance on the application of the capital gains provisions apply to a CGT asset being the right to sue or the right to seek compensation at paragraphs 86 to 139 and a summary at paragraphs 167 to 171. In short: • The right to sue or to seek compensation is the relevant CGT asset • CGT event D1 occurred for the Solicitor when you acquired the right • You didn't physically pay any amount to acquire the right to sue • The market value substitution rule does not apply to adjust the cost base • You have incurred legal expenses that may form part of the cost base • CGT event C2 occurred when Deed of Release took effect • Your capital proceeds for this event was the amount received from the Solicitor • You held the right to sue as a CGT asset for longer than 12 months