Edited version of your written advice

Authorisation Number: 1012998544653

Date of advice: 2 August 2016

Ruling

Subject: Mining compensation payments

Issue 1

Income Tax

Question 1

Will the compensation payments (upfront and annual) received be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the compensation payments received represent capital proceeds of any capital gains tax (CGT) event in Division 104 of the ITAA 1997 in respect of a CGT event happening?

Answer

No.

Question 3

Will the compensation payments received reduce the cost base of the land under sections 110-40 or 110-45 of the ITAA 1997?

Answer

Yes.

Issue 2

Goods and Services Tax

Question 1

Is there a GST liability for you when Entity X pays you compensation under the Agreement for the effects caused or likely to be caused by Entity X's activities on the Land?

Answer:

No.

Question 2

Are the legal fees and accounting fees incurred by the Landholders creditable acquisitions?

Answer:

Yes.

This ruling applies for the following periods

Year ended 30 June 2014

Year ended 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2021

Year ending 30 June 2022

The scheme commences on

1 July 2013

Relevant facts and circumstances

You are the landowners of a property which you use to carry on a primary production business. You are registered for GST.

You have entered into an agreement under a statutory authority with a company to compensate you for activities carried out on your property. This agreement has been varied.

The agreement and variation details the agreed authorised activities relevant to the damages caused.

The agreement and variation along with the statutory scheme provides that you have been compensated for a number of heads of damage:

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 Section 110-40

Income Tax Assessment Act 1997 Section 110-45

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-10

A New Tax System (Goods and Services Tax) Act 1999 section 11-5

A New Tax System (Goods and Services Tax) Act 1999 section 11-15

A New Tax System (Goods and Services Tax) Act 1999 section 11-20

Reasons for decision

Issue 1

Summary

The compensation payments the Landholders will receive under the agreements do not form part of their assessable income. The payments are considered to be compensation received for the permanent reduction in value and damage relating to the Land and will be treated as a reduction in the Land's cost base.

Detailed reasoning

Compensation payments under the Agreements

Compensation payment as ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Compensation paid due to loss and damage or a capital asset in the process of an Authority undertaking activities on a taxpayer's land is an isolated transaction. Whether a profit from an isolated transaction is ordinary assessable income according to ordinary concepts depends 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

(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 of Taxation Ruling TR 92/3).

Neither of the above elements apply in this situation. The compensation payments were made in accordance to the relevant statutory authority.

Accordingly, the compensation payments paid under the agreements 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 ITAA 1997.

Compensation payments and the capital gains tax (CGT) provisions

Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in a taxpayer's assessable income due to another provision of the tax law. These amounts are 'statutory income'. Statutory income may arise from CGT events as consequence of an eligible claimant being entitled to receive compensation and the loss and destruction of a CGT asset.

Taxation Ruling TR 95/35 provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying post-CGT asset, or part of an underlying post-CGT asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, the Commissioner considers that the amount is not consideration for the disposal of any other asset, such as the right to seek compensation.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Accordingly, 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 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.

In this case the Landholders have received, and will continue to receive, compensation for the compensatable effects of the activities undertaken on the Land. The Activities have resulted in the permanent damage to, or permanent reduction in the value of, the Land.

As the Landholders did not dispose of all or part of the affected land there are no CGT consequences at the time of entering the agreements or receiving the compensation payments.

However, the Land's acquisition cost will be reduced by the compensation payments received in relation to that Land. That is, the cost base of the Land will be reduced by the value of the payments and any gain or loss will crystallise at a later time when the Land is sold.

Issue 2

Summary

The payment from the company to the Landholders is paid and received as compensation to the Landholders to discharge the company's statutory compensation liability for losses relating to the Land including damage to the Land resulting from company's activities being carried on the Land. Any loss suffered by the Landholders is not a supply that the Landholders make to the company, hence there is no GST liability for the Landholders.

The legal fees and accounting fees incurred by the Landholders in relation to the agreements are creditable acquisitions because they are enterprise costs.

Detailed reasoning

GST Liability relating to compensation payments

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 Landholders to the company of the right to access the Land and carry out the Authorised Activities?

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 company is the holder of the leases and the registered holder of an Authority. The company has the rights to undertake Activities on the Land provided the company meets its Compensation Liability to the Landholders and enter into a Conduct and Compensation Agreement with the Landholders according to the statutory authority.

In such circumstances, the right to access the Land and carry out the Activities on the Land is vested in the company as a holder of the Authority under the statutory authority. The Landholders do not transfer or surrender their rights related to mining on the Land to the company. Hence there is no supply from the Landholders to the company of the right to access the Land and carry out the Activities.

