CGT - Settlement Sum

1 Is the Settlement Sum ordinary income of the Taxpayer under section 6-5 of the ITAA 1997?

1 No. Question 2 If the answer to Question 1 is No, did CGT Event C2 happen in relation to a right to seek compensation on entering into the settlement deed? Answer 2 Yes. Question 3 If the answer to Question 2 is Yes, is the capital gain derived on disposal of the right to seek compensation under CGT Event C2 a discount capital gain under section 115-5? Answer 3 Yes. This ruling applies for the following period : Year ending 30 June 20XX The scheme commenced on: XX XX 20XX

This private ruling is based on the facts and circumstances set out below. If your facts and circumstances are different from those set out below, this private ruling has no effect and you cannot rely on it. Find out more about when you can rely on your private ruling at ato.gov.au/relyonprivateruling . The Taxpayer carries on a business. The Taxpayer is an Australian resident for tax purposes. On X XX XXXX, the Taxpayer entered into a contract with the Vendors to purchase the Property on unregistered Plan of Subdivision. The Property was intended to be used by the Taxpayer in its business. The relevant terms of the contract were as follows: a.               purchase price of $X plus GST; b.               deposit of $X to be paid on the date of the contract; c.               the Vendors will do all things necessary, pay all costs, expenses and fees in order to secure registration of the Plan of Subdivision. On or about X XX XXXX, the Vendors lodged an application to obtain a planning permit for the proposed Plan of Subdivision with the council.

The Taxpayer believed the Vendors had deliberately delayed obtaining the planning permit in order to postpone settlement and thereby have the right to rescind the contract with no obligation to pay compensation. On X XX XXXX, the lawyer for the Taxpayer sent a letter to the Vendors' lawyer which stated the following: a.               that the Taxpayer had contacted the council and was advised that the Vendors needed to immediately lodge certain documents; b.               that the Taxpayer had continued to contact the council who continued to advise that the documents had not been lodged; c.               that the Taxpayer had last contacted the council on X XX XXXX and was advised that the documents were still not lodged and that there had been no contact from the Vendors; d.               that it was abundantly clear that the Vendors were not doing all things necessary and diligently to pursue the registration of the Plan of Subdivision; and e.               that they were putting the Vendors on notice that they will not have the right to terminate the contract.

After ongoing dispute in relation to whether the Vendors had done all things necessary and diligently to pursue the registration of the proposed Plan of Subdivision, the Taxpayer commenced legal proceedings against the Vendors by lodging a writ and statement of claim with the Supreme Court on X XX XXXX. The Taxpayer's statement of claim included further background to the Vendors' conduct: a.               As early as XX XXXX, the Vendors had delayed in preparing and obtaining all information and reports required of them relating to issues identified by the council before a planning permit application for the proposed Plan of Subdivision could be submitted. b.               On or about X XX XXXX, the Vendors lodged an application to obtain a planning permit for the proposed Plan of Subdivision with the council, taking over X months from the date the contract was executed with the Taxpayer on X XX XXXX.

c.               On or about X XX XXXX, the council requested further information from the Vendors with a deadline of X XX XXXX. The Vendors provided a response to the council after the deadline. Between XX XXXX and X XX XXXX, the Taxpayer contacted the council directly and was informed that the Vendors had failed to provide the required information and documents. d.               The Vendors were eventually issued a planning permit on X XX XXXX, more than X years after the contract with the Taxpayer was executed on X XX XXXX. e.               On X XX XXXX, the Vendors informed the Taxpayer that it forecast the registration of title would occur approximately X months after the date by which the registration of the Plan of Subdivision was due. In light of the events outlined above, the Taxpayer's statement of claim made the following submissions: a.               that the Vendors had breached, or was in anticipatory breach, of the sale contract on the basis that they failed or refused to: i.                    do all things necessary in order to secure the registration of the Plan of Subdivision with the council by X XX XXXX;

ii.                    do all things necessary and diligently to pursue the registration of the Plan of Subdivision with the council by X XX XXXX; iii.                    co-operate and do all things reasonably necessary to enable the Taxpayer to enjoy the full benefits of the sale contract by securing the registration of the Plan of Subdivision by X XX XXXX; and iv.                    to use its best endeavours to secure the registration of the Plan of Subdivision by X XX XXXX in breach of the implied duty of best endeavours. b.               that the Vendors were not permitted to exercise its contractual right to terminate the contract. The Taxpayer sought the following relief in its statement of claim: a.               an injunction to prevent the Vendors from terminating the contract; b.               further, or alternatively, specific performance of the Vendors' obligations to do all things necessary and diligently to pursue the registration of the Plan of Subdivision;

