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Does a CGT event happen under Division 104 of the Income Tax Assessment Act 1997 (ITAA 1997) upon receipt of an ex gratia payment made to a landowner in the Mitta Mitta Valley by the Murray Darling Basin Commission under the scheme of ex gratia payments announced in March 2000?

No. Division 104 of the ITAA 1997 does not apply, however the payment will result in a cost base adjustment to the affected land pursuant to subsection 110-45(3) of the ITAA 1997.

The Dartmouth Dam is located in North East Victoria. It was constructed across the Mitta Mitta and was commissioned in 1979. Since that time the reduction in the river's flow has adversely affected pasture productivity on properties downstream of the dam.

The Murray-Darling Basin Commission (MDBC) is responsible for the operation of the dam. In March 2000 the MDBC recognised the adverse effects of the dam by offering to land owners a once-only ex gratia payment to them, without admission of any liability for damage or loss caused.

The calculation of the payment for each landowner who took up the offer, was based on the likely cost of installing sufficient irrigation capability so as to restore their affected land back to pre-dam productivity.

Taxation Ruling TR 95/35 sets out the capital gains tax consequences when a taxpayer receives a compensation payment. The ex gratia payment from the MDBC is considered to be a compensation receipt in terms of paragraph 3 of TR 95/35.

The ruling applies a 'look through' approach to determine the underlying asset to which the payment relates. Applying the look-through approach it is considered that the underlying asset is the affected land itself.

Paragraph 6 of TR 95/35 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.'

The landowners did not suffer a loss of any of their land nor have they disposed of any part of the land, however the reduction in the pasture productivity of the land resulted in a permanent reduction in the value of their properties. As there was no disposal of the affected land it is considered that ex gratia payments were made in respect of the permanent reduction in the value of the properties.

Therefore landowners who acquired their affected properties after 19 September 1985 should reduce their total acquisition costs of the properties by the amount of the ex gratia payment received, pursuant to subsection 110-45(3) of the Income Tax Assessment Act 1997.

Receipt of the ex gratia payment has no CGT consequences for those landowners who acquired their properties prior to 20 September 1985.