Taxation Law: Tax Implications of Compensation Receipts and Capital Gains Tax Consequences for Disposal of Main Residence

This article discusses the tax implications of compensation receipts and capital gains tax consequences for disposal of main residence under Taxation Law. It covers various compensation receipts and their tax implications, laws, and applications. It also discusses the capital gains tax consequences for disposal of main residence and relevant laws.

Running head: TAXATION LAW
Taxation Law
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Table of Contents
Answer to question 1:.................................................................................................................2
Introduction:...........................................................................................................................2
Various Compensation Receipts:...........................................................................................2
Sophie Client:.........................................................................................................................2
2.1: Lump sum damages for potential loss of reputation.......................................................2
2.2: Compensation for the loss of income whilst the machine was being replaced:..............3
2.3: Reimbursement of Legal Fees:.......................................................................................5
3: Kate Client:............................................................................................................................5
3.1 A Lump sum payment for pain and suffering:.................................................................5
3.2 Payment of ongoing medical and cosmetic surgery costs................................................6
3.3 Interest on the lump sum payment...................................................................................7
Conclusion:............................................................................................................................8
Answer to question 2:.................................................................................................................8
Introduction:...........................................................................................................................8
Issues:.....................................................................................................................................8
Laws:......................................................................................................................................8
Application:..........................................................................................................................12
References:...............................................................................................................................15

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Answer to question 1:
Introduction:
Issues:
1.1. The problems concerned in this question is linked with the tax implications of lump
sum amount of damages that is received by the taxpayer as the compensation for the
income loss and reimbursement that relates to the legal fees by Sophie and Kate. Whether
or not such receipts will be considered taxable as income under the ordinary sense of “sec
6-5, ITAA 1997”.
1.2. Another issue that is concerned in this question is regarding the consequences of
capital gains tax that transpires from the payment relating to the damages that is received,
whether or not such kinds of payment will be treated for assessment under “sec 118-37,
ITAA 1997”.
Various Compensation Receipts:
Sophie Client:
2.1: Lump sum damages for potential loss of reputation
Laws:
The description that is made in the “Taxation Ruling of TR 95/35” involves the
application of taxes on the earnings made by a taxpayer from receiving any compensation.
This ruling is imposed on taxpayers that reports the receipts from compensation (Bankman et
al., 2018). The “Taxation Ruling of TR 95/35” is regarded as supportive in establishing the
consequences of the CGT that is linked with the receipt of compensation and ascertaining
whether the money that is received will be considered taxable earnings for the recipient in
“Part IIIA of the ITAA 1936”.

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On finding that the taxpayer has got compensation which is primarily as the outcome
of disposal of any form of underlying asset or any part of the underlying asset of taxpayer,
then in such situation the compensation received will be treated as consideration obtained
from disposing the underlying asset (Oishi et al., 2018). The decision which is passed by the
law court in “Speedly Securities Ltd v FC of T (1988)” on receiving any form of
compensation for the damage of goodwill of business the amount that is given to the taxpayer
is treated capital in nature.
Application:
As understood from the situation of Sophie, it is noticed that she has bought forward a
law suit against Fracpro for providing her with the laser machine that had faulty calibration.
In return Sophie was compensated by Fracpro because she suffered loss of business goodwill
and reputation. The amount of $100,000 given to Sophie by Fracpro amounted to damages
that is received on account of loss of business reputation. By referring the decision that was
made in “Speedly Securities Ltd v FC of T (1988)” the sum of $10,000 that is given to
Sophie is a compensation for the loss business reputation (Schenk, 2017). The money
received does not hold any character of ordinary taxable income under “sec 6-5, ITAA 1997”
and the amount must be considered as the capital in nature.
2.2: Compensation for the loss of income whilst the machine was being replaced:
Laws:
The elucidation that has been given in “taxation determination ruling of TD 93/58”
there are some instances when a taxpayer receives any compensation as the lump sum amount
or in regard to the settlement payment, then the amount that will be received will be held as
taxable income (Miller, 2018). When noticing that the taxpayer has received compensation

