Issue
Is a compensation payment received by the taxpayer for damage to a depreciable asset, assessable income under either section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income, or section 6-10 of the ITAA 1997 as statutory income?
Decision
No. The compensation payment received by the taxpayer for the damage to a depreciable asset is not assessable under section 6-5 of the ITAA 1997 as ordinary income or under section 6-10 of the ITAA 1997 as statutory income.
Facts
The taxpayer conducts a business that is reliant on a major item of plant.
The taxpayer received a compensation payment from a supplier for permanent damage, not capable of repair, to the item of plant due to their supply of a contaminated product used in the item of plant.
The compensation payment was received under an executed compensation deed, which provided that, while denying liability, the product supplier would pay the taxpayer an amount of money and the taxpayer would release the product supplier from any future claims or legal actions in relation to the damage to the depreciable asset.
Reasons for Decision
Under section 6-5 of the ITAA 1997 an amount is assessable income if it is income according to ordinary concepts (ordinary income).
Characteristics of what is ordinary income have evolved from case law and include receipts that: • are earned; • are expected; • are relied upon; and • have an element of periodicity, recurrence or regularity.
The amount received by the taxpayer does not possess these characteristics of income. Further, the replacement principle applies in that compensation payments will be income where they replace revenue items, and they will be capital where they replace capital items. In this case the payment is compensation for the permanent damage to a depreciable asset and is a capital amount.
Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.
An amount received for permanent damage to a depreciable asset may be assessable income as follows: • the compensation is assessable as a capital gain under Part 3-1 of the ITAA 1997; or • the amount is recouped under the depreciation provisions; or • the amount is considered a recoupment under subdivision 20-A of the ITAA 1997.
The amount received for permanent damage to a depreciable asset is not assessable as a capital gain because it is considered that the depreciable asset is the underlying asset for CGT purposes rather than the right to seek compensation, and a CGT event has not occurred in relation to that asset.
The depreciation provisions in Division 42 of the ITAA 1997 do not provide for a reduction in the cost of an item of plant in these circumstances. Therefore, the taxpayer is not required to adjust the undeducted cost of an item of plant.
The general recoupment provisions of subdivision 20-A of the ITAA 1997 do not apply to deductions available under Division 42 of the ITAA 1997 for the taxpayer's expenditure on their item of plant.
Therefore, the amount received for permanent damage to the taxpayer's depreciable asset is not assessable either as ordinary income under section 6-5 of the ITAA 1997 or as statutory income under section 6-10 of the ITAA 1997.