Private ruling: Compensation
Published: June 2015
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Is any amount of the compensation payment assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 ? | A1: No. | Q2: Is the compensation assessable under the capitals gains tax provisions? | A2: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 6-10. | Income Tax Assessment Act 1997 Section 6-15. | Income Tax Assessment Act 1997 Section 10-5

Reasons for decision: Summary: Ordinary income Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: • are earned, • are expected, • are relied upon, and • have an element of periodicity, recurrence or regularity. For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433). On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. The compensation payment you will receive is not earned by you as it does not relate to services performed or from carrying on a business. Although the compensation relates to your property, the payment is not akin to rent. Rather the compensation is being received to help restore your land to its original condition. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from any personal services performed. The compensation payment relates to the damage to your property and is capital in nature. Accordingly, it is not regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997. Statutory income Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997). These specific provisions are listed in section 10-5 of the ITAA 1997 and include capital gains, which are included in assessable income by virtue of the capital gains tax (CGT) provisions. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation payments. Why the payment was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes. TR 95/35 discusses the various scenarios, including: • disposal of the underlying asset, • compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and • disposal of the right to seek compensation. As outlined in the ruling, the Commissioner adopts an ''underlying asset'' approach to determine the asset to which the compensation amount is most directly related. In concluding that the underlying asset is the most relevant asset to which an amount of compensation relates, a person must be able to show that the compensation receipt has a direct and substantial link with the underlying asset. If an asset has not been disposed of and has not been permanently damaged or permanently reduced in value by the happening or event which generated the amount of compensation, the taxpayer is not able to demonstrate that link. It follows that the compensation cannot be directly related to that asset. In those cases, the most relevant asset may be the right to seek compensation, or the notional asset. Paragraph 3 of TR 95/35 states that 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. In your case, the underlying asset is the land. You have not disposed of the land however the land has suffered permanent damage. You are now receiving compensation in respect of restoring the land (the underlying asset) to its former state. The compensation amount being received is viewed as having a direct and substantial link or nexus with the land. Paragraph 9 of TR 95/35 states that compensation received has no CGT consequences if the underlying asset which has suffered permanent damage or a permanent reduction in value was acquired before 20 September 1985 or is any other exempt CGT asset. Your land is considered to be the asset that suffered damage, for which the loss was compensated. However there are no CGT consequences because your asset was acquired before 20 September 1985. Therefore the compensation received for restoring your land cannot be held to be a capital gain and is thereby not assessable under the capital gains provisions of the ITAA 1997. Your payment is not assessable under any other taxation provision. The payment you received is not ordinary income and is not statutory income. Consequently, it is not assessable income (subsection 6-15(1) of the ITAA 1997).

You purchased the land before September 1985. | A few years ago the land was leased to entity A under a lease agreement which allowed them the right to conduct operations on the land. | Under the lease agreement entity A was to restore the land to its original condition after operations ceased. | Entity A is now in receivership and its receivers have offered to pay you an amount as compensation for the costs of restoring the land to its original condition in order to meet the obligation under the lease agreement. | You expect to incur costs higher than the compensation amount offered to restore the land to its original condition. You will not claim deductions for these costs as they are on capital account.