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for the loss of income then those receipts attracts tax liability under the legislative provision
of “subsection 25 (1) of the ITAA 1936”, provided that;
a. The amount received by taxpayer constitute the payment made as compensation for
the loss of income; or
b. The payment to a certain extent can be identified and categorized as income (Feld,
2016). This becomes possible only when there is an existence of impliedly or
expressly agreement between either of the parties that some portion of the
compensation that is received is related to the loss of income.
The judgement that was handed down by the federal court in “Allsop v FC of T
(1965)” noted that the amount received by the recipient that was included into the lump sum
receipt also holds the nature of capital as well (Schmalbeck et al., 2015). But, the ingredients
of the payment can be identified as income and a portion of those payments which is related
to income is considered as taxable income.
Application:
The case study vibrantly provides that Sophie has received compensation from
Fracpro that is associated to the loss of income. The lump sum value of $20,000 that is
received as loss of income must be treated as carrying the elements of income and would be
treated taxable under the legislation of “subsection 25 (1) of the ITAA 1936”. By denoting
the judgement that was given in “Allsop v FC of T (1965)” the lump sum value of $20,000
received as loss of income by Sophie is regarded as income (Abrams & Leatherman, 2019).
This is because the amount received by Sophie is quantifiable and indefinable as receipts of
income nature. Hence, under the legislative provision of “subsection 25 (1) of the ITAA
1936” the lump sum value of $20,000 is a taxable income for Sophie.

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2.3: Reimbursement of Legal Fees:
Laws:
As elaborated under the “section 118-37 (2)”, the taxpayers are required to simply
overlook the capital gains and loss when they receive any form of reimbursement for the
outgoings that is occurred by them (Sadiq et al., 2016). This usually includes the
reimbursement associated to the legal expenditure. The legal expense reimbursement cannot
be regarded as the capital gains because they are treated as the capital asset for those that
receives it.
Application:
The case study of Sophie provides an instance where it is noticed that she received a
reimbursement of legal expenditure that she has occurred when bringing a law suit against the
Fracpro. The reimbursement of the legal expenditure must be regarded as the element of the
cost base of business. As a result, no CGT consequences arises in this context regarding the
receipt of legal expenditure.
Particulars Tax Consequences Amt ($)
Receipts of lump sum for damages Non-Taxable 1,00,00
0
Receipts of compensation for loss of
income
Taxable under (s25-1, ITAA
1936)
20,000
Receipts of reimbursement of legal Fees Non-Taxable 7,000
3: Kate Client:
3.1 A Lump sum payment for pain and suffering:
Laws:
As denoted under the “paragraph 118-37 (1)(a), ITAA 1997” an individual taxpayer
is required to overlook the consequences associated to the capital gains tax that is mainly the

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outcome of the compensation receipt derived from the injuries or any form of wrong doings
suffered by a person (Kenny et al., 2016). An important explanation has been made in the
“paragraph 118-37 (1)(a), ITAA 1997” where it states that the capital gains which is
obtained from the “right to seek” compensation is generally ignored. This is because the
receipts that are received by the taxpayer are treated as capital in type.
Application:
The case of Kate brings forward that the lump sum amount of money is given to Kate
by Fracpro because she has suffered personal injuries and pain from the faulty calibration of
the laser machine. The compensation were mainly for the medical treatment. The lump sum
amount given to Kate for medical treatment will be considered as the payment for personal
injuries. With respect to the “paragraph 118-37 (1)(a), ITAA 1997” Kate should simply
ignore any kind of capital gains or capital loss that is made from the compensation that is
received for the wrong and injuries suffered by her personally (Stumbles et al., 2016). This
implies that the compensation that is received by Kate for the personal injury is not included
into her assessable income by virtue of the CGT provisions. Neither the compensation
amounts to ordinary income nor it is a statutory income. Therefore it is not taxable under
“subsection 6-15, ITAA 1997” as assessable income.
3.2 Payment of ongoing medical and cosmetic surgery costs
Laws:
As explained in the “paragraph 118-37(1)(a), ITAA 1997” capital gains should be
disregarded if the compensation or damages that is given to the taxpayer as the outcome of
illness or injury suffered on a personal account (Sadiq et al., 2016). The Taxation Ruling of
TR 95/35, compensation receipts comprises of the sum received by the taxpayer in respect of
the right of seeking compensation or any kind of proceedings instituted by the taxpayer due

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to the cause of action. A claim made for the past and future medical expenditure cannot be
regarded as taxable income.
Application:
The evidences that is gained from the situation of Kate suggest she received cost for
medical and cosmetic surgery. Under the “paragraph 118-37(1)(a), ITAA 1997” the claims
for medical expenses should be ignored since the compensation or damages that is given to
Kate as the outcome of illness or injury suffered on a personal account (Kenny, 2015). The
compensation does not amounts to ordinary income nor is it a statutory income. Therefore it
is not taxable under “subsection 6-15, ITAA 1997” as assessable income.
3.3 Interest on the lump sum payment
Laws:
As stated in “Taxation Ruling of TR 95/35” interest received by taxpayer from the
lump sum payment of compensation then it is regarded as taxable ordinary income under
“sec 6-5, ITAA 1997”.
Application:
Kate has received an interest of $7,000 on the lump sum amount received as
compensation. The sum of $7,000 will be considered taxable as the ordinary income for Kate
and will be included for assessment under “sec 6-5, ITAA 1997”.

