Edited version of your written advice

Authorisation Number: 1012777793545

Ruling

Subject: GST and payment of compensation/damages under the Water Act 2000

Question

Is there a GST liability for the Bore Owners when ABC Pty Ltd (ABC) pays them compensation under the Make Good Agreement (MGA) for the effects caused by ABC's activities to the water bores?

Answer

No, the Bore Owners do not make a supply to ABC under the MGA when ABC pays them compensation hence there is no GST liability for the Bore Owners.

Relevant facts and circumstances

The Bore Owners own some water bores on the farmland. The Bore Owners are registered for GST. They carry on an enterprise of farming on the farmland.

The Bore Owners entered into a Make Good Agreement (MGA) under the Water Act 2000 (Water Act) with ABC Pty Ltd. The MGA states that the MGA is a Make Good Agreement under Division 3 of Chapter 3 of the Water Act.

ABC is registered for ABN and GST in Australia. ABC is the registered holder of a Petroleum Lease.

The Water Act 2000 (the Water Act)

Chapter 3 of the Water Act is about Underground Water Management. Division 3 of Chapter 3 of the Water Act explains the general obligations of petroleum tenure holders.

Part 4 of Chapter 3 of the Water Act explains about ABC's obligation to negotiate and enter into a Make Good Agreement with the Bore Owners as follows:

Part 4 General agreements about water bores

406 Obligation to negotiate general agreement

(1) This section applies to each petroleum tenure holder-

(a) from the start day for the holder's tenure; and

(b) until an underground water impact report applies to the holder's petroleum tenure.

(2) For each water bore the holder reasonably believes has an impaired capacity, the holder must use the holder's best endeavours to negotiate and enter into an agreement with the Bore Owners of the bore about the following matters-

(a) the reasons for the bore's impaired capacity;

(b) the measures the holder will take to ensure the bore owner has access to a reasonable quantity and quality of water for the authorised use and purpose of the bore;

(c) any monetary or non-monetary compensation payable to the Bore Owners for impacts on the bore.

407 Effect of an agreement under this part

If an agreement relating to a water bore is entered into under section 406-

(a) the agreement is taken to be a make good agreement for the bore for the purposes of part 5; and

(b) the petroleum tenure holder is taken to have complied with the holder's obligation to undertake a bore assessment for the bore under section 417.

Part 5 of Chapter 3 of the Water Act explains about the make goods obligations of ABC.

The Make Good Agreement (MGA)

The MGA provides that the water bores will have a decline of the water level in the aquifer to which the bores relate. This is the result of ABC's activities in exercising their relevant underground water rights as a Petroleum and Tenure Holder.

The MGA identifies the Responsible Tenure Holder for the water bores as ABC for make good purposes under the Water Act 2000 (Water Act).

ABC has completed a Bore Assessment for the water bores per the requirements of Section 411 of the Water Act.

The MGA acknowledges the fact that the water bores are impaired in their capacity by ABC's activities and that money compensation is the most effective measure for the purpose of making good the impaired capacity of the water bores.

The Make Good Measures for the likely impaired capacity of the water bores consist of the payment of Compensation from ABC to the Bore Owners and the decommissioning of the water bores by ABC in accordance with Best Industry Practice.

The monetary compensation is listed in the MGA and the compensation is in full and final settlement of Make Good Obligations under Chapter 3 of the Water Act with respect to the water bores.

Reasons for decision

Summary

The payment from ABC to the Bore Owners is paid and received as compensation to the Bore Owners to discharge ABC's statutory compensation liability for losses relating to the Bores resulting from ABC's activities in exercising their relevant underground water rights as a Petroleum and Tenure Holder. Any loss suffered by the Bore Owners is not a supply that the Bore Owners make to ABC hence there is no GST liability for the Bore Owners.

Detailed reasoning

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) states:

You make a taxable supply if:

(a)    you make the supply for *consideration; and

(b)    the supply is made in the course or furtherance of an *enterprise that you *carry

on; and

(c)    the supply *is connected with Australia; and

(d)    you are *registered or *required to be registered.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

A supply is broadly defined in section 9-10 of the GST Act to include the creation, grant, transfer, assignment or surrender of any right or an entry into, or release from an obligation to refrain from an act or to tolerate an act or situation.

Is there a supply from the Bore Owners to ABC of the right to exercise ABC's relevant underground water rights as a Petroleum and Tenure Holder?

