Taxation Law: Tax Consequences of Compensation Receipts and Disposal of Main Residence

This article discusses the tax consequences of compensation receipts and the disposal of a main residence under Taxation Law. It covers various compensation receipts received by Sophie and Kate, including lump sum damages, compensation for loss of income, and reimbursement of legal fees. It also explores the tax treatment of these receipts and provides insights into the capital gains tax consequences for Joe and Amy regarding the disposal of a main residence.

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:.......................................................................................4
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...................................................................................6
Conclusion:............................................................................................................................7
Answer to question 2:.................................................................................................................8
Introduction:...........................................................................................................................8
Issues:.....................................................................................................................................8
Laws:......................................................................................................................................8
Application:..........................................................................................................................12
Conclusion:..........................................................................................................................13
References:...............................................................................................................................14

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Answer to question 1:
Introduction:
Issues:
1.1. The central issue that is discussed in the question regarding the tax consequences of
the lump sum damages, compensation associated to the loss of earnings and
reimbursement associated to the legal fees received by Sophie and Kate relating to the
damages would be held as assessable earnings under the “sec 6-5, ITAA 1997”.
1.2. Whether or not the capital gains that arises from the receipt of damages payment will
be considered as assessable earnings under “sec 118-37, ITAA 1997”.
Various Compensation Receipts:
Sophie Client:
2.1: Lump sum damages for potential loss of reputation
Laws:
As clarified in “Taxation Ruling of TR 95/35” the guiding principle about imposing
tax on income derived from the compensation receipts. This rule is applicable to those
taxpayers that receives money as receipts for compensation (Woellner et al., 2016). The
“Taxation Ruling of TR 95/35” is helpful in drawing the outcomes associated with the CGT
that relates to derivation of compensation payment and determine whether the sum received
must be taken into the account as the chargeable receipts for the receiver within the “Part
IIIA of the ITAA 1936”.
When it is noticed that the taxpayer receives any kind of compensation that is largely
related with the sale of underlying asset or any portion of underlying asset of a taxpayer the
compensation that is received under such circumstances would amount to consideration that

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is received for the disposal of the asset (Long et al., 2016). The judgement handed by the
federal court in “FC of T v Spedley Securities Ltd (1988)” noted that where the taxpayer
receives any compensation regarding the damage of business goodwill then the sum will be
held as capital receipt.
Application:
The evidences that is derived from the question relating to the situation of Sophie it is
found that she initiated a legal proceedings against Fracpro for delivering her with a faulty
calibration of laser machine. The compensation that was received by Sophie from Fracpro is
for loss of earnings and business reputation. The sum of $100,000 that is obtained by Sophie
must be regarded as the damages received for probable business goodwill loss. Denoting the
judgement that was handed by federal court in “FCT v Spedley Securities Ltd (1988)” the
amount of $100,000 obtained by Sophie will be held as compensation received for causing
damage to the business reputation and goodwill (Burns, 2017). The compensation amount is
regarded as the capital receipt and it is not taxable as the incomes under ordinary conception
of “sec 6-5, ITAA 1997”.
2.2: Compensation for the loss of income whilst the machine was being replaced:
Laws:
As explained under the “taxation determination ruling of TD 93/58” there are certain
circumstances where the compensation that are received by the taxpayer as the lump sum
compensation or the settlement payment will be regarded as assessable income (Campbell,
2018). Compensation that a taxpayer receives for the loss of income is usually considered as
taxable earnings under the “subsection 25 (1) of the ITAA 1936”, given that;
a. The payment that is received by the taxpayer amounts to the payment of
compensation regarding the loss of income or

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b. Up to the extent that at a part of the lump sum payment can be recognized and
quantifiable as the income. This is generally possible when the parties either
impliedly or expressly agrees that the certain part of the payment is associated to the
loss of income nature.
The decision of the law court in “Allsop v FC of T (1965)” where the law court held
that the receipt received by the taxpayer included in the lump sum receipt also comprise of
the capital in nature (Burton, 2017). However, the ingredients of the payment can be
recognized as income and hence the portion of the payment that is related to income is
assessable.
Application:
An amount of $20,000 was received by Sophie in the form of compensation regarding
the loss of her income. The sum of $20,000 received as lump sum regarding the loss of
earnings would be viewed as having the nature of income and will be regarded as ordinary
earnings. Citing the verdict that was agreed in the “Allsop v FC of T (1965)” compensation
that Sophie got is linked with the loss of income (Yuan, 2016). The lump sum payment can
be recognized and quantifiable as the income. Compensation that Sophie has received for the
loss of income is usually considered as taxable earnings under the “subsection 25 (1) of the
ITAA 1936”.
2.3: Reimbursement of Legal Fees:
Laws:
A noteworthy explanation has been made in “section 118-37 (2)”, which puts forward
that capital gains or loss must be disregarded when a person receives any kind of payment as
the reimbursement for the outgoings incurred (Shaw, 2017). When the taxpayer gets the

