Edited version of your written advice

Authorisation Number: 1051378167464

Date of advice: 22 June 2018

Ruling

Subject: Compensation payments, mining operation

Question 1

Will the compensation amounts received under the Compensation Agreement (the agreement) be taxed as assessable income in accordance with section 6-5 Income Tax Assessment Act 1997 (ITAA97) or be subject to Capital Gains Tax (CGT)?

Answer

The portion of compensation amounts that is income in nature will be taxed as assessable income for the partnership. The portion of compensation amounts that is capital in nature will be subject to Capital Gains Tax.

Question 2

Will the landholder incur a GST liability on the receipt of compensation amounts from xxxxx (the resource authority holder)?

Answer

No.

This ruling applies for the following periods:

1 July 2017 to 30 June 2023

The scheme commences on:

2017

Relevant facts and circumstances

You (landholder) own Land known as “Lot 1” and “Lot 2” (the Land).

Lot 1 is a pre-CGT asset. Lot 2 is a post-CGT asset.

You and your partner carry on a farming enterprise on the land, as partners in a partnership (the partnership). The partnership is registered for GST.

The activities of the partnership include cattle grazing and growing fodder to feed the cattle.

You and your partner have entered into an agreement with the resource authority holder. This is an agreement under the Mineral and Energy Resources (Common Provisions) Act 2014 (X) and the Petroleum and Gas (Production and Safety) Act 2004 (X) and the Petroleum Act 1923 (X). The agreement stipulates compensation amounts to you and your partner for the impact of all continuing activities and proposed impacts which include the proposed placement of x resource wells on the land.

The compensation amounts to be paid to the landholder are:

Clause 5 of the agreement states that the agreement will cease when the resource authority holder gives you and your partner notice that it has completed all of the activities on the land.

These compensation amounts relate to the impacts of the resource authority holder constructing, testing, developing, operating, maintenance, decommissioning and rehabilitation of wells on the Land. These activities include constructing, maintaining and installing: Relevant wells (approximately 1.2 hectares each site), access points, fences and gates, roads and access tracks, Gathering System and Cables, Related Infrastructure and electrical substations.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 160ZH(11)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 division 20

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

Mineral and Energy Resources (Common Provisions) Act 2014 section 81

Reasons for decision

Question 1

Will the compensation amounts received under the Compensation Agreement (the agreement) be taxed as assessable income in accordance with section 6-5 Income Tax Assessment Act 1997 (ITAA97) or be subject to Capital Gains Tax (CGT)?

Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts (TR 95/35) takes a look-through approach where it seeks to connect the relevant compensation to the most relevant impacted asset or head of claim which generated the compensation.

Whether a lump sum or other compensation payment constitutes assessable income in the hands of the recipient depends on whether it is a receipt of a capital or income nature (based on the circumstances surrounding the payment). It is the character of the receipt in the hands of the recipient that must be determined. For income tax purposes, a compensation amount generally bears the character of that which it intends to replace.

Also in the case of an undissected lump sum compensation amounts, whether a receipt constitutes income or capital in the hands of the taxpayer depends on the circumstances of the receipt and the character of the receipt in the hands of the taxpayer (FC of T v. Slaven 84 ATC 4077; (1984) 15 ATR 242). We therefore need to establish what the compensation amounts are supposed to cover.

What is covered by the compensation amounts?

Clause 10 of the agreement explains what the compensation payments are in relation to compensatable effects, Disturbance Impacts and Noise Impacts of carrying out the mining activities.

Section 81 of the Mineral and Energy Resources (Common Provisions) Act 2014 defines the general liability of the resource authority holder to compensate each owner/occupier of private and public land that is in an authorised area for any compensatable effect the eligible claimant suffers caused by authorised activities carried out by the holder or a person authorised by the holder. Subsection 4 of section 81 goes on to define compensatable effect as follows:

Compensatable effect means all or any of the following-

(a) all or any of the following relating to the eligible claimant’s land-

i. deprivation of 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 that the eligible claimant owns;

v. any cost, damage or loss arising from the carrying out of activities under the resource authority on the land;

(b) accounting, legal or valuation costs the claimant necessarily and reasonably incurs to negotiate or prepare a conduct and compensation agreement, other than the costs of a person facilitating an ADR;

…

(c) consequential damages the eligible claimant incurs because of a matter mentioned in paragraph (a) or (b).

