Edited version of your written advice

Authorisation Number: 1051404619704

Date of advice: 10 August 2018

Ruling

Subject: Compensation payments

Question 1:

Do you make a taxable supply under section 9-5 of the A New Tax Systems (Goods and Services Tax) 1999 when you entered into a compensation agreement (Agreement) and receive compensation payments under the Agreement?

Answer:

No

Question 2:

Do the compensation amounts you receive under the Agreement constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No

Question 3:

To the extent that the compensation amounts do not constitute assessable income under section 6-5 of the ITAA 1997, will these amounts constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a capital gains tax (CGT) event happening?

Answer:

No

Question 4:

To the extent that the compensation amounts do not constitute assessable income under section 6-5 of the ITAA 1997 and do not constitute capital proceeds under Division 116 of the ITAA 1997, will they reduce the cost base of the Property in accordance with subsection 110-40(3) or 110-45(3) of the ITAA 1997?

Answer:

Yes

This ruling applies for the following periods:

1 July 2017 – 30 June 2018

1 July 2018 – 30 June 2019

1 July 2019 – 30 June 2020

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You are an Australian resident for tax purposes and you are not registered for GST.

You are the registered proprietor of a block of land (Property). You acquired the Property after 19 September 1985.

An entity related to you carries out a primary production business on the Property.

Company A is an entity holding a licence to enter the Property for exploration purposes.

Prior to entering the Property to carry out certain activities Company A is required by the relevant legislation to enter into the Agreement with you.

You receive compensation payments from the Agreement.

No part of the compensation payments is for water usage and gravel extraction.

The compensation payments are compensation for damages caused to the Property such as deprivation of the possession of land surface; increase level of dust, noise and weed infestation; soil compaction, contamination and disturbance, and erosion of the land; and impacts on livestock and crops produced due to soil and chemical contamination. These damages will directly reduce the market value of the land for agricultural use.

You made an assessment that the damages caused by the activities do not affect the income of primary production business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

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

Income Tax Assessment Act 1997 Subsection 116-20(1)

Goods and Services Tax Act 1999 Section 9-5

Reasons for decision

Question 1

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if you make the supply for consideration; the supply is made in the course or furtherance of an enterprise that you carry on; the supply is connected with the indirect tax zone; and 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.

‘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.

Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements (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 GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9), examines the meaning of ‘supply’ in the GST Act. Paragraph 71 of GSTR 2006/9 explains that an entity will make a supply whenever that entity (the supplier) provides something of value to another entity (the recipient). This is consistent with the ordinary meaning of ‘supply’ being to furnish or provide.

In this case, Company A holds a licence which allows it to enter the Property to carry out authorised activities for exploration purposes. However, under the relevant legislation, it cannot access the Property to carry out these activities unless there is an agreement in place to compensate you for the effects caused by these activities on your land.

The compensation amounts under the Agreement, therefore, are not paid for the right to enter and carry out authorised activities on the Property. The right to access the Property and carry out authorised activities has already been granted under the licence. Therefore, upon entering into the Agreement with Company A you do not create, transfer or surrender any rights related to these activities on the Property to Company A. Hence, there is no supply made by you to Company A; instead the payments in the Agreement are compensation in respect of any damage caused or likely to be caused to the Properties as a consequence of authorised activities being carried out.

Accordingly, you do not make any supply to Company A when you entered into the Agreement. As there is no supply, there is no taxable supply for the purpose of section 9-5 of the GST Act.

Question 2

Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes income according to ordinary concepts, which is called ordinary income.

There is no definition of 'ordinary income' in the tax law. In order to determine whether the compensation payments constitute ordinary income it is necessary to consider how the courts have determined