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Ruling

Subject: Mining compensation payments

Questions:

1. Will the compensation payment received under the terms of the compensation agreement be assessable as ordinary income?

Answer: No.

2. Will the compensation payment received under the terms of the compensation agreement be assessable under the capital gains tax provisions as capital payments?

Answer: No.

3. Will the compensation payment received under the terms of the compensation agreement be treated as an adjustment to the cost base of the underlying asset?

Answer: Yes.

4. If the cost base is reduced to nil as a result of the adjustments, will any other capital gains tax consequences arise?

Answer: No.

5. Does the cost base adjustment occur when the property is disposed of if the compensation is paid in a lump sum or instalments?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2011

Relevant facts

You and your spouse operate a primary production business activity on your family property under a partnership structure.

The property is a post 1985 CGT asset.

During the relevant financial year, you were approached by XYZ to conduct a business activity on the property.

Negotiations were entered into between the parties and a draft compensation agreement was established.

The draft compensation agreement is in reference to the relevant state legislation.

The agreement states that the compensation to be provided under the agreement is in full and final satisfaction of all compensation claims, including but not limited to:

· deprivation of possession of its surface

· diminution of its value

· diminution of the use

· severance of any part of the land from other parts

· surface rights of access

· all losses and expenses.

It has not yet been determined if any compensation payable under the agreement will be made as a lump sum or by instalments.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 6-5

Income Tax Assessment Act 1997 - Section 6-10

Income Tax Assessment Act 1997 - Section 15-15

Reasons for decision

The relevant state legislation (the Act) sets out the general compensation provisions under the act. The purchaser is liable to compensate each relevant owner or occupier of private or public land, known as the 'eligible claimant'. The eligible claimant owns private or public land included in the relevant area. The Act makes each purchaser liable to compensate for the effect the eligible claimant suffers caused by relevant authorised activities of holder.

'Compensatable effect' is defined under the Act to mean all or any of the following occurring to the claimants land; 'deprivation of possession of its surface, diminution of its value, diminution of the use made, or that may be made, of the land or improvement on it, severance of any part of the land from other parts, any cost or loss arising from the carrying out of the activities on the land'. As such, the types of compensatable events are not exhaustive and this list is a reflection of the nature of event that compensation is generally warranted.

The eligible claimant and purchaser may enter into an agreement (a 'compensation agreement') about the holder's compensation liability to the claimant or any future compensation that the holder may have to the claimant that relates to all or part of liability or future liability.

Pursuant to the Act, a compensation agreement must be in writing and signed by, or for, the holder and the eligible claimant and state whether it is for all or part of the liability. Where the agreement is for only part of the liability the agreement must state, the details of each activity, or effects of it and the period for which the agreement has effect.

It follows that where a landowner is an eligible claimant under the Act this gives rise to a right to compensation.

Ordinary income section 6-5 of the ITAA 1997

Taxation Ruling TR 95/35 considers the tax treatment of compensation receipts. A compensation receipt, or compensation, includes any amount (whether money or other property), received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not, in relation to any underlying asset; arising out of Court proceedings; or made up of dissected amounts (paragraph 3).

Compensation paid due to loss and damage of a capital asset, or forgoing a right to sue, may be an isolated transaction. Whether a profit from an isolated transaction is ordinary assessable income according to the ordinary concepts depends very much on the circumstances of the case. Profit from an isolated transaction is generally ordinary income when both of the following elements are present:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and the transaction was entered into, and

(b) the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 Taxation Ruling TR 92/3).

Neither elements (a) or (b) as noted above, apply in the circumstances of receiving compensation where the purchaser exercises it's powers to accesses and uses a claimants land for the intended purpose under the Act.

The compensation payments are made in accordance with the legislative criteria outlined in the Act. Standard compensation agreements state that payments may be dissected into events, for example, damages from drilling and clearing land where payments are received by the claimant over a number of years. A receipt received this way this does not disturb the nature of the compensation payment in the hands of the claimant.

Accordingly, the compensation payments do not give rise to income according to ordinary concepts or to a profit arising from a profit-making undertaking or plan pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).

Statutory income under section 6-10 of the ITAA 1997

Statutory income may arise from CGT events as a consequence of an eligible claimant being entitled to receive compensation, and the loss and destruction of a CGT asset.

Compensation for loss and destruction of underlying assets

The CGT consequences of an award of damages depends on whether there is an underlying asset that damages have a direct and substantial link 'by looking through the transaction that gave rise to the compensation receipt to the most relevant asset relating to the receipt' (paragraph 76 of TR 95/35). In Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd and Graeme McDonald 93 ATC 4418; (1993) 25 ATR 192, Harper J suggested that the compensation receipt should be linked to the underlying asset in determining whether the plaintiff had received any capital gain.

The ATO view is that where there is loss or destruction of the underlying asset that is why the compensation is received, rather than for the disposal of any rights arising from that loss or destruction. Only if the insurance or settlement proceeds do not relate to the disposal of part or all of any underlying asset is it necessary to consider the policy rights or the right to seek compensation as the relevant asset (paragraph 77 TR 95/35).

The standard compensation agreements consist of an upfront payment and future ongoing payments reflective of the damages to underlying assets.

If the payment relates to permanent damage to, or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (that is, you reduce the cost base and reduced cost base by the amount of the compensation). The total acquisition costs of the post-CGT asset should be reduced by the amount of the compensation. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset. If, in the case of a post-CGT underlying asset, the compensation amount exceeds the total unindexed acquisition costs (including a deemed cost base) of the underlying asset, there are no CGT consequences in respect of the excess compensation amount (paragraph 7 TR 95/35).

For example, where there is an upfront lump sum payment paid by the statutory authority party to the claimant in relation to clearing land and the constructing of a dam. The consideration received is treated in respect of the underlying asset, the land. The cost base of the land is reduced to the extent of the consideration and any gain or loss will crystallise at the later time when the land is sold.

Conclusion

Compensation payments paid to an eligible claimant under the Act in the forgoing circumstances are not assessable income under section 6-5 of the ITAA 1997. Compensation received by the eligible claimant in relation to the damage and loss of value of an underlying asset will be treated as a reduction of the cost base. If the compensation amount exceeds the total acquisition costs of the property, there are no CGT consequences in respect of the excess compensation amount. The cost base of the land is reduced to the extent of the consideration and any gain or loss will crystallise at the later time when the land is sold.

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