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reimbursement associated to the legal outgoings then the receipt cannot be treated as capital
gains because it amounts to capital asset for the recipient.
Application:
As understood, Sophie while filing a suit against the Fracpro incurred certain legal
outgoings in that respect. The legal outgoings was also reimbursed by the Fracpro to Sophie.
The receipt of legal expenses as the reimbursement must be regarded as the cost base of
business. Hence, no CGT is applicable in regard to the receipt of legal fees as reimbursement
for Sophie.
Receipts Tax Treatment Amount ($)
Lump sum damages Non-Taxable 1,00,000
Compensation for loss of income Taxable under (s25-1, ITAA
1936)
20,000
Reimbursement of Legal Fees Non-Taxable 7,000
3: Kate Client:
3.1 A Lump sum payment for pain and suffering:
Laws:
Referring to the description that has been made in “paragraph 118-37 (1)(a), ITAA
1997” a person must ignore the capital gains which is resultant from the compensation receipt
that is obtained from the injuries or any wrongdoing suffered by taxpayer (Krever & Sadiq,
2019). Referring to the “paragraph 118-37 (1)(a), ITAA 1997” capital gains which is made
from the right of seeking compensation is disregarded because the receipts are viewed to
having the characteristics of capital.
Application:

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The questions presents the facts that Kate has received a lump sum money that she
has suffered out of pain and sufferings as well as undergoing a medical treatment. The
amount that Kate has received cannot be treated as the outcome of providing personal
services or from any business activities. The compensation amount that Kate has received
should be viewed that it has not been earned from rendering employment services. As a
substitute, the compensation amount that is received is only for the one-off payment that is
regarding the injuries suffered and do not hold any characteristics of repetition.
It can be assumed that Kate anticipated the payment but the anticipation was the
outcome of pain and sufferings that she sustained was for general damage rather than treating
the amount as the product of any personal exertion.
The compensation amount acquired by Kate was largely for the settlement for the
injuries. The amount of $120,000 amounts to a capital amount under “CGT event C2” (Lee,
2018). The amount was the product of “right to seek” compensation. Under the “sec 118-
37(1)(b), ITAA 1997” the capital gains resulting from the CGT event C2 must be disregarded
by Kate.
3.2 Payment of ongoing medical and cosmetic surgery costs
Laws:
The present case study highlights that Kate also received compensation for her
medical and surgery cost. The compensation that is received by Kate is the product of single
payment which lacks any characteristics of repetition. The amount received as compensation
cannot be regarded as carrying the characteristics of income obtained as the outcome of
individual services. In actual sense, the amount of $50,000 should be observed as the product
of capital receipt inside “paragraph 118-37(1)(a), ITAA 1997” (O’Connell, 2017). The
reason for considering the compensation receipt as capital because it is linked to her personal

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injury. The sum will be viewed as capital receipt with in the provision of “CGT event C2”
because it is the “right to seek” compensation.
3.3 Interest on the lump sum payment
Laws:
The explanation that has been given in “Taxation Ruling of TR 95/35” evidently lays
down that when a taxpayer receives any kind of interest or any lump sum amount as the
outcome of any award for compensation then it will be regarded as the chargeable earnings in
regard to ordinary conceptions of “sec 6-5, ITAA 1997” (Minas et al., 2018).
Application:
Denoting the aforementioned explanation given under the “Taxation Ruling of TR
95/35” Kate reports the receipt of interest amounting to $7,000 on the lump sum payment of
compensation (Butler, 2016). The interest that is received by Kate will be viewed as the
product of ordinary earnings. The interest will be attracting a tax liability under “sec 6-5,
ITAA 1997”.
Receipts Tax Treatment Amount
($)
Lump sum payment for pain and
suffering
Exempted under (“S118-38 (a)), ITAA
1997”)
120000
Payment for medical and cosmetic
surgery
Exempted under (“S 118-37 (1) (b),
ITAA 1997”)
50000
Interest on lump sum payment Taxable under (“S 6-5, ITAA 1997”) 7000
Conclusion:
The lump sum payment as compensation that is received by Kate and Sophie mainly
forms the product of personal injuries and damages that is suffered by Sophie in her ordinary
business course. The compensation amount is treated as the capital receipt and it will be