c.               further, or alternatively, if the injunctions and/or orders for specific performance are refused, but the Vendors have otherwise been found to have repudiated or committed an anticipatory breach of the contract, damages for loss and damage the Taxpayer suffers. On X XX XXXX, court proceedings began with the Supreme Court. On X XX XXXX, the Taxpayer and the Vendors entered into a Settlement Deed. The Taxpayer and the Vendors agreed to the following in the Settlement Deed: a.               that the dispute was in relation to whether the Vendors had done all things necessary and diligently pursued the registration of the Plan of Subdivision; b.               that the Vendors would release and repay the deposit, including an interest accursed on the deposit; c.               that the Vendors would pay the Settlement Sum to the Taxpayer in full satisfaction of the claims made against them; d.               that the contract would be mutually terminated and cancelled. There was no correspondence or discussion between any of the parties regarding the calculation of the claimed loss or the Settlement Sum.

The Taxpayer incurred legal costs of approximately $X which were payable out of the Settlement Sum. Neither the Taxpayer nor any of its related parties have previously entered into any contracts to purchase land on similar terms.

ITAA 1997 section 6-5 ITAA 1997 section 10-5 ITAA 1997 section 104-25 ITAA 1997 section 108-5 ITAA 1997 section 109-5 ITAA 1996 section 115-5 ITAA 1997 section 116-20 Does IVA apply to this private ruling? No.

Question 1 Subsection 6-5(1) provides that assessable income includes income according to ordinary concepts, which is called ordinary income. In determining whether the Settlement Sum is ordinary income of the Taxpayer, it is therefore necessary to consider whether the Settlement Sum is income according to ordinary concepts. Neither 'income according to ordinary concepts' nor 'ordinary concepts' are defined in the ITAA 1997; the boundaries of 'income according to ordinary concepts' have largely been defined by case law. Some general principles and indicia of ordinary income can be drawn from case law: a.               Receipts falling within 'income according to ordinary concepts' must be determined in accordance with the ordinary concepts and usages of mankind, in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income. [1] Receipts that are earned, expected, received as a product of employment, services rendered, or a business are typically characterised as income according to ordinary concepts.

b.               Periodicity, regularity and recurrence of a receipt are considered to be hallmarks of the characterisation of a receipt as income in accordance with ordinary concepts. [2] c.               The character of the receipt must be determined from the point of view of the recipient, and whether the receipt constitutes income or capital depends on the circumstances and the reasons why it was paid to the taxpayer. [3] d.               Compensation receipts generally take the character of what they are intended to replace. [4] e.               Capital receipts are not ordinary income. [5] The Taxpayer's intention in acquiring the Property was to utilise it as a premises from which its business would be conducted. It is clear that the Property would have been a capital asset of the Taxpayer's business if settlement occurred and there was in fact a change in ownership of the Property.

The Settlement Sum was received by the Taxpayer pursuant to the Settlement Deed in full satisfaction of the claims made by the Taxpayer against the Vendors in the legal proceedings that commenced with the Supreme Court. These legal proceedings arose in the course of the Taxpayer's efforts to acquire the Property. In its statement of claim, the Taxpayer sought protection of its rights under the contract through injunctions and specific performance of the Vendors' obligations. Damages were sought as an alternative if the injunctions and/or specific performance was refused by the court. In considering the character of the receipt of the Settlement Sum from the point of view of the Taxpayer, it is apparent that the Settlement Sum is viewed as a payment in lieu of the Taxpayer being able to purchase the Property, a capital asset. There is nothing to suggest that the Taxpayer entered into the contract with an intention to make a profit or gain such that compensation received by the Taxpayer by way of the Settlement Sum could be considered as income arising from profit from an isolated transaction. [6]

