Private ruling: Capital gains tax - compensation - loss or destruction of a capital gains tax asset
Date of advice: 17 September 2015
Published: September 2015
Ruling period: Income year ending 30 June 2015.
Date scheme commenced: 1 July 2014.

Ruling: Q1: Did capital gains tax event C1 happen to the property, or any part of the property, due to the event? | A1: No. | Q2: Is the capital gains tax rollover available under subdivision 124-B of the Income Tax Assessment Act 1997 in relation to the building located on the property? | A2: No.

Relevant facts and circumstances: You purchased a rental property after 20 September 1985. The building located on the property was damaged a number of years later. You lodged an insurance claim with your insurer, with settlement on your claim being settled around nine months after the event. As a result of the settlement you received a Settlement Sum which included amounts for the building and loss of rent and an amount taken out for the policy excess. The building is structurally sound, but needs extensive repairs as a result of the event. The building has asbestos materials in it which have been affected by the event. You intend to demolish the building because it contains asbestos and to construct a replacement rental building on another block you own. You have provided copies of a number of documents, which should be read in conjunction with and forms part of the scheme of this private ruling:

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 20-25(1) | Income Tax Assessment Act 1997 Subdivision 40-D | Income Tax Assessment Act 1997 Section 104-20 | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Section 108-55 | Income Tax Assessment Act 1997 Section 108-60 | Income Tax Assessment Act 1997 Subsection 110-45(3) | Income Tax Assessment Act 1997 Subdivision 124-B

Reasons for decision: Detailed Reasoning - Capital gains tax assets: Section 108-5 of the ITAA 1997 provides that land and buildings are capital gains tax (CGT) assets. Generally, it is viewed that what is attached to land is part of the land. That is, the land and what is attached is considered one asset. However, for CGT purposes, there are exceptions to this rule which may treat the land and what is attached to it as separate assets. Where this is the case: • any capital gain or loss must be determined separately for each asset, and • depending on the date of acquisition of each asset, it may not be possible to apply the CGT discount to both assets. For CGT purposes, the exceptions to the rule that what is attached to the land is part of the land are considered in Subdivision 108-D of the ITAA 1997. Subsection 108-55(1) of the ITAA 1997 states that any buildings or structures on land acquired on or after 20 September 1985 will be a separate CGT asset if the balancing adjustment provisions specified in Subdivision 40-D of the ITAA 1997 apply to the building or structure. Broadly, a building will be treated as a separate asset from the land to which it is affixed if the building is a depreciating asset for which a balancing adjustment must be worked out on sale, or the building is a post CGT asset and the land to which it is attached is a pre CGT asset that was acquired before 20 September 1985. Section 108-60 of the ITAA 1997 provides that a depreciating asset that is part of a building or structure is taken to be a separate CGT asset from the building or structure. Subsection 108-5(2) of the ITAA 1997 provides that a CGT asset also includes part of, or an interest in, a CGT asset, including land and buildings. | Detailed Reasoning - Loss or destruction of CGT assets: CGT event C1 in subsection 104-20(1) of the ITAA 1997 happens if a CGT asset you own is lost or destroyed. The words 'lost' and 'destroyed' in subsection 104-20(1) of the ITAA 1997 are not defined in the Act and they take their ordinary meaning. The word 'lost' in its context in subsection 104-20(1) of the ITAA 1997 does not contemplate voluntary actions. The word in its context in CGT event C1 suggests an involuntary rather than a voluntary act. The word 'destroyed' in subsection 104-20(1) of the ITAA 1997 contemplates both voluntary and involuntary actions. The word in its context in CGT event C1 applies if a CGT asset is destroyed in an involuntary occurrence, such as a natural disaster, or if it happens by the actions of others over which the taxpayer has no control. It also applies if a CGT asset is destroyed in a voluntary occurrence, such as if it happens due to a deliberate act of the taxpayer when the taxpayer demolishes a building in the course of redeveloping a property. Neither of the words 'lost' or 'destroyed', in the context of CGT event C1, contemplates damage to an asset that does not amount to the asset being lost or destroyed. A CGT asset must be wholly lost, or wholly destroyed, not just damaged for the circumstances to be covered by CGT event C1. This is not to say, however, that CGT event C1 cannot happen to a discrete and identifiable part of a CGT asset, being a CGT asset in its own right, if the part is wholly lost or wholly destroyed and not just damaged. | Detailed Reasoning - Replacement asset roll-over: The general effect of the replacement asset roll-over provisions is to defer or reduce the making of a capital gain or capital loss from one CGT event until a later CGT event happens. They require the ownership of one CGT asset to end and another CGT asset to be acquired. The roll-over under Subdivision 124-B of the ITAA 1997 