Private ruling: Time of C2 event when parties sign contract on different dates
Published: January 2015
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Questions and Answers: | 1. Did your CGT event C2 in relation to your settlement with the insurer occur during the year ended 30 June 20XX? | Yes. | 2. When calculating the capital gain from your C2 event, can the value of the insurance policies that have been surrendered under the terms of the Release Agreement, in connection with the ending of your right to seek compensation, be included in the cost base? | No. | 3. If the answer to question 2 is 'no', did a separate CGT event C2 occur in relation to the insurance policies upon you entering into the Release Agreement and surrendering the insurance policies under the terms of the Release Agreement? | No.

Relevant facts and circumstances: In early 20YY, you made a claim against the relevant insurance policy, which the insurer accepted and paid monthly benefits to you, in accordance with the policy. In 20ZZ, you commenced legal action against the insurer, which, without any admission of liability by any party, was subsequently settled, in exchange for you releasing the insurer from all actions, suits, claims or demands by you. Prior to 30 June 20XX, you signed the relevant Release Agreement and the settlement amount was paid by the insurer to your legal representative. However, after 30 June 20XX, the insurer signed the relevant Release Agreement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Section 104-35 | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Section 112-20

Reasons for decision: Summary: Section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) is about CGT event C2, in which subsection 2 states: The time of the event is: (a) when you enter into the contract that results in the asset ending; or (b) if there is no contract - when the asset ends. In DTR Nominees Pty Ltd v. Mona Homes Pty Ltd (1978) 138 CLR 423, it was recognised that a contract can come to an end merely by being treated as being at an end by the parties. Similarly, in Fitzgerald v. Masters (1956) 95 CLR 420 at 432, it was held that a contract can be discharged by agreement (such as when each assuming from a long-continued ignoring of the contract on both sides that the matter is off altogether). In your case, based on the literal wording of paragraph 104-25(2)(a), "you" entered into the contract prior to 30 June 20XX. To avoid doubt, based on the legal principles in the court cases cited above, the settlement payment by the insurer (prior to 30 June 20XX) indicates their fulfilment or ending of the contract (from their side). It follows your CGT event C2 occurred in the year ended 30 June 20XX. | Detailed Reasoning - CGT cost base: Taxation Ruling TR 95/35 is about compensation receipts and discusses the right to seek compensation, which is the creation of CGT asset (event D1) under section 104-35 of the ITAA 1997. Paragraph 3 of TR 95/35 states: 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. Section 110-25 of the ITAA 1997 explains, in general, the cost base of a CGT asset consists of five elements, namely: (1) The money you paid, or are required to pay, and the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition). (2) Incidental costs you incurred, which are listed in section 103-5. (3) Interest on money you borrowed to acquire the asset; costs of maintaining, repairing or insuring it; rates or land tax, if the asset is land; interest on money you borrowed to refinance the money you borrowed to acquire the asset; and interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value. (4) Capital expenditure you incurred, the purpose or the expected effect of which is to increase or preserve the asset's value; or that relates to installing or moving the asset. (5) Capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. Section 112-20 of the ITAA 1997 includes modifications to cost base of a CGT asset, specifically, the market value substitution rule, which applies when no expenditure is incurred to acquire an asset. However, the section excludes CGT event D1 from the market value substation rule. In your case, when calculating the capital gain that arose as a result of your C2 event, you cannot include the value of the insurance policies that have been surrendered in your the cost base. This is because: (i) the value of the insurances policies do not fall within the five elements of a CGT cost base under section 110-25, which are about expenditure you incurred in acquiring of your right to seek compensation, which you acquired at no cost on the occurrence of the relevant compensable injury; and (ii) the market value substitution rule cannot be applied to the acquisition (D1 event) of your right to seek compensation that was subsequently disposed of (in your C2 event). | Detailed Reasoning - Another event: As written above, paragraph 3 of TR 95/35 states: "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" and "The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged." Therefore, in your case, although your right to seek compensation was created as a result of your injury, the resultant legal action against your insurer included all of the rights under your policy, including your income rights. It follows when your right to seek compensation was released, this included all of your rights under the relevant policies (and not only your right to seek compensation).