The tax treatment of ‘disturbance payments’ in connection with the compulsory acquisition of land proposed in a recently issued ATO class ruling has the potential to disadvantage some taxpayers while delivering a windfall to others.
In NSW, the compulsory acquisition of land is governed by the Land Acquisition (Just Terms Compensation) Act 1991. That Act requires that the compensation provided to a landowner must reflect various items including any loss attributable to “disturbance”. Losses attributable to disturbance include legal costs in connection with the compulsory acquisition, stamp duty costs in acquiring an replacement provision, financial costs such as the cost of repaying an existing mortgage and loss of income in the period prior to the acquisition of a replacement property.
Tax issues relevant to disturbance payments
The characterisation of a disturbance payment is relevant to:
- whether any part of the payment is ordinary income;
- whether any part of the payment is statutory income (e.g., under the assessable recoupment provisions in Division 20);
- whether any capital gain qualifies for ‘compulsory acquisition rollover’; and
- whether any capital gain is from taxable Australian property.
In CR 2017/4, the Commissioner concluded that in the circumstances of acquisitions resulting from the Sydney Metro City and Southwest:
- the portion of a disturbance payment that related to lost income was ordinary income;
- the portion of a disturbance payment that related to the cost of Division 40 depreciating assets was a “grant” that was assessable over time under Division 20 (to match the resulting depreciation deductions);
- the balance of the disturbance payment was a capital gain under CGT event C2 (i.e., not part of the capital proceeds of the sale of the land).
The facts on which the ruling is based refer to a detailed claim by landowners for specific disturbance costs.
The class ruling applies whether there is a true compulsory acquisition or a negotiated acquisition. The class ruling is stated to not apply to residential premises, although it is difficult to see that the principles should be any different.
There is a general principle of income tax that an un-dissected lump sum received in compensation for a number of items, some of which are capital, is a wholly capital receipt. Apportionment may be permitted where the lump sum is in fact a collection of liquidated claims.
In this case, it is implicit that (in the Commissioner’s view) the claim for specific disturbance amounts was sufficient to permit apportionment. It is not clear that this outcome would apply if there had been an overall claim that was not broken down in negotiations between the parties.
Despite there being no obligation to spend the disturbance payment on any particular item, the Commissioner concluded that the portion of the payment ultimately spent on depreciating assets was subject to Division 20. Any portion of the disturbance payment eventually spent on a Division 40 asset would be assessable as and when depreciation deductions are claimed in respect of that amount.
There is little authority on the meaning of “grant” in this context. Presumably, not every payment by a government is a “grant”, and in particular it is not clear that a compensation amount owing under statute is intended to be covered by this provision.
The Commissioner’s conclusion that CGT event C2 applies to the balance of the disturbance payment contradicts the position taken in several private rulings that a disturbance payment is part of the proceeds of disposal of the relevant land.
The Commissioner’s position in the class ruling has the effect that, for an Australian resident:
- no CGT discount is available; and
- compulsory acquisition rollover may not be available (unless that provision is read broadly to extend to capital gains indirectly associated with the compulsory acquisition).
This potentially places a landowner in a difficult position as part of the disturbance payment may be lost in income tax leaving a cash shortfall to be funded from other sources if the asset is to be replaced.
For an owner-occupier of residential property, it is also not clear whether the main residence exemption will apply. CGT event C2 can be covered by the exemption but only if it happens “in relation to” a CGT asset that is an interest in a dwelling (e.g., termination of a Crown lease on which a house is located). In this case, CGT event C2 happens to the right to receive compensation and so may fall outside the exemption.
In contrast to the disadvantages stated above, non-residents may receive a windfall benefit. The right to receive compensation for disruption costs is not real property and so is unlikely to be taxable Australian property. This would mean that the CGT event C2 capital gain is exempt from tax, but the resulting expenditure will go into the cost base of any replacement land.
It is difficult to tell whether the Commissioner’s position with respect to capital gains was dependent on the facts of the class ruling or if it represents a general position. At least where a disturbance payment is included in an overall purchase price under a contract of sale, there are strong arguments to suggest that the Commissioner’s position is incorrect.