Edited version of your private ruling

Authorisation Number: 1012528661665

Ruling

Subject: Land use compensation

Question:

Are license fee payments received, under the relevant access licences, taxable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as ordinary income?

Answer:

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You operate a primary production business in an Australian state. This region is part of a coal seam gas project.

You have entered in an agreement with an entity that pays you a monthly license fee for the defined purpose to authorise the licensee to carry out the authorised activities on the licence area.

The agreement also states the licence fee paid by the licensee, to you, is in full and final satisfaction of the licensee's compensation liability for any damage or lack of access to your land.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

You have entered into Access Agreements with an entity. The entity requires access to the area to carry out the Authorised Activities.

You have argued the Licence Fees payable under the Access Agreements are compensation amounts, because the "licences state the compensation is payable for the compensatable effects from carrying out the Authorised Activities".

In this state, there is a comprehensive statutory framework dealing with land access and compensation in relation to mining and exploration activities. Whether an amount is treated as compensation is largely determined by the relevant legislation. Prima facie, as landowners, you are potentially able to get compensation for damages arising from coal seam gas activities on your land.

In your case, the Access Agreements simply identify the governing law. The specific legislation governing exploration, recovery and transport through pipelines of petroleum and fuel gas is the Petroleum and Gas (Production and Safety) Act 2004 (the P&G Act). Therefore the requirements of this Act are considered in determining whether the Licence Fees received by you can be treated as compensation.

A review of the P&G Act shows it provides for two main types of agreement:

1) access agreements; and

2) conduct and compensation agreements.

In your case, you have potentially entered into a conduct and compensation agreement. For the Licence Fees payment to be compensation amounts, the Access Agreements would be expected to meet the requirements of a 'conduct and compensation agreement' under the P&G Act.

It is noted that pursuant to section 533(4) of the Act, a conduct and compensation agreement may be included in an easement relating to a pipeline licence or petroleum facility licence. The Access Agreements contain schedules entitled 'Section 399 Permission'; this provision of the P&G Act deals with pipeline licence easements. You have, therefore, potentially entered into a conduct and compensation agreement as part the easement relating to the pipeline licence.

P&G Act conduct and compensation agreements

The primary purpose of a conduct and compensation agreement is to address the petroleum authority's compensation liability to the landowner, sections 532 and 533. (In this case the petroleum authority is a pipeline licence). The P&G Act sets out specific requirements for example, and agreement must provide the compensation liability requirements in sections 533(1) and 534 (1)(a). Compensation liability is the liability of the petroleum authority to compensate the landowner for any compensatable effect caused by relevant authorised activities, section 532(2).

Compensatable effects come under five broad heads:

· deprivation of possession of the land's surface;

· diminution of value of the land's value;

· diminution of the use made or that may be made of the Land by the Licensor or any improvement on it

· severance of any part of the Land from other parts of the land or from other Land that the Licensor owns;

· any cost, damage or loss arising from the carrying out of the Authorised Activities on the Land;

· consequential damages the Licensor incurs because of any of the matters mentioned above;

· reasonable and necessary legal costs incurred by the Licensor in the negotiation and preparation of this agreement.

To illustrate the compensation liability requirements of a conduct and compensation agreement, the state Government has published the Standard Conduct and Compensation Agreement. The agreement template includes a schedule setting out the authorised activities that are proposed to be carried out on the land; and a schedule setting out all of the agreed compensation for the agreed authorised activities. The details contained in this schedule should also include whether the agreement is for all or part of the compensation liability and if it is for part, the details of each activity or effect of each activity to which the agreement relates.

Are the Access Agreements conduct and compensation agreements for the purposes of the P&G Act?

You have entered into two agreements. You are arguing that the Licence Fees payable under the Access Agreements are compensation amounts, because the "licences state the compensation is payable for the compensatable effects from carrying out the Authorised Activities".

A review of the Access Agreements shows that whilst the agreements have a definitions clause that sets out the meaning of compensatable effects (in keeping with the P&G Act definition); both agreements fail to identify any compensatable effects of the agreed authorised activities.

A review of the agreements set out a list of authorised activities; neither agreement sets out any details at all as to the compensatable effects of these activities.