Although the Settlement Sum is divided into two payments, this is insufficient to conclude that the Settlement Sum is a periodical, regular, or recurring receipt of the Taxpayer. Furthermore, the receipt is not earned, or a product of any service or good that has been provided by the Taxpayer to the Vendors. Accordingly, the characteristics of income according to ordinary concepts are not present in the Settlement Sum. The Settlement Sum is properly characterised as a capital receipt and is not ordinary income of the Taxpayer under section 6-5. Question 2 Subsection 108-5(1) provides that a CGT asset is any kind of property, or a legal or equitable right that is not property. The right to seek compensation is capable of being a CGT asset pursuant to subsection 108-5(1). This is confirmed in paragraph 3 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts ('TR 95/35') where it is stated that 'a right to seek compensation is an asset for the purposes of Part IIIA [of the Income Tax Assessment Act 1936 'ITAA 1936']'. [7]

TR 95/35 defines the right to seek compensation as 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. TR 95/35 outlines the Commissioner's view on the tax consequences for amounts received as compensation, including amounts received in respect of the disposal of the right to seek compensation. Paragraph 29 of TR 95/35 provides that the disposal of the right to seek compensation is to be considered under the general disposal provisions, noting former sections 160A, and former subsections 160M(6), 160M(3), and 160ZB(1) of the ITAA 1936. Former section 160A of the ITAA 1936 was replaced by section 108-5 and outlines the assets to which former Part IIIA of the ITAA 1936 applies. It provided that 'asset' means any form of property and includes an option, a debt, a chose in action, and any other right, whether legal or equitable and whether or not a form of property.

Former subsection 160M(3) of the ITAA 1936 provided for events that resulted in a change in ownership of an asset. Notably, former paragraph 160M(3)(b) of the ITAA 1936 provided that in the case of an asset being a debt, a chose in action or any other right, or an interest or right in or over property - the cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, at law or in equity, of the asset would result in a change in the ownership of the asset. The equivalent of former paragraph 160M(3)(b) of the ITAA 1936 in the ITAA 1997 is section 104-25. Subsection 104-25(1) provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset: a.               being redeemed or cancelled; or b.               being released, discharged or satisfied; or c.               expiring; or d.               being abandoned, surrendered or forfeited; or e.               if the asset is an option - being exercised; or f.                 if the asset is a convertible interest - being converted.

Given the equivalency between subsection 104-25(1) of the ITAA 1997 and former paragraph 160M(3)(b) of the ITAA 1936, and the definition of 'CGT asset' in subsection 108-5(1) of the ITAA 1997 and 'asset' in former section 160A of the ITAA 1997, the Commissioner's views in TR 95/35 continue to apply to the equivalent provisions in the ITAA 1997. In Re Coshott v Federal Commissioner of Taxation (' Re Coshott '), [8] which was decided in the context of the ITAA 1997, the Tribunal agreed with the Commissioner that CGT event C2 occurred when the taxpayer executed a settlement deed that released the defendant from all of the claims made in the relevant statement of claim. The Tribunal stated held that that CGT event C2 happened because the taxpayer's chose in action, a CGT asset, had ended by release, discharge, satisfaction, or by being surrendered. Settlement monies received by the taxpayer were the relevant capital proceeds. Re Coshott

is consistent with the Commissioner's view in TR 95/35 on the right to seek compensation; the right to seek compensation is a right of action that is capable of ending by release, discharge, satisfaction, or being surrendered, and where the parties enter into an arrangement to settle a matter, the right to recover and monies or pecuniary damages is satisfied or surrendered. [9] The facts here are largely analogous to Re Coshott and the examples found in TR 95/35. Here, the Taxpayer has a CGT asset in the form of a right to seek compensation that has arisen due to a breach of contract. By entering in the Settlement Deed with the Vendors on X XX XXXX, the Taxpayer agreed to the payment of the Settlement Sum by the Vendors in full satisfaction of the claims made against them. Accordingly, CGT event C2 happened to the Taxpayer's right to seek compensation as the Taxpayer's ownership of this asset ended by it being satisfied. In accordance with paragraph 104-25(2)(a), the timing of this event is when the contract that resulted in the asset ending was entered into, being the Settlement Deed on X XX XXXX.

The capital proceeds from the CGT event will be $X, being the money the Taxpayer received in respect of the event happening. [10] Question 3 Section 115-5 provides that a discount capital gain is a capital gain that meets the requirements of sections 115-10, 115-15, 115-20, and 115-25. From these sections, the following requirements for a discount capital gain are as follows: a.               the capital gain must be made by an individual, complying superannuation entity, trust, or life insurance company in relation to a discount gain from a CGT event in respect of a CGT asset that is a complying superannuation asset; [11] and b.               the capital gain must result from a CGT event happening after 11:45am on 21 September 1999; [12] and c.               the capital gain must not have been worked out with an indexed cost base; [13] and d.               the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. [14] The capital gain must also not be excluded by one of the exceptions in sections 115-40, 115-45, 115-50, or 115-55.