The compensation payments received can be treated as income or capital depending on the compensatable effect that is being compensated for. Paragraph 83 of TR 95/35 states that if compensation amounts are received for a number of heads of claim (e.g., lost profits, interest etc.); the amount also needs to be apportioned between the items.

The compensatable effects

You have listed many compensatable effects. We have grouped these compensatable effects into five categories and will discuss below whether each category of compensatable effects is capital or income in nature.

1) ‘Lost’ land

This category includes land that is ‘lost’ or stranded due to the presence of relevant infrastructure either on it or adjacent to it. This includes land under roads, wells, electrical substations, etc. You will be deprived of the use of this land permanently.

We note that paragraph 3 of TR 95/35 defines “Permanent damage or reduction in value” as:

Permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

This category definitely meets this definition. Therefore, any compensation received for this category is capital in nature.

2) Permanent diminution in the productive capacity of the land

This category relates to the permanent diminution in the productive capacity of the remaining land that is not lost or stranded in the category above. The productive capacity of the remaining land can be greatly diminished due to many factors:

● significantly increased soil compaction, due to heavy vehicles and increased access to the land, especially near access roads.

● during the excavating and burying of the gathering system, pipes and cables, there will be removal of top soil and/or mixing with inferior quality sub-soils. Contamination of the soil may also occur due to pooling of waste water proximate to the wells. Excavation and subsequent restoration also poses a risk that holes/hollows appear afterwards in the land.

● not being able to plough or dig more than X mm (Y mm close to resource infrastructure) into the ground, will greatly inhibit your ability to maintain soil structure and health, or carrying on other agricultural enterprises that require deep cultivation of soil (such as deep ribbing), especially where erosion or soil movement leads to less than Y/X mm of soil cover in some parts.

● there is always a risk that rehabilitation of the land may not be successful, and in any scenario, the land will most likely not return to its condition before the activities were commenced, for many years, if at all.

All these factors combined, will lead to permanent reduction in the productive capacity of the remaining land. Therefore, any compensation received for this category is capital in nature.

3) Ongoing effects on primary production

The presence of relevant infrastructure and industrial activities on the land will have many enduring effects on primary production, whether during construction phase or ongoing even after the construction has ceased.

These effects include:

● breach of bio-security by several potential sources of introduced weeds and/or diseases due to materials being sourced from outside the property (such as gravel), rigs that drill the well holes not required to undergo wash down procedures, and inability to control access to the land (open access required to the land by equipment, personnel and vehicles, effectively removing the natural barriers of remoteness and limited entry).

● potential reduction to the value of farm output due to the risk of contamination (soil and other chemical contamination impacting on livestock or crops produced). This includes risk to or reduction in the value of market status. Potential consumers of the high quality beef produced by the partnership may avoid the land output produced in an industrial related environment.

● Take longer to undertake common pastoral and farming activities due to the general inconvenience from the presence of structures on the land, including movement of livestock. Aerial spraying is also made very difficult due to the presence and height of the relevant infrastructure.

● dust and other particles being blown from infrastructure and access roads, and residing on leaves or crops, making herbicides less effective.

These effects are ongoing and each will lead to increased costs of carrying on primary production activities on the land. Whether it is higher costs of controlling and eradicating weeds, or cleaning dust or sourcing feed off the property due to lack of suitable crops, the compensation amount attributed to this category is akin to reimbursement of future expenses that are deductible to the partnership. Therefore, any compensation for these factors should be classified as income for the partnership.

4) Lasting effects on you and your household

The existence of relevant infrastructure on the land will definitely severely impact the existing quality of life, lifestyle, and quiet enjoyment of the land. This includes the visual impact of the relevant infrastructure, noise concerns, dusty environment and more difficult everyday primary production activities.

There is also a blight on the land/ diminution in the long term market value of the land as a result of having an unwelcome attribute (industrial related activities) on the land. There is a negative stigma of having this activity on the land that could depress the overall value of the property.

All these effects are permanent and any compensation received for this category is capital in nature.

5) Temporary effects on your primary production enterprise

There will be temporary effects of the infrastructure construction phase on your primary production enterprise which are:

● De-stocking the property for a period of X months while the construction activity takes place by the resource authority holder.

● Additional agistment, pasturage and fodder costs that may be incurred during the construction phase.

