Edited version of your written advice

Authorisation Number: 1051215454668

Date of advice: 21 April 2017

Ruling

Subject: Compensation

Questions and Answers

1. Will the non-monetary compensation detailed at clause 1 of schedule 1 in accordance with the 2016 Conduct and Compensation Agreement (CCA) form part of the assessable income for the landholder?

No

2. If the non-cash benefits detailed at Clause 1 of schedule 1 are assessable income will the assessable amount be reduced to Nil under Section 21A(3) as the deductible percentage for the taxpayer is 100%?

N/A

3. Are the compensation receipts detailed at clause 2 of schedule 1 in accordance with the 2016 CCA, assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No

4. Does the compensation received have no CGT consequences as the underlying asset which has suffered the permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985?

Yes

5. Is the compensation received for deductible accounting, legal and valuation costs assessable?

Yes

6. Is the compensation received for non-deductible accounting, legal and valuation costs assessable?

No

7. Does the inclusion of the Family Partnership (occupier of the land) as a party to the agreement mean that compensation needs to be apportioned between the land holder and the occupier?

No

This ruling applies for the following periods

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

1 July 2020 to 30 June 2021

1 July 2021 to 30 June 2022

1 July 2022 to 30 June 2023

The scheme commences on

1 July 2016

Relevant facts and circumstances

You and the family partnership, together the owner and occupier are the 'landholders', have entered into a Conduct and Compensation Agreement (CCA) for the purposes of compensating you for the impact of activity on the land owned by you for a term of YY years. The compensation is being paid in accordance with the Relevant (Production and Safety) Act 2004. The land was purchased prior to 20 September 1985.

The prime objective of the CCA is to ensure you are properly compensated as required under the Relevant Legislation. You acknowledge that the compensation is payable in respect of the impacts of the related activities, including the loss of use of part of the property, all impacts of noise, light, dust, odour, vibration, vehicular movements and loss of amenity generally.

In accordance with schedule 1 of the CCA the following compensation will be paid:

1) The Company will provide you with non-monetary compensation by causing water bores to be drilled and equipped on the land.

2) The Company will pay you compensation as follows:

(a) $ as an upfront payment for the first year of the Agreement;

(b) $ per annum from year two to year six (inclusive) of the Agreement, being five annual payments;

(c) $ per annum from year seven and for the remainder of the Term (prorated for any partial years of the Term); and

(d) up to $ for legal, accounting and valuation costs reasonably and necessarily incurred by you in respect of the negotiation of the Agreement.

Schedule 2 to the CCA describes the nature of the activities to be carried out on the land and the impact that those activities are expected to have at each phase. (Information provided)

The individual activities on the land have been provided.

Schedule 3 to the CCA outlines special conditions included in the agreement including a Rehabilitation Clause which provides that the surface of the land will be restored to a condition that is equivalent (to the extent practicable) to the surface of the land that existed prior to commencement of the activities.

The current purpose of the land is to run a Primary Production business of cattle breeding which is carried on by you and your spouse as partners in the family partnership (the occupier).

There is currently no lease or share farm agreement in place between you and the partnership.

The partnership currently operates with a conservative paddock management approach in that the property is not as heavily stocked as it could be and therefore there will be no need to reduce cattle numbers or agist any cattle away from the property during the construction phase or post construction phase.

No improvements made by the partnership (fencing, yards etc) will be permanently damaged by the activities carried out on the land.

You do not undertake any farming activities in your own right. Water produced by the bores will be used only by the partnership.

The partnership derived income in the 20XX-YY income year, your interest in the partnership income or loss is 50%.

By agreement of the partners, you are entitled to 100% of the deductible amount relating to the bores.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 21A

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Paragraph 20-20(3)

Income Tax Assessment Act 1997 Section 20-30

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Subsection 110-55(6)

Reasons for decision

Section 21A of the Income Tax Assessment Act 1936 (ITAA 1936) provides that any non-cash business benefit is to be treated as convertible to cash for the purpose of determining whether the benefit is income of a taxpayer from the carrying on of a business.

Section 21A of the ITAA 1936 does not actually deem any benefit in the form of property or services to be income. Its effect is that in the event that the non-cash benefit is already considered to be income derived in carrying on a business, subsection 21A(2) specifies that the amount to be brought to account is the amount that the taxpayer would have paid the provider for the property or services under an arm's length transaction.

In determining whether the bores are a non-cash business the following definitions must be considered:

Income derived by a taxpayer means income derived by a taxpayer in carrying on a business for the purpose of gaining or producing assessable income.

Non-cash business benefit means property or services provided after 31 August 1988:

(a) wholly or partly in respect of a business relationship; or

(b) wholly or partly for or in relation directly or indirectly to a business relationship.

For income tax purposes, a partnership is not a separate legal entity distinct from the partners forming the partnership. A partnership does not pay tax on its net income but is required to furnish a return of the income of the partnership. The partners are then taxable under section 92 of the ITAA 1936 on their individual shares of the net income of the partnership, whether distributed to them or not.