It is uncontentious that the capital gain is made by a trust that resulted from a CGT event happening after 11:45am on 21 September 1999. Further, it is also uncontentious that the capital gain would not be worked out with an indexed cost base, or that the capital gain is excluded by any of the exceptions. As noted under Question 2, the timing of the CGT event was X XX XXXX. In order for the requirements for a discount capital gain to be met, the Taxpayer must have acquired the CGT asset on or before X XX XXXX. Together, paragraphs 86 and 88 of TR 95/35 state that a right to seek compensation is not acquired as a result of any disposal, rather it is vested by operation of law, with the time of ownership beginning when the asset comes into existence. Paragraph 3 of TR 95/35 provides clarification on this, stating that the right to seek compensation is acquired at the time of the compensable wrong or injury. Similarly, paragraph 153 of TR 95/35 states that in a breach of contract claim, it is generally at the time of the breach of contract that the asset, being the right to seek compensation, is acquired. [15]

It is therefore necessary to determine when the breach of contract occurred that gave rise to the cause of action. As noted in the Settlement Deed, the dispute between the Taxpayer and the Vendors was in relation to whether the Vendors did all things necessary and diligently pursued the registration of the proposed Plan of Subdivision. Breaches and anticipatory breaches of these special conditions are the relevant breaches that gave rise to the cause of action. In the Taxpayer's statement of claim lodged with the Supreme Court on X XX XXXX, the Taxpayer complained of delays by the Vendors as early as XX XXXX. Additional complaints made by the Taxpayer in its statement of claim related to the Vendors missing a deadline by XX XXXX, and the Vendors continuing to fail to provide information to the council between XX XXXX and X XX XXXXX. These events led to the lawyer for the Taxpayers sending a letter to the Vendors on X XX XXXX stating that it was clear that the Vendors were not doing all things necessary and diligently. Accordingly, it is apparent that there had been a breach of the contract and an anticipatory breach of the contract by X XX XXXX.

While it is evident that there are multiple causes of action, with each being a separate CGT asset, paragraph 89 of TR 95/35 states that the right to seek compensation encompasses all of those causes of action where they are related. Because all of the breaches of contract that gave rise to the cause of action occurred between XX XXXX and X XX XXXX, before X XX XXXX, it is unnecessary do determine a precise date. Accordingly, the CGT asset, being the right to seek compensation, was acquired by the Taxpayer before X XX XXXX, over 12 months before CGT event C2 happened on X XX XXXX. The capital gain made by the Taxpayer from CGT event C2 happening on X XX XXXX will be a discount capital gain in accordance with section 115-5. > [1] Federal Commissioner of Taxation v Anstis [2010] HCA 40; 241 CLR 443; Scott v Federal Commissioner of Taxation (1935) 35 SR (NSW) 215. [2] Federal Commissioner of Taxation v The Myer Emporium Ltd [1987] HCA 18; (1987) 163 CLR 199. [3] McLaurin v Federal Commissioner of Taxation [1961] HCA 9; 104 CLR 381; see also paragraph 188 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts. [4]

Federal Commissioner of Taxation v Montgomery [1999] HCA 34; (1999) 198 CLR 639; Federal Commissioner of Taxation v Dixon [1952] HCA 65; (1952) 86 CLR 540; see also paragraphs 70-82 of Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts . [5] Federal Commissioner of Taxation v Montgomery [1999] HCA 34; (1999) 198 CLR 639; Scott v Federal Commissioner of Taxation (1935) 35 SR (NSW) 215. [6] Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income . [7] Former Part IIIA of the ITAA 1936is the predecessor to Part 3-1 of the ITAA 1997. See also paragraphs 35-61 of TR 95/35. [8] [2014] AATA 622; 99 ATR 416. [9] See paragraph 163 of TR 95/35. [10] Paragraph 116-20(1)(a). [11] Section 115-10. [12] Section 115-15. [13] Section 115-20. [14] Subsection 115-25(1). [15] See also paragraph 112 of TR 95/35.