Edited version of your written advice

Authorisation Number: 1013072141628

Date of advice: 26 August 2016

Ruling

Subject: CGT - compensation payments

Question 1

Should the amounts received that relate to the easement be treated as capital proceeds for the part disposal of the land?

Answer

Yes.

Question 2

Where a capital gain arises on the part disposal of the land, are you able to access the small business capital gains tax (CGT) concessions where the other conditions for the concessions are satisfied?

Answer

No.

Question 3

Should receipts that relate to the sale of water that has been drawn from dams and artesian bores and gravel on the property be considered to be assessable income in the year of receipt?

Answer

Yes.

Question 4

Should receipts that relate to compensation for the use of water and gravel be considered to represent permanent damage to the land?

Answer

No.

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

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commences on

The scheme has commenced

Relevant facts and circumstances

You own Land which you acquired prior to 20 September 1985.

The land has been subject to petroleum related activities undertaken by a constructing authority.

Easement related payments

You entered into a Deed of Option for Easement with a constructing authority.

The constructing authority has the legislative power to compulsorily acquire easements under the Acquisition of Land Act 1967 (ALA).

Under the Option Deed you agreed to grant an option to acquire an easement or easements in respect of area of your Land.

You received a non-refundable payment for entering the Option Deed.

The option was exercised and an easement registered on your Land.

The Easement Purchase Price is payable under the provisions of the relevant legislation and is full and final satisfaction of all money payable for the granting of the easement including the related compensatable effects as defined in the relevant legislation. The easement purchase price does not include any payment for loss of income from business activities.

'Compensatable effect' is defined in the relevant legislation as meaning all or any of the following:

(a) all or any of the following relating to your Land

(i) deprivation of the possession of its surface

(ii) diminution of its value

(iii) diminution of the use made, or that may be made, of the Land or any improvement on it

(iv) severance of any part of the Land from other parts of the Land or from other land you own

(v) any cost or loss arising from the carrying out of the activities on the Land

(b) accounting, legal or valuations costs you incur to negotiate or prepare a conduct and compensation agreement, and

(c) consequential damages you incur because of a matter mentioned in (a) or (b).

Subsequent to the completion of the easement documents you became aware that the impact on your Land was significantly greater than first anticipated.

You lodged additional claims with the constructing authority.

A settlement deed was entered into and you were paid an additional amount for the compensatable effects of the activities on your Land.

Water and gravel sales

You sold water and gravel to the constructing authority and independent contractors.

You were paid on a volume basis for the water and gravel used.

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 Section 104-35

Income Tax Assessment Act 1997 Section 104-40

Income Tax Assessment Act 1997 Section 110-45

Income Tax Assessment Act 1997 Section 116-65

Income Tax Assessment Act 1997 Section 134-1

Income Tax Assessment Act 1997 Division 152

Reasons for decision

Summary

There are no, capital gains tax (CGT) implications from the payments you will receive from granting the easements. This is because the payments are in relation to a pre-CGT asset.

Payments received for the extraction of water and gravel, are considered to be payments of royalties and form part of your assessable income.

Detailed reasoning

Payments relating to the easements

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.

CGT event D2 happens if you grant an option to an entity. You make a capital gain if the capital proceeds from granting the option are more than the expenditure you incurred to grant it. However, a capital gain you make from the grant of an option is disregarded if the option is exercised. In these situations, the amount you receive from the disposal of the 'asset' the option relates to, includes. any payment you received for granting the option.

In your situation, you received a payment for granting an option to acquire an easement over part of the Land. As the easement was exercised, the payment you received forms part of the easement purchase price and will be treated in the same manner. It will be used in calculating if you have a capital gain or loss resulting from the granting of the easement.

After granting of the easement you sought additional compensation for the detrimental effects the easement had on your Land. You were paid an additional amount under a settlement agreement. After reviewing the agreement, it is considered the additional amount forms part of the easement purchase price and should be treated in the same manner.

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 160(M) of the Income Tax Assessment Act 1936 referred to in the above paragraph has been replaced with section 104-35 of the ITAA 197. 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 granting the easement (paragraphs 9 and 10 of TR 93/7).

Whilst you have voluntarily entered into an agreement for the easement, it is accepted that the constructing authority had the legislative power to compulsorily acquire the easement. Thus, the payments you received as are considered to be capital proceeds for the part disposal of the Land. These payments include the option payment, the easement purchase price and the additional payment made under the settlement deed.

Any capital gain you make from the granting of the easement will be disregarded as you acquired the Land prior to 20 September 1985.

Small business CGT concessions

Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) allows small businesses to apply certain concessions where a CGT event happens in relation to a CGT asset in an income year which results in an assessable capital gain.

In your situation, whilst you may have made a gain from the granting of the easement, it is not an assessable 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.

Payments for water and gravel extraction

Payments for water and gravel as a royalty

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 agreed to receive payments for the volume of water and gravel extracted from your property and sold to the constructing authority and contractors. Water and gravel are natural resources.

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

Alternatively, the sale of the gravel and water would be considered ordinary income of the existing business carried out on the property and simply be the sale of resources surplus to the business's needs.

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