is available where a CGT asset owned by a taxpayer is wholly or partially lost or destroyed and the taxpayer receives compensation for the loss or destruction and CGT event C1 occurs. Section 104-20 of the ITAA 1997 does not specifically refer to the possibility of partial loss or destruction. However, it is clear from the definition of a CGT asset in section 108-5 of the ITAA 1997 that this event can encompass a partial loss or destruction of an asset. Loss or destruction of part of a CGT asset must be distinguished from mere damage to the asset, for the purposes of Subdivision 124-B of the ITAA 1997. The importance of this distinction is that the destruction or loss of a CGT asset, in full or in part, is an eligible roll-over event whereas damage to the whole or part of a CGT asset is not. It is possible that damage to an asset may, in some circumstances, amount to loss or destruction, but the question whether a CGT asset or part of it is damaged rather than destroyed is a question of fact that depends on the circumstances of each particular case. Taxation Determination TD 2000/38 (TD 2000/38) provides the following examples of events that amount to loss or destruction and events that are merely damage: • Example 1. The keel of a yacht was destroyed and the yacht is damaged. The keel is viewed as part of the yacht, however it is a separate CGT asset. To the extent that the roll-over is available, it would be available in respect of the destroyed keel and not the damaged yacht, if the other requirements in Subdivision 124-B of the ITAA 1997 are satisfied. • Example 2 A holiday home is reduced to rubble by a cyclone. Roll-over is available for the destruction of the home as long as the requirements of Subdivision 124-B of the ITAA 1997 or met. However, if only part of the house is damaged, and not destroyed during the cyclone, then roll-over is not available. If part of the house is destroyed by the cyclone, and it can be identified as a separate CGT asset, the roll-over will be available for that separate CGT asset if the other requirements of Subdivision 124-B of the ITAA 1997 are satisfied. • Example 3 The iron roof of a factory is destroyed as a result of a hailstorm. Roll-over is available for the roof, the part of the factory that was destroyed and which is a identifiable CGT asset. However, if the roof was just damaged during the hailstorm, roll-over is not available because neither the factory nor the roof was lost or destroyed. | Detailed Reasoning - Compensation for permanent damage to, or permanent reduction in the value of, the underlying asset: Taxation Ruling TR 95/35 (TR 95/35) sets out the capital gains tax (CGT) consequences when a taxpayer receives a compensation payment. One of the receipt types it addresses is 'compensation for permanent damage to, or permanent reduction in the value of, the underlying asset'. The term 'permanent damage or reduction in value' is defined in paragraph 3 of TR 95/35 as not meaning an everlasting damage or reduced value, but damage or value reduction which will have permanent effect unless some action is taken by the taxpayer to put it right. In applying the 'look through' approach to determine the underlying asset to which the payment relates, paragraph 6 states: If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset. Paragraphs 7 and 8 discuss the consequences of the recoupment, and have direct application to the calculation of the cost base of an asset in terms of subsection 110-45(3) of the ITAA 1997, recouped expenditure. These paragraphs state: 7. Accordingly, the total acquisition costs of the post-CGT asset should be reduced by the amount of the compensation. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset. If, in the case of a post-CGT underlying asset, the compensation amount exceeds the total unindexed acquisition costs (including a deemed cost base) of the underlying asset, there are no CGT consequences in respect of the excess compensation amount. 8. The adjustment of the total acquisition costs effectively reduces those costs by the amount of the recoupment as if those costs had not been incurred … Paragraph 133 of TR 95/35 outlines that if the amount of recoupment exceeds the taxpayer's total acquisition costs at the time of the compensation; the effect is to reduce the costs to zero. The excess of the recoupment over the costs in these circumstances does not represent a taxable capital gain derived from the disposal of that asset. There are no CGT consequences in respect of any excess. It follows that the whole consideration received on a later actual disposal of that asset by the taxpayer will be a taxable capital gain (unless the taxpayer incurs additional expenditure which forms part of the cost base of that asset). Where the compensation received relates to a property acquired after 19 September 1985 (post CGT) then using the look through approach, if the compensation relates to permanent damage to it, or a permanent reduction in its value, then the cost base of the asset is reduced accordingly. Subsection 110-45(3) of the ITAA 1997 outlines that expenditure does not form part of the cost base to the extent that any amount you have received as recoupment of it, except so far as the amount is included in your assessable income. | Detailed Reasoning - Application to your situation: You have made the following submissions in the private ruling application: • the block of land on which the building is located on is valued at approximately $85,000.00 