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considered as the exempted amount under the legislative provision of “sec 118-38 (a)” and
“sec 118-37 (1) (b), ITAA 1997”.
Answer to question 2:
Introduction:
Issues:
The main issue which is dealt in this question is there any kind of capital gains tax
consequences for Joe and Amy, the taxpayer, regarding the disposal of the main residence
provided that the;
a. The house was considered as the pre-CGT asset of the deceased
b. The house was utilized as the main residence of the deceased before he passed away
c. The taxpayer acquired the house in this situation on the basis of the estate of deceased
d. The taxpayer was residing in the property from the day when he passed away till the
day when the house was sold;
Laws:
As per the “Division 100-104, ITAA 1997” capital gains tax is viewed as the set of
rules that are main created to compute the gains which would be considered taxable as
income tax on the sale of the capital asset (Peiros & Smyth, 2017). Consequently, the
provision of capital gains tax is not regarded as the separate tax. The legislation of CGT was
established during 20th September 1985 with the objective of imposing tax on gains that are
earned from the selling the assets purchased or acquired on or following the aforementioned
date. Assets which is purchased or acquired before the 20/09/1985 are regarded as the “pre-
CGT assets” and any kind of gains that are earned from the sale of the pre-CGT asset are
simply excluded from the CGT regimes.

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In order to raise the CGT liability, there should be two conditions that must be met.
This includes;
a. There should be a CGT asset purchased following 20th September 1985
b. There should also be a CGT event under sec 104-5 such as the sale of the CGT asset
(King, 2016).
A capital gains or capital loss must be ignored under the “section 104-10 (5)(a)]” if the
asset is purchased prior to 20/9/1985.
The main residence in which a taxpayer lives is generally excluded from the capital
gains tax under “sec 118-110, ITAA 1997” (Brydges & Yuen, 2018). A taxpayer is permitted
to get the partial main residence exemption when they subdivide and sell a portion of their
main residence or if they use the house for making chargeable revenues. When it is noted that
a taxpayer makes the use of house for generating earnings and results in any kind of CGT
event, the taxpayer will be required to bring into the account the portion of the proceeds as
the capital gains or loss under “sec 118-190, ITAA 1997”.
There should always be the CGT event in respect of the CGT asset. CGT event
comprises of the different forms of transactions which can lead to capital gains or the capital
loss. A “CGT event A1” under “sec 104-10 (1), ITAA 1997” is mainly related with the sale
of CGT asset (Jones, 2017). A sale of CGT-asset event would in normal course originate
when the taxpayer enters in the contract of sale.
There are certain kinds of rules that are associated to the CGT and the demise of the
taxpayer. The general rule that is explained in the “sec 128-10, ITAA 1997” provides an
explanation that when the taxpayer dies, their legal heirs or their beneficiaries is assumed to
acquire the CGT assets on the day when the deceased taxpayer passes away (Blakelock &
King, 2017). On the other hand, when it is noticed that the pre-CGT asset of the deceased

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taxpayer is inherited, the new beneficiary under such kind of circumstances is assumed to
have acquired the asset based on the market value upon the day of the deceased taxpayer
demise.
“Sec 128-15, ITAA 1997” is related with the instances of inherited post-CGT assets.
Under “sec 128-15, ITAA 1997” when it is found that the post-CGT of the deceased taxpayer
is inherited then in such situation the beneficiary is viewed as to have acquired the asset on
the day of demise at the cost base of deceased taxpayer (Freudenberg et al., 2017). While
“sec 188-195” is associated with the instances of inherited main residence. When it is noticed
that the asset forms the main residence of the deceased and the same is not utilized for
generating assessable income, the cost base to the beneficiary denote the market value on day
when the deceased taxpayer passed away. Where the asset becomes the main dwelling of
residence for the deceased and the same has not been utilized for generating assessable
earnings, the beneficiary in this circumstances may inherit the exemption from the main
dwelling upon satisfying the certain criteria listed under “sec 188-195, ITAA 1997”.
Under the “Division 110, ITAA 1997” the cost base of the asset is usually ascertained
when the asset is passed to the taxpayer as the personal legal representative or the heir of the
deceased taxpayer (Kudrna, 2016). The division is mainly related to the ascertainment of cost
base of property that are used by the taxpayer as the main residence immediately following
the demise and not being used for generating assessable income. “Sec 128-15, ITAA 1997”
usually comprises of the cost base that are based on the market worth of the CGT asset.
“Sec 118-195, ITAA 1997” explains that the capital gains or loss that happens from
the CGT asset in respect of the dwelling is under some of the situation is ignored given the
taxpayer is regarded as the individual and the interest of ownership is passed among the