Discontinuance supply:

Upon receipt of the compensation amounts in the agreements, the Landholders accept that they give up their rights to pursue further compensation in relation to the Activities. However, we do not consider that the giving up of the rights is a separate supply from the Landholders to the company since it is not the reason the compensation amount is paid to the Landholders. 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.

Damage

The payment under the agreements is compensation in respect of any damage caused or likely to be caused to the Land and any inconvenience suffered by the Landholders as a consequence of the company's Activities carried out on the Land. 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. Hence the payment under the agreements is not consideration for a supply from the Landholders to the company.

In summary, when the Landholders receive compensation damage from the company, there is no supply from the Landholders to the company and no consideration. Hence there is no GST liability arising for the Landholders.

Creditable acquisitions

Under section 11-20 of the GST Act, an entity is entitled to an input tax credit for any creditable acquisition that it makes.

The term 'creditable acquisition' is defined in section 11-5 of the GST Act as follows:

You make a creditable acquisition if:

(a)   you acquire anything solely or partly for a creditable purpose; and

(b)    the supply of the thing to you is a taxable supply; and

(c)    you provide, or are liable to provide, consideration for the supply; and

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

The Landholders acquired the accounting service and the legal services from the third parties. These supplies to the Landholders are taxable supplies. The Landholders are registered for GST. The acquisitions would satisfy paragraphs (b), (c) and (d) of section 11-5 of the GST Act. The next step is to consider paragraph (a) of section 11-5 of the GST Act.

Creditable purpose:

In the context of assessing the creditable purpose of the Landholders' acquisitions of the legal and accounting services, it needs to be determined if the Landholders acquired them in carrying on their enterprise, which is predominantly a livestock grazing enterprise including a cattle fattening operation (cattle grazing).

'Creditable purpose' is defined in section 11-15 of the GST Act as follows:

(1)   You acquire a thing for a creditable purpose to the extent that you acquire it in carrying on your enterprise.

(2)   However, you do not acquire the thing for a creditable purpose to the extent that:

(a)   the acquisition relates to making supplies that would be input taxed; or

(b)   the acquisition is of a private or domestic nature.

(3)   An acquisition is not treated, for the purposes of paragraph (2)(a), as relating to making supplies that would be input taxed to the extent that the supply is made through an enterprise, or part of an enterprise, that you carry on outside Australia.

Paragraph 55 of GSTR 2006/4 states:

....The acquisition needs to be made in the course of the activities that constitute your enterprise. An acquisition is made 'in carrying on your enterprise' if it is made for the purposes of that enterprise, but not if it is made for some other purpose. You could engage in an activity that is usually done by the enterprise, but is not for the purposes of that enterprise.

We accept that the legal and accounting expenses would be acquired for the purpose of ensuring that the primary production enterprise as a whole is sustained. However, to the extent that the legal and accounting expenses are identified as relating to the agreements, we need to consider whether they are properly characterised as costs that relate to all supplies that the Landholders make, or would the acquisitions be incurred for the purpose of receiving compensation.

We consider that the acquisitions do not relate to a particular supply because no supply is made by the landowners to the company for which the Landholders receive the compensation amount.

Paragraph 138 of Goods and Services Tax Ruling (GSTR) 2008/1 describes acquisitions that do not directly relate to particular supplies as follows:

Other acquisitions do not directly relate to any specific type of supplies. Instead, they have an indirect relationship to all the supplies that the entity makes in carrying on its enterprise.

Paragraphs 141 and 142 of GSTR 2008/1 characterises these types of expenditures as overheads or enterprise costs.

Paragraph 63 of Goods and Services Tax Ruling (GSTR) 2006/4 states:

63. Carrying on an enterprise includes those activities that you do in actually managing or conducting that enterprise. Certain acquisitions or importations relate to the carrying on of the enterprise as a whole and are not directly linked to the making of supplies but nonetheless they relate indirectly to all activities of the enterprise. These may be referred to as enterprise costs and may include costs such as compliance costs for meeting Australian Securities and Investment Commission (ASIC), GST or income tax obligations, directors' fees or the costs of maintaining a register of shareholders...

We accept that the accounting and legal acquisitions relate to the the Landholders' enterprise as a whole and the expenses may be incurred for a creditable purpose because:

• the legal expenses involves the provision of advice and information that may protect/ preserve the primary production enterprise.

• the accounting expenses are incurred for the Landholders to meet income tax obligations.

The acquisitions therefore satisfy the requirements of subsection 11-15(1).

The acquisitions of legal and accounting services are not of a private or domestic nature.

The Landholders do not make any input-taxed supply.

Therefore, the acquisitions of legal and accounting services satisfy the requirements of "creditable purpose' of section 11-15 of the GST Act, hence paragraph 11-5(a) of the GST Act is satisfied. In summary, all requirements of section 11-5 of the GST Act are satisfied, and the legal and accounting fees are creditable acquisitions.

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