Goods and Services Tax Ruling 2001/4 (GSTR 2001/4), sets out the Commissioner's views relating to GST consequences of court orders and out-of-court settlements. In relation to the meaning of supply, paragraphs 22 and 25 of GSTR 2001/4 state:

22. Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

25. Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release

Goods and Services Tax Ruling 2006/9 (GSTR 2006/9), examines the meaning of 'supply' in the GST Act. Proposition 5 in paragraph 71 of GSTR 2006/9 provides that to 'make a supply' an entity must do something. The relevant paragraphs are paragraphs 74 and 78 (as follows):

74. However, Underwood J was of the view, with which the Commissioner also agrees, that an entity can still make a supply even if the supply is made under the compulsion of statute if the entity takes some action to cause a supply to occur. His Honour went on to compare a supply resulting from a positive act against a situation where there is no supply because nothing is done.

It seems to me that different considerations arise when considering the meaning of 'supply' in the Act. Notwithstanding the statutory compulsion, the liquidator's disposition in St Hubert's Island Pty Ltd (in liq) was something that was 'made' by him and for that reason would be likely to be considered a supply within the meaning of the Act. This is quite a different situation from the matter at hand, for the release of the obligation to pay a judgment sum by the payment of that sum will occur regardless of whether the judgment creditor makes or does any act at all. It was held in Databank Systems Ltd v. Commissioner of Inland Revenue (NZ) (1987) 9 NZTC 6213 that 'supply' means 'to furnish or provide'. Application of that proposition to the word 'supply' as enacted in the Act, s9-10 reinforces the concept that there is a legislative intention not to include in the word 'supply' the release of an obligation that occurs independently of the act of the releasor.

78. The Court's wider comments about 'supply' and 'obligation' in paragraphs 16, 22 and 23 of its decision were expressed with some caution. With respect, the Commissioner does not consider the Court has stated a general principle, contrary to our proposition, that a supply can be brought about by operation of law in the absence of an entity taking any positive action. The Commissioner distinguishes something brought about solely by operation of law where there is no supply, from something done by an entity as a consequence of a legal requirement where there may be a supply, as was the situation noted by Underwood J in Shaw citing the example of the liquidator's actions in St Hubert's Island. The Commissioner also distinguishes an action that results in obligations arising by operation of law, as the Full Court found in Westley, where there may be a supply by the entity taking the action.

The current 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 Barrett's case, 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.

In the current case, ABC is the holder of petroleum leases and the registered holder of the Petroleum Authority under the Petroleum Legislation. ABC has the rights to exercise ABC's relevant underground water rights as a Petroleum and Tenure Holder; however, Chapter 3 of the Water Act requires ABC to monitor and assess the impact of the exercise of underground water rights on water bores and to enter into make good agreements with the owners of the bores. Since ABC's activities led to the impaired capacity of the bores which belong to the Bore Owners, ABC has statutory obligations to enter into a MGA with the Bore Owners as required under section 406 of the Water Act.

The Make Good Measures for the likely impaired capacity of the Relevant Bore and the C&A Bore consist of the payment of Compensation from ABC to the Bore Owners and the decommissioning of the water bores by ABC in accordance with Best Industry Practice.

In such circumstances, the right to exercise ABC's relevant underground water rights is vested in ABC as a holder of the Petroleum Authority under the Petroleum Legislation. The Bore Owners do not transfer or surrender their rights related to the water bores to ABC. Hence there is no supply from the Bore Owners to ABC of the right to exercise ABC's relevant underground water rights.

Discontinuance supply:

Upon signing the MGA, the Bore Owners accept that they give up their rights to pursue further compensation in relation to the water bores. However, we do not consider that the giving up of the rights is a separate supply from the Bore Owners to ABC since it is not the reason for the decommissioning of the water bores and for the compensation amount being paid to the Bore Owners. Paragraphs 106 to 109 of GSTR 2001/4 state:

106. Where the only supply in relation to an out-of-court settlement is a 'discontinuance' supply, it will typically be because the subject of the dispute is a damages claim. In such a case, the payment under the settlement would be in respect of that claim and not have a sufficient nexus with the discontinuance supply.

107. In most instances, a 'discontinuance' supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

Damages

The Make Good Measures under the MGA is compensation in respect of any damage caused or likely to be caused to the water bores and any inconvenience suffered by the Bore Owners as a consequence of ABC's activities in exercising their relevant underground water rights as a Petroleum and Tenure Holder. In paragraph 71 of GSTR 2001/4, the Commissioner identifies situations where the subject matter of a claim for damages or compensation cannot be regarded as a 'supply'. Examples of such claims include property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury. We consider that this payment under the MGA is not consideration for a supply from the Bore Owners to ABC.

In summary, when the Bore Owners receive the Make Good Measures from ABC, there is no supply from the Bore Owners to ABC and no consideration. Hence there is no GST liability arising for the Bore Owners.

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