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taxpayer in the form of beneficiary or the taxpayer held the asset as the trustee of the
deceased estate.
As per “sec 118-195”, when it is noticed that the asset was the pre-CGT asset in the
deceased hands and the same was sold inside the time period of two years of the death of the
deceased or any other longer time period provided the discretion of the commissioner is
implemented, the taxpayer in this situation gets the complete exemption from the available
CGT (Grudnoff, 2016).
The explanation given in “sec 118-195, ITAA 1997” explains that if the pre-CGT
asset was not sold inside the required time period there are still full main residence exemption
is available to the taxpayer from the day of demise till the day when the title interest finishes
it formed the main residence of either of the following;
a. The spouse of deceased
b. A person or individual that has the right of occupying it under the will of deceased
or
c. If any CGT event was brought about by a person or individual to whom the title of
interest of ownership is passed as the beneficiary.
The “taxation ruling of TD 1999/70” main deals with the post-CGT asset. When it is
noticed that the asset becomes the post-CGT asset for the recipient then the conditions that is
listed under the pre-CGT asset must be met (Sadiq & Sawyer, 2018). Furthermore, the
dwelling should have to be the main house of residence of the deceased taxpayer just prior to
the day of demise and it is not been utilized for generating assessable earnings. While “sec
118-95” explains that where is unable to obtain full exemption from its main residence for
CGT purpose, then a partial exemption from main residence of dwelling would be available
under “sec 118-200, ITAA 1997” (Hemmings & Tuske, 2015). The capital gains and loss

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must be apportioned by computing the number of non-main residence days in comparison to
the days of ownership which is necessary for main residence exemption.
Where a taxpayer does not applies any capital gains and the asset has been held under
the ownership of the taxpayer for greater than 12 months, a CGT discount is allowed under
“Division 115, ITAA 1997”.
Application:
The instances that are obtained from the case puts forward that Bob Wilson a resident
has passed away on 23rd May 2015 and left behind his two children. The only asset that was
owned by Bob was the family home that purchased originally for $11,000 with his late wife
during 1982. On the day when Bob passed away the market value of the property was
$560,000. The evidences that is obtained from the case puts forward that Joe was living in the
property from April 2006 to take care of his father as the full-time caretaker. During this
period there was no alternative residence for Joe and he completely used the property as the
main residence. While on one occasion an advice of the solicitor was sought and the deceased
will of Bob left behind the equal share of house among the two siblings.
As apparent from the fact that the dwelling that was purchased by the deceased
taxpayer Bob on 1982 should be regarded as the pre-CGT asset. The property was bought
before the introduction of the CGT regime on 20th September 1985. The dwelling also formed
the main house of residence for Bob before he passed away and the same was not used for
generating assessable income (Pakphan et al., 2018). Following the death of the Bob, Joe who
lived on the same property utilized it as his main residence and no income producing
activities were conducted on the property.

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On the basis of the law discussed, for the application of the full main residence under
the “sec 118-195, ITAA 1997”, the taxpayer would have to satisfy either of the conditions
listed below;
a. The taxpayer has disposed the property inside the time of two years of Mr Bob death
(or any longer time period if the discretion of the taxation commissioner is sought); or
b. The dwelling starting from the day of demise to the day of property sale has been used
by taxpayer as the main residence of either the spouse of the deceased or an individual
having the right of occupying the property in regarded to the will of the deceased or
provided the CGT event was carried about by the individual to whom the interest
relating to the ownership of the asset has been passed as the beneficiary.
The case that is obtained here puts forward that the house was not sold by Joe and
Amy within the time span of two years from the demise of Bob. Therefore option (a) is not
applicable in this case. As the house formed the main residence of Joe and Amy starting from
the day of demise to the day of sale and also the respective individual to whom the title of the
asset has been passed in the form of beneficiary (Osborn, 2018). The CGT event was also
brought about by them, hence option (b) is applicable in this case. Joe and Amy can obtain
the full main residence exemption under the “sec 118-195, ITAA 1997” since the asset was
used as the main residence starting from the day of Bob’s demise to the day when the asset
was sold. No income generating activities were carried out by Joe and Amy.
Conclusion:
On the basis of the fact that is mentioned in the question and also imposing the
relevant conditions to apply for the main residence exemption in the respect of the asset
obtained from the estate of decease, Joe and Amy would be getting the full main residence
exemption in agreement of the “sec 118-195, ITAA 1997”. The asset was used as the main

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residence starting from the day of Bob’s demise to the day when the asset was sold. No
income generating activities were carried out by Joe and Amy.

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