Edited version of your written advice

Authorisation Number: 1013070561866

Date of advice: 17 August 2016

Ruling

Subject: CGT - compensation payments

Question 1

Should the amounts received that relate to the easement taken by Entity X be treated as capital proceeds for the part disposal of the relevant property?

Answer

Yes.

Question 2

Where an assessable capital gain arises from granting an easement, are you able to access the small business capital gains tax (CGT) concessions?

Answer

Not applicable as the asset is pre-CGT

Question 3

Should the receipts under the Compensation Deed be considered compensation for the permanent damage to the other land?

Answer

Yes.

Question 4

Are there any CGT implications from the receipts paid under the Compensation Deed for the permanent damage to the other land?

Answer

No.

Question 5

Should any future receipts that relate to compensation for the use of water by Entity be considered as assessable income?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on

1 July 2014

Relevant facts and circumstances

You own a property on which a partnership operates a business.

You acquired the property prior to 20 September 1985.

You have entered an Agreement to grant Easement ('the Easement Agreement') and Compensation Deed with Entity X.

Entity X has a statutory power to compulsorily acquire the easement under legislation.

You have received consideration for agreeing to an easement to be registered.

You will accept a compensation payment in satisfaction of your entitlement to compensation under the Compensation Deed.

You will grant Entity X an irrevocable licence to enter on and use specified areas of your property to access the Easement area.

Entity X will pay you for water extracted and used in their activities.

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 15-20

Income Tax Assessment Act 1997 Subsection 104-10(5)

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Subsection 110-40(3)

Income Tax Assessment Act 1997 Subsection 110-45(3)

Income Tax Assessment Act 1997 Division 152

Reasons for decision

Summary

There are no CGT implications resulting from the payments you will receive under the Easement Agreement or the Compensation Deed. This is because the payments are in relation to a pre-CGT asset.

Payments you receive from Entity X for the extraction and use of water from your property form part of your assessable income as a royalty.

Detailed reasoning

Statutory income may from CGT events as a consequence of an owner of a property being entitled to receive compensation for the disposal of all or part of an asset.

Taxation Ruling TR 95/35 considers the tax treatment of compensation receipts. For the purposes of TR 95/35 a compensation receipt is defined as including:

… 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 undissected amounts.

TR 95/35 uses a 'look-through' approach to identify the most relevant asset. This approach requires an analysis of all the possible assets of the taxpayer in order to determine the asset to which the compensation is most directly related to.

An underlying asset is defined in TR 95/35 as:

… 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 directly leads to the payment of the amount of compensation.

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

Where the underlying asset is a pre-CGT asset, the receipt of the compensation on disposal has no CGT consequences for the taxpayer.

You have received payments under the Easement Agreement and the Compensation Deed. Each payment will be examined separately to determine how it should be treated.

Payment for granting an easement

An easement is a right over someone else's land or property. It is an asset which is created at the time it is granted.

The taxation treatment of a payment for the granting of an easement depends on whether the easement has been created by compulsory acquisition or as a voluntary action.

Taxation Ruling TR 93/7 at paragraph 4 states:

Compensation in respect of an easement created by statute in favour of a public authority cannot be said to have been received for the grant of the easement. The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation. In these circumstances, the landowner cannot be said to have created an asset as required for subsection 160M(6) of the Act to apply. The easement is created by operation of the relevant statute and is vested in the public authority. This constitutes a compulsory acquisition of the easement.

Note: subsection 160M(6) of the Income Tax Assessment Act 1936 referred to in the above paragraph has been replaced with section 104-35 of the Income Tax Assessment Act 1997 (ITAA 1997). The effect of both provisions is the same.

As stated above, TR 95/35 examines the treatment of any amount received in respect of a right to seek compensation in relation to an underlying asset. Where easements are acquired under statute, the underlying asset is the landowner's pre-existing land with its rights of ownership, including the right to exclude all others. This right to exclude all others is forfeited when the easement comes into existence.

Compensation received by a landowner for the loss of part of the rights of ownership is accepted as being consideration received in respect of the part disposal of the underlying asset (the land) (paragraph 8 of TR 93/7).

It is possible that a public authority that has the power to compulsorily acquire an easement by exercising a statutory power may enter into an agreement with the landowner to acquire the easement.

The Commissioner's view, in these situations, is the amount received takes on the same character as compensation for a compulsorily acquired easement. Thus, the consideration (compensation) for granting the easement is treated as being paid in respect of the part disposal of the land and not in respect of the grant of the easement (paragraphs 9 and 10 of TR 93/7).

In your situation you received consideration for granting the easement. Legislation gives Entity X the power to compulsorily acquire easements.

The payment you received for granting the easement is considered to be proceeds for the part disposal of the land. Any capital gain which you make from the granting of the easement will be disregarded as you acquired the land prior to 20 September 1985.

Easement - assessable gain and eligibility for small business CGT concessions

Division 152 of the ITAA 1997 allows small business to apply certain concessions where a CGT event happens in relation to a CGT asset in an income year and results in an assessable capital gain.

In your situation, whilst you have made a gain from the granting of the easement, it is not an assessable capital gain as the underlying asset (the land) is a pre-CGT asset.

Therefore, there is no gain the small business CGT concessions can be applied against.

Payment under the Compensation Deed as a compensation for permanent reduction in the value of the land

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

Where the underlying asset is a post-CGT asset, its' total acquisition costs should be reduced by the amount of the recoupment as if those costs had not been incurred (subsections 110-40(3) and 110-45(3) of the ITAA 1997). If the compensation amount exceeds the total acquisition costs of the underlying asset, there are no CGT consequences in respect of the excess of compensation.

Compensation received by a taxpayer has no CGT consequences if the underlying asset which has suffered permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985.

It is accepted that the payment you received under the Compensation Deed is in respect of permanent damage suffered or a permanent reduction in the value of the land on Entity X's activities are carried out.

As the land was acquired prior to 20 September 1985 there are no CGT consequences from receiving the payment.

Payments for water taken and used by Entity X

Section 6-5 of the 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.

In your situation, you will receive payments for water Entity X extracts from your property for use in the construction activity. These payments are not considered payments for services provided, income from property or from a business of selling water.

Section 15-20 of the ITAA 1997 states your assessable income includes an amount that you receive as or by way of royalty if the amount is not assessable as ordinary income under section 6-5 of the ITAA 1997. Royalties are statutory income.

The Commissioner's view on the definition of a royalty is provided by Taxation Ruling IT 2660. The ordinary meaning of the term 'royalty' has been considered by the Courts on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that:

… the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken.

Paragraph 10 of IT 2660 provides that in the Commissioner's view there are four key characteristics of a common law royalty:

• it is a payment made in return for the right to exercise a beneficial privilege or right, for example to remove minerals or natural resources such as timber (McCauley v. FC of T (1944) 69 CLR 235)

• the payment is made to the person who owns the right to confer that beneficial privilege or right (Barrett v. FC of T (1968) 11 CLR 666)

• the consideration payable is determined on the basis of the amount of use made of the right required (McCauley, Stanton), and

• the consideration will usually be paid as and when the right acquired is exercised. However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired (IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272).

In your case you have entered into agreements whereby you will receive a payments for the volume of water extracted from your property. Water is a natural resource.

It is considered that the payment for each mega litre of water extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997.

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