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Conclusion:
The lump sum payment received by Sophie and Kate cannot be considered as
outcome of any personal services rather it amounts to compensation for the pain and injuries
suffered both professional and personally. The compensation amount will be considered
capital receipt under “sec 118-38 (a)” and “sec 118-37 (1) (b), ITAA 1997”.
Answer to question 2:
Introduction:
Issues:
The problem that is taken under discussion is regarding the outcome associated to the
capital gains tax consequences for Joe and Amy, the taxpayer in the present case, for the
disposal of main residence assuming that;
a. The main residence can be considered as the post-CGT asset of the deceased
b. The property was viewed as the main house of dwelling for the deceased before the
death
c. The main house of dwelling was obtained by the present taxpayer in the current based
on the will of deceased estate.
d. The present taxpayer lived in the as their main residence from the day when the
deceased passed away till the day when the main dwelling was disposed.
Laws:
The CGT is made applicable commonly on the assets that is purchased or events that
happens on or following the 20 September 1985. Accordingly, there are certain common
terms that are used to refer the assets acquired are the word pre-CGT and post-CGT (Miller,
2018). This is mainly because of the events that occurs prior to or after the aforementioned
date. Assets that are bought before the introduction of the CGT system or before 19th

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September 1985 then it is termed as the pre-CGT asset. On the other hand, the assets that are
acquired after this date are termed as post-CGT asset. Capital gains are ignored from the
events occurring for the pre-CGT asset while the post-CGT events are only included into the
assessable income and tax regimes. The sale of CGT asset usually results in CGT event A1
under “sec 104-10, ITAA 1997”. When making the disposal of the assets when the proceeds
exceeds the cost base then the capital gains would originate.
Where the net capital gains has been accrued to the taxpayer during the relevant
income year, that gain is included in the assessable income of the taxpayer for that year
(Siebert, 2019). The capital is not considered for deduction but it is rather allowed for offset
against the capital gains made during the same year or in the future years to ascertain the net
capital gains. The wider concept of the CGT usually involves the comparison among the
capital proceeds and the cost base of the assets. A capital gains or loss is usually ascertained
by subtracting the relevant cost base associated to the asset or events that takes from the
capital proceeds following the sale of the asset or other forms of events.
For a taxpayer to obtain the exemption on the main house of dwelling under “sec
118-110, ITAA 1997”, the house must qualify as the main dwelling for the taxpayer
(Lieuallen & Shurtz, 2018). When it is noticed that the taxpayer has more than one dwelling,
then it becomes necessary to ascertain which dwelling is used by the taxpayer as his or her
main residence and hence eligible for exemption. When it is noticed that the taxpayer has
owned only a single house of dwelling, then it self cannot be viewed as sufficient enough that
house is being used by the taxpayer as their main dwelling. Whether the dwelling is regarded
as the main house of residence is completely dependent on the fact. There are some of the
important factors that should be considered;
a. The amount of time the taxpayer has spent on the house.

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b. The place where the family of the taxpayer resides
c. Whether or not the taxpayer has moved his personal belongings in the dwelling
d. The fixed address of the taxpayer where the main is delivered
e. The intention of taxpayer in occupying the new dwelling
f. Connection of the services such as telephone, gas etc. for the taxpayer.
As evident from the above stated factors, there should be some certain degree of
occupancy that is required to set up the entitlements for main residence exemption.
There are some important rules that are associated to the CGT event and demise of an
individual taxpayer. As per the broad rule, when the taxpayer dies, under the “sec 128-10,
ITAA 1997” the CGT event linked to the CGT asset is ignored. In the event of the death of
the taxpayer their lawful heirs is assumed to hold the possession of the asset on the very same
day when the taxpayer passes away (Miller & Oats, 2016). Where the asset becomes the pre-
CGT asset of the deceased taxpayer, the new heir or the beneficiary is supposed to hold the
possession of the asset with the respect to the current market value on the day of demise. Sec
“128-15, ITAA 1997” delivers elucidation regarding the inherited post-CGT assets (Arnold,
2019). Where the asset turn out to be the post-CGT asset of the deceased taxpayer, the new
heir or the recipient is believed to hold the ownership of the asset with the respect to the
existing market price on the day of demise.
Discussion concerning the inherited main residence is given in “sec 188-195, ITAA
1997”. On noticing that the asset constitutes the main residence of the deceased taxpayer and
the property is not put into use for the purpose of making taxable earnings, the cost base of
the property to the heir in this situation denotes the market price on the day of demise (Evans
et al., 2015). When noticing that the asset formed the main dwelling of the deceased, the