The benefit is assessable only if it has the character of income derived by the partnership from the carrying on of a business and is provided in the context of a business relationship.

It cannot be said that the water bores would normally be income from carrying on cattle breeding (for the partnership) or letting property (for the individual), therefore the water bores are not assessable under section 21A of the ITAA 1936.

If the water bores were a non-cash business benefit derived by the taxpayer and, if the taxpayer had, at the time the benefit was provided, incurred and paid unreimbursed expenditure in respect of the provision of the benefit equal to the amount of the arm's length value of the benefit - a once-only deduction would, have been allowable to the taxpayer in respect of a percentage of the expenditure, the benefit is reduced by the percentage (subsection 21A(3) of the ITAA 1936).

The decline in value of a water facility for the income year in which you incurred the expenditure is the amount of the capital expenditure you incurred on the construction, manufacture, installation or acquisition of the water facility.

A deduction is only available if the expenditure on the water facility is incurred primarily and principally for the purpose of conserving or conveying water for use in a primary production business conducted by the taxpayer on land in Australia. Thus, a deduction is not allowable to a person who owns land upon which a primary production business is carried on by some other person. However, the person carrying on a primary production business on the land is allowed a deduction, even if the person is only a lessee of the land.

A partnership which incurs expenditure that is deductible is not entitled to a deduction in determining the net income of the partnership or the partnership loss. In these circumstances, a deduction is allowed to the individual partners with the amount of the deduction being determined by reference to the individual interests of the partners in the net income or net loss of the partnership. If, however, the partners have agreed that they are to meet the relevant expenditure in special proportions, the proportions agreed between the partners are the basis upon which the deduction is allowed.

Therefore, as the partners have agreed that any deduction would be available in full to you, if the water bores were a non-cash business benefit assessable to you, you would be entitled to a deduction for the full amount of the assessable 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 to a capital asset, or forgoing a right to sue, in the process of a specific authority undertaking relevant activities on a taxpayer's land is an isolated transaction. Whether a profit from an isolated transaction is ordinary income 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 applies. The compensation payments were made in accordance to the legislative provisions of the Relevant Legislation.

Accordingly, the compensation payments paid under the CCA are not ordinary income or arise from a profit-making undertaking or plan.

Under section 6-10 of the ITAA 1997 amounts are included in a taxpayer's assessable income due to another provision. These amounts are 'statutory income'. Statutory income may arise from CGT events as consequence of an eligible claimant being entitled to receive compensation for the loss or 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.

Paragraph 9 of TR 95/35 provides that compensation has no CGT consequences if the underlying asset which suffered permanent damage or a permanent reduction in value was acquired before 20 September 1985 or is any other exempt CGT asset.

The land was acquired prior to 20 September 1985 therefore there are no CGT consequences.

As the compensation receipt related to the permanent damage or reduction in value of the land only, there is no requirement to apportion between the landowner and the land occupier.

Subsection 20-20(3) of the ITAA 1997 provides that an amount you receive as a recoupment of a loss of outgoing is an assessable recoupment if:

● you can deduct an amount for the loss or outgoing in the current year, or

● you have deducted or can deduct an amount for the loss or outgoing for an earlier income year

under a provision listed in section 20-30 of the ITAA 1997.

To determine if the compensation for the accounting, legal and valuation costs are an assessable recoupment, it must first be determined if those costs are deductible and under what provisions.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income or a provision of the taxation legislation excludes it.

Section 25-5 of the ITAA 1997 allows a deduction for expenditure you incur to the extent that it is for:

● managing your tax affairs

● complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity

● the general interest charge or shortfall interest charge

● a penalty under Subdivision 162-D of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) which relates to situations where a taxpayer varies their instalment rate too low, or

● obtaining a valuation in accordance with section 30-212 (gifts of properties to deductible gift recipients) or 31-15 (entering into conservation covenants).

Costs which relate to your tax affairs are an allowable deduction. Where the services to which the fees relate go beyond managing your tax affairs, you must apportion the fees between the various purposes and only those services that directly relate to your tax affairs are deductible (Bartlett v FC of T; Falcetta v FC of T 2003 ATC 4962; [2003] FCA 1125)

Legal fees will be deductible where the nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses (Hallstroms Pty Ltd v FC of T [1946] HCA 34; (1946) 72 CLR 634) (Hallstroms).

Where accounting, legal and valuation costs are not incurred in managing your tax affairs they are capital in nature and not deductible.

Only those costs which relate to managing your tax affairs are deductible. Section 20-30 of the ITAA 1997 includes tax-related expenses deductible under section 25-5 as assessable recoupments.

A reimbursement of accounting, legal and valuation costs which are deductible will be an assessable recoupment and are required to be included in your assessable income in the year in which they are reimbursed.

A reimbursement of accounting, legal and valuation fees for which you cannot claim a deduction are not an assessable recoupment or ordinary income.

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