In your case, the two agreements provide details of the activities that are authorised to take place on your land. However, the activities are not related to any compensatable effects. The agreements simply define what constitutes a compensatable effect (in terms of the broad heads found under the P&G Act). There is no consideration given as to what the actual compensatable effects of the described activities would be, on the land on which you operate your livestock enterprise. For example, there are no details provided as to the type of damage that may be caused; which head/s of damages are relevant; and no compensation amounts specified in respect of the effects of each activity.

The wording of the agreements you have entered into does not recognise that the Authorised Activities have any impact. Accordingly, neither of the agreements meets the requirements of a conduct and compensation agreement as set out under the P&G Act. As it has not been established that there are any compensatable effects from the authorised activities, it is considered the monthly Licence Fee payments (inclusive of GST) that are received by you cannot be treated as compensation for damages arising from coal seam gas activities on your land.

The agreements you have entered into show the stated purpose of the licence is to authorise the Licensee to carry out the Authorised Activities on the Licence Area; and the monthly payments under both agreements are referred to as Licence Fees. (It is noted that this does not mean a licence fee for the purposes of section 423 P7G Act).

Accordingly the amounts are not capital in nature and are not taxable as statutory income under section 6-10 of the ITAA 1997.

What is the nature of the payments under the Access Agreements?

Section 6-5 of the ITAA 1997 assesses ordinary income. Ordinary income has generally been held to include three categories, namely, income from rendering personal service, income from property and income from carrying on a business.

In your case, the amounts received under the Access Agreements are potentially income from property.

The payments under the Agreements are called Licence Fees. Taxation Ruling IT 2561 provides the Commissioner's view on the meaning of a licence. At paragraph 2 of IT 2561, a licence is defined as:

… an authority to do something which would otherwise be unlawful. An authority to occupy land (but without exclusive possession as against others) is an example of a licence.

Your case has a number of similarities to the decisions in Nullaga Pastoral Company Pty Ltd v FC of T78 ATC 4329; (1978) 8 ATR 757; and Barrett v Federal Commissioner of Taxation 1968] HCA 59; (1968) 118 CLR 666; 15 ATD 149; 10 AITR 685. These cases involve 'compensation' payments relating to mining activities conducted on farming properties; and consider whether the payments that were made to the farmers were licence fees.

In both Barrett's case and Nullaga's case, the Commissioner argued the payments were for the granting of a licence and were rental in nature. In Barrett's case, the Commissioner contended that the taxpayer granted a licence to the miner to enter his land and conduct mining operations and therefore the receipts were of an income nature. Owen J of the High Court held that the payments were not received (by the landholder) as income in return for the grant of a licence to use the land for the purpose of mining, as the mining company already had the right to take the minerals from the land and do all things necessary for that purpose pursuant to an agreement with another party. That is, the landowner taxpayer did not receive the payments for granting an authority to the mining company.

Similarly, in Nullaga's case, the mining operators already had a permit to enter the land and could also apply for a mining tenement on the land pursuant to the Mining Act (WA). Their exploration rights were, therefore, not pursuant to any licence granted by the landowner. Wickham J of the Supreme Court of Western Australia thought that the agreement did embrace a kind of licence but it was held that the money was paid as consideration for the deprivation of a capital asset and in order to replace that capital.

The decisions in Nullaga and Barrett can be contrasted with the decision in the Queensland Federal Court case of Cape Flattery Silica Mines v FCT 97 ATC 4552. Cape Flattery involves a series of recurrent payments by a mining operator to an Aboriginal community living on an Aboriginal Reserve. In that case, it was held the essential character of the payments was that of a series of recurrent payments in the nature of rental for the right to occupy the land that would otherwise have been enjoyed by the Aboriginal inhabitants.

In your case, the P&G Act enables you, the landowner, to provide authority to the construction contractor to do something which would otherwise be unlawful. The authority provided is evidenced by the schedules to the Access Agreements, which deal with section 399 permission. Accordingly, the Access Agreements are considered to be properly characterised as contractual licences. As in Cape Flattery the payments are in the nature of rent.

The Licence Fees payable under the Access Agreements are recurrent payments in the nature of rental payments for the right of the entity to occupy the land that would otherwise have been enjoyed by you. The Licence Fees are considered to be taxable as ordinary income under section 6-5 of the ITAA 1997.

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