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beneficiary in this situation can inherit the exemption on the main dwelling upon satisfying
the required conditions.
Under the “division 110”, the cost base of the asset is generally ascertained (Yates,
2016). Under “sec 128-15, ITAA 1997” nevertheless, when the ownership of the asset is
passed on to the taxpayer on the basis of the deceased’s legal heir, the house was put into use
for main dwelling of the taxpayer instantly prior to demise and was never utilized for making
income, the cost base is represented on the basis of the market value of CGT asset.
Under the “sec 118-195”, capital gains or loss that are originating from the CGT event in
respect to the main dwelling is ignored in some of the situation. This includes when the
taxpayer is regarded as the individual and interest of title is given to the taxpayer in the form
of heir, or the taxpayer has owned as the trustee of deceased estate (Feld et al., 2016). While
“sec 118-195, ITAA 1997”, also explains that when the asset is viewed as the pre-CGT asset
to the receiver of the deceased and it is sold inside two years of deceased death or any long
time period given the commissioner has applied any discretion, a full exemption under this is
situation is available to the taxpayer from CGT.
In the alternative situation given in the “sec 118-195”,, on discovering that the asset is
the pre-CGT asset and sold inside the prescribed time period, then full exemption may still be
available to the taxpayer on meeting certain criteria given under this act (Chardon et al.,
2016). This includes, if from the day of demise until the day when the title of interest comes
to an end, it formed the main residence of either;
a. The deceased spouse or
b. An individual that is treated as having the right of occupying the asset under the will
of deceased; or

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c. Given that the CGT event was took by a person to whom the interest of title is given
as the heir.
In the alternative situation if it is noted that the asset formed the post-CGT asset in the
hand of the demise taxpayer, then the identical conditions listed for the pre-CGT asset must
also be met for the post-CGT asset is well (Mangioni, 2015). However, the dwelling must be
used as the main house of dwelling of the deceased just prior to death and was not utilized for
generating any chargeable business earnings during that time.
When it is noticed that there cannot be any full main residence exemption under “sec
118-95”, then in such case a partial exemption from main residence for CGT purpose can be
availed by the taxpayer under the “s 118-200, ITAA 1997”. The capital gains and loss should
be apportioned by computing the total number of days spend as the non-residence in
comparison to the total number of ownership days spend which is necessary for the
application of exemption on main residence.
Application:
The case study opens up by stressing on the fact that Bob a resident in Australia
passed away on May 2015. He had two children named Joe and Amy. Bob prior to his death
only owned the main house as his sole asset that he had actually purchased with his late wife
in January 1982. Following the day when Bob passed, the market value of the property which
was obtained stood $560,000. The case study also provides that his son Joe has been living on
the property as the caretaker of Bob from April 2006 until the day his father’s demise. On one
occasion a solicitor valued the property and advised that the will of Bob has divided the
property among his two children in equal shares. The property was eventually sold for a price
of $680,000 with each sharing the receipts in equal shares among themselves.

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The facts that is obtained from the question explains that the house was purchased by Bob
before 19 September 1985 and hence the house should be treated as the post CGT asset to
him. The property was also the main place of dwelling for Joe and Amy before the demise of
Bob and was not utilized for business purpose or for generating income. On the basis of the
law that is explained above, the taxpayer have to meet any of the two listed conditions below;
a. The taxpayer would have to either sell the dwelling inside the span of two years of Mr
Bob’s death or any long time period if the discretion of the commissioner was sought,
b. The property starting from the day demise to the day until the house was sold must be
used as the main dwelling of either the wife of Mr Bob, a person that holds the right
of occupying of the house under the will of the deceased or if the CGT event was took
by person to whom the interest of ownership is given as the legal heir or beneficiary.
The evidences that is gained from the question clearly explains that the dwelling was
not sold by Joe and Amy inside the prescribed time limit of two years from the day of Bob’s
demise. As a result in this situation option (a) is not applied. While the main house of
dwelling formed the only residence for Joe and Amy from the day of demise of Bob till the
day when the sale happened. In addition to this, Joe and Amy, both are the individual to
whom the assets ownership or the title to the asset is passed in the form of beneficiary.
Furthermore, the CGT event was also took by both Joe and Amy. Hence, the option (b) is
applicable in this situation. Both Joe and Amy will be entitled to get the main residence
exemption from the capital gains tax that is available under the “sec 118-195, ITAA 1997”.
Conclusion:
As understood from the facts that is derived from the question and following the
application of the relevant laws relating to the exemption on the main residence in respect of

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the assets acquired from the estate of the deceased, Joe and Amy will be able to claim the full
exemption from the capital gains tax under “sec 118-195, ITAA 1997”.

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