and the cost to demolish and remove the building has been estimated to be $60,000.00, • there is doubt whether you can demolish and build a replacement building on the property to rent because of the uncertainty concerning the demolition and removal costs of the asbestos, • you are considering selling the property by auction and are hoping that someone will purchase the property, • you own another block of land on which you could build a replacement rental building, • while the building is standing, there is no practicable alternative other than to have the building demolished; and • essentially the land and building would be a single CGT asset as they were acquired at the same time. Therefore, it would appear that you have a partial destruction of the CGT asset being the building. This would imply that the replacement building needs to be constructed on the land itself. Whereas, if the building is treated as a separate asset, it doesn't seem to matter where the building is constructed. This separate asset is the concept explained in Taxation Determination TD 2000/38 . In your situation, you purchased the rental property which consisted of a building and land. Based on the facts provided, the building is not covered by the balancing adjustment provisions and was not constructed on land acquired before 20 September 1985. Therefore, the building will not be treated as a separate asset and the building and land will be treated as a single asset in accordance with subsection 108-55(1) of the ITAA 1997. The building was damaged as a result of an event and you put in an insurance claim. You received a Settlement Sum which included amounts for the building and loss of rent. You have provided a report which supports that the building on the property required extensive repairs after the event, but was structurally still sound after the event. There was no recommendation in the report for the building to be demolished. An asbestos site assessment report has also been prepared in relation to the event damaged property which outlines that the asbestos cement sheeting in the building had been extensively damaged as a result of the event, and is in poor condition. The report recommends that the house materials and a layer of soil where asbestos materials have been in contact be removed under controlled conditions. The report does not recommend that the building be demolished/removed, only the removal of the asbestos contaminated house materials and around five centimetres of soil that has friable asbestos debris on it. In your case: • Based on the information you have provided, we are unable to determine if there are any separate CGT assets, for example depreciating assets. To the extent that you can identify that any separate CGT assets have been destroyed as a result of the event, CGT event C1 will happen in relation to those CGT assets. The roll-over will be available to those CGT assets if the requirements in Subdivision 124-B of the ITAA 1997 are satisfied. The Settlement Sum you received in relation to the building should be apportioned on a reasonable basis to account for those separate CGT assets and the building in accordance with section 116-40 of the ITAA 1997. However, the roll-over will not be available to the building as the building has not been lost or destroyed and CGT event C1 has not occurred in relation to the building; and • If you demolish the building, CGT event C1 will occur. However, it is viewed that you will not receive any capital proceeds from the demolition of the building. The Settlement Sum has been received for the event damage to the building and cannot be viewed as being capital proceeds arising in relation to the demolition of the building. Therefore, you will not make a capital gain from the demolition of the building. Accordingly, the roll-over available under subdivision 124-B of the ITAA 1997 cannot apply in a situation when you do not have a capital gain. To the extent that your property suffered damage from the event that caused permanent damage which reduced the value of the property, then CGT event C1 has not happened, and the principles in TR 95/35 will apply instead of the roll-over relief in Subdivision 124-B of the ITAA 1997 to your situation. In accordance with TR 95/35, the property is viewed as the underlying asset. No CGT event occurred in the income year in which the Settlement Sum was received. Therefore, as no CGT event had occurred at the time of the receipt of the Settlement Sum, there would be no assessable capital gain in terms of Division 104 of the ITAA 1997. The Settlement Sum amount relating to the "building" was received in respect of the permanent damage to the property and that amount will represent a recoupment of part of the acquisition cost of the property. The recoupment amount, being the amount you received for the "building", will reduce your cost base in the property. Based on the information provided with the private ruling, your cost base for the property could reasonably be expected to be less than the "building" portion of the Settlement Sum. Therefore, your cost base for the property will be reduced to nil. The excess amount of the Settlement Sum paid in relation to the "building" does not represent a taxable capital gain and there are no CGT consequences in respect of the excess. Note: Any expenditure on the property incurred after the date the Settlement Sum was received, and which cannot be claimed as a deduction, can be included in the cost base of the property