Private ruling: The treatment of a compensation payment as a capital expense.
Date of advice: 26 June 2018
Published: September 2018
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Is the compensation payment made to the related party an allowable capital loss? | A1: No

Relevant facts and circumstances: You entered into a contract to purchase a commercial property with an unrelated party It was intended that a related party would lease the property A verbal agreement was made with the related party Finance was obtained and approved by a financial lending institution The contract to purchase the commercial property from the unrelated party became unconditional The verbal agreement to lease the property to the related party was mutually agreed to be binding and written contacts were to begin The relationship with the financial institution deteriorated and the finance was terminated by you You obtained approval for finance from a second financial institution which was also terminated Due to the lack of financing you were unable to meet the terms of the unconditional contract to purchase the property You paid compensation to the unrelated party for breach of contract You also paid an amount to the related party for loss of income and loss of business progression

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104.10 | Income Tax Assessment Act 1997 Section 102.20 | Income Tax Assessment Act 1997 Section 104.5 | Income Tax Assessment Act 1997 Section 108.5

Reasons for decision: Summary: Section 102.20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital gain or capital loss can only be made if a Capital Gains Tax (CGT) event occurs. You can only make a capital gain or loss when a CGT event happens to a CGT asset you own. A CGT asset is defined in ITAA 1997 section 108.50 as any kind of property or a legal or equitable right that is not property, which includes the right to enforce a contract. Taxation Ruling TR 1999/19 Income tax capital gains: treatment of forfeited deposits notes that when an individual signs a contract to purchase property, they acquire a CGT asset in the form of a contractual right to a transfer of the property (the contractual right). When a contract for the sale of real estate is not proceeded with and a deposit is forfeited by a defaulting purchaser, Taxation Ruling TR 1999/19 specifies that either CGT event C1 or C2 happens to the contractual right acquired by the defaulting purchaser when the contract was entered into. The event that applies is the one which is most specific to the defaulting purchaser’s circumstances. CGT event C1 happens when a CGT asset is lost or destroyed. In cases where no compensation is received for the loss or destruction of the asset, the time of the event is when the loss is discovered or the destruction occurred. CGT event C2 happens when your ownership of an intangible CGT asset (such as contractual rights) ends. The time of the event is when you enter into a contract that results in the asset ending or, if there is no contract, when the asset ends. There are a number of ways such an asset can end, including being abandoned, surrendered or forfeited. In your case, the CGT asset was the contractual right to a transfer of the property which was lost when you defaulted on the contract with the owner of the commercial property. As the lease agreement relied on the transfer of the property taking place first, the timing of the CGT event and subsequent loss of the CGT asset occurred at a point prior to the defaulting of the lease agreement and therefore the CGT asset was not associated with the lease agreement or the compensation payments made to the related party. | Detailed Reasoning - Conclusion: A capital loss cannot be made as you did not have a CGT asset which precludes a CGT event from occurring, therefore the compensation payments are not an allowable capital loss.