Any compensation received for this category is income in nature for the partnership.

Income Tax treatment

Where compensation is classified as Income in nature, the amounts are included as ordinary income in accordance with s 6-5 ITAA97 or alternatively under Division 20 ITAA97. Accounting records and source documents (invoices, receipts etc.) can be used to determine the amounts of additional expenses incurred as a result of the related activities. We note that these amounts will relate to the partnership rather than to you personally.

Where the compensation amounts were received wholly in respect of permanent damage or permanent reduction in the value suffered to a post-CGT asset (lot 2), 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, subsection 160ZH(11) of Income Tax Assessment Act 1936 applies to reduce the total acquisition costs of the post-CGT asset by the amount of the compensation that is classified as capital in nature above.

No capital gain or loss arises in respect of the land until the taxpayer actually disposes of it, which has not happened yet in this case. If, in the case of a post-CGT underlying asset, 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.

We note that Lot 1 is a pre-CGT asset so any compensation amounts attributed to permanent damage or permanent reduction in the value of Lot 1 for the categories classified as capital in nature above will not incur CGT.

Question 2

Will the landholder incur a GST liability on the receipt of compensation amounts from the resource authority holder?

The partnership carries on a farming enterprise on the land, and is registered for GST.

For the compensation amounts to give rise to a GST liability there has to be a taxable supply made. Section 9-5 of the GST Act states that you make a taxable supply if the supply is made in the course or furtherance of an enterprise that you carry on, in connection with Australia, you are registered for GST and the supply was made for consideration.

The main question here is whether you made a supply for consideration. Moreover, whether you provided something in return for the compensation amounts that are paid to you. You received the compensation amounts as a landholder under state mining legislation as compensation for any economic loss, hardship and inconvenience as a result of mining activities carried out on your land by the resource authority holder. The amount of compensation is an amount determined by agreement between the landholder and the mining operator (conduct and compensation agreement).

In this case, you as the landholder do not transfer or surrender any rights related to mining on the land to the mining company because the mining company is already the holders of these rights. These rights vested in the mining company upon the grant of the statutory authority by the Relevant Government. The resource authority holder has the rights to mine on the land and you are not able to stop them. In the process of the resource authority holder mining the land, significant damage and adverse effects (as discussed earlier) will impact you, for which the resource authority holder must compensate you under the law. Therefore, we do not find that you provided the resource authority holder with any supply in return for the compensation amounts.

This is also consistent with our view as stated in Goods and Services Tax Ruling 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4). Paragraph 73 states that:

The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss or injury in itself does not constitute a supply under section 9-10 of the GST Act.

You as the landholder are not making a supply, let alone a taxable supply, on which you would have a GST liability.

In regards to giving up your rights for further compensation upon commencing the agreement, this raises the issue of whether giving up of a landholder’s rights would be a separate supply or as termed in Goods and Services Tax Ruling GSTR 2001/4 a 'discontinuance supply'. Paragraphs 106 to 109 in GSTR 2001/4 discuss discontinuance supplies as follows:

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.

In this instance, the compensation received relates to damages suffered by the landholder as a result of activities carried out by the mining company on their land and is not consideration for a supply and accordingly no taxable supply will be made by the landholder. This is also consistent with other rulings that were issued to mining entities to advise that the compensation payments made do not of themselves constitute a supply for GST purposes. In addition, as no part of the compensation is attributable to discontinuance supplies, there are no GST consequences for the discontinuance supplies. Giving up your right for further compensation is not a separate supply for GST purposes but rather is considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by you as landholder.

Compensation amounts that are classified as income (as they relate to compensation for the recoupment of deductible expenses) were considered in several recent court cases. The courts confirmed that a damages award should be calculated on a GST exclusive basis in circumstances where the recipient is entitled to a full Input Tax Credit for a cost or expense (Millington v Waste Wise Environmental Pty Ltd [2015] VSC 167, Gagner Pty Ltd v Canturi Corporation Pty Ltd [2009] NSWCA 413). Since the partnership is registered for GST, you will be entitled to claim input tax credits associated with additional costs, compensation of which is classified as income, above. This includes additional cost of agistment and fodder, livestock relocation, maintaining soil health or eradicating weeds etc. Therefore, the receipt of a recoupment of that expenditure will not give rise to a GST liability.

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