If the asset is acquired before 1985
If you acquired the original asset before 20 September 1985, any replacement asset is generally exempt from CGT.
The replacement asset will also be taken to have been acquired before 20 September 1985, provided:
- a) the replacement asset does not exceed 120% of the market value of the original asset (immediately before its destruction); or
- b) The 120% rule does not apply if the original asset was destroyed by a natural disaster (such as a bushfire or flood), and it’s reasonable to treat the replacement asset as “substantially the same.”
If the asset is acquired after 20 September 1985
Firstly, there is a Capital Gains Tax (CGT) rollover. This can operate to defer the liability to pay tax on any capital gain that has arisen from the involuntary disposal of an asset.
If you do not end up replacing the building, the insurance proceeds will be taken from the cost base of the destroyed assets, and that will result in a capital gain or loss.
If you do replace the building, you must incur at least some of the expenditure in repairing or restoring it within one year of the end of the income year in which the disaster occurs.
For example, the current income year will end on 30 June 2022.
You must incur some expenditure on repairing or restoring the asset by 30 June 2023.
The replacement asset does not need to be identical to the original asset but it must be used for a similar purpose to the original.
In the case where the insurance proceeds do not exceed the replacement cost, the CGT treatment means you disregard any capital gain. You can also reduce the replacement expenditure you include in the cost base of the replacement asset by the amount of the capital gain.
The building was destroyed in a fire and you receive a $246,000 payout from the insurance company as compensation.
The CGT cost base of the building was $244,000.
So, a capital gain of $2,000 is made.
You spend $257,000 to replace the building.
Because the insurance money does not exceed the replacement cost, you disregard the capital gain of $2,000. However, the cost base for the replacement building is reduced from $257,000 to $255,000.
GST & Insurance payouts
One question we often get is, “Why doesn’t the insurer include GST in their payout?”
If you are registered for GST and are entitled to claim GST credits on the premiums on your business assets, you should notify the insurer to the extent that you will be claiming GST credits.
In the case where your business can claim full input tax credits on the annual premiums (and your insurer has been notified prior to the first claim), the settlement proceeds will not be subject to GST. Your insurer will only compensate you for the actual loss you have incurred.
Here’s an example
The ATO has provided an example.
Repairs to Marilyn’s business premises cost $5,500, including GST. Marilyn is registered for GST.
When she pays for the repairs, she is entitled to claim a GST credit of $500. The insurer has taken this into account and only pays her the $5,000.
Note that failing to correctly notify your insurer of your entitlement to claim GST credits on your premiums can result in the insurance settlement proceeds being subject to GST.
Have a question about tax consequences following an insurance claim? Talk to an expert today.