Capital Gains Tax: compensation payment received for cessation of allowance

Is there a disposal of an asset for the purposes of Part IIIA of the Income Tax Assessment Act 1936 (ITAA 1936) when a taxpayer enters into an agreement not to take any legal action in relation to the cessation of the payment of an allowance by another entity?

Yes. As the taxpayer has created a right that, on its creation vests, in another entity, subsections 160M(6) and (6A) of the ITAA 1936 treat the taxpayer as having owned the right and to have disposed of it to the other entity.

The taxpayer had for many years received an allowance from another entity.

In the 1995-96 income year it was decided that the allowance would no longer be paid. At that time the taxpayer signed a deed agreeing not to take any legal action in relation to the cessation of the allowance.

Upon signing the deed the taxpayer received a payment from the other entity.

Subsection 160M(6) of the ITAA 1936 provides that subsections 160M(6A) and (6B) of the ITAA 1936 apply if a person creates an asset that is not a form of corporeal property and which, on its creation, vests in another person.

Subsection 160M(6A) of the ITAA 1936 outlines the consequences for the person creating the asset. It provides that the person creating the asset is taken to have acquired it and commenced to own it at a particular time and to have later disposed of it.

By entering into the deed the taxpayer created a right in another entity to resist any legal action in relation to the cessation of the allowance. As the right is not a form of corporeal property, subsection 160M(6) of the ITAA 1936 and the consequences determined under subsection 160M(6A) of the ITAA 1936 will apply.

The right is taken to have been acquired by the taxpayer immediately before the deed was entered into (subparagraph 160U(6)(a)(ii) of the ITAA 1936) and is taken to have been disposed of at the time of entry into the agreement (subparagraph 160U(6)(a)(iii) of the ITAA 1936).

The amount paid by the entity to the taxpayer will be consideration for the disposal of the right (subsection 160ZD(1) of the ITAA 1936). Note: The payment may also be assessable as a general income receipt under subsection 25(1) of the ITAA 1936, or as a bounty or subsidy under paragraph 26(g) of the ITAA 1936. In either case in order to prevent double taxation subsection 160ZA(4) of the ITAA 1936 will apply to reduce the capital gain the taxpayer made by the amount to be included as assessable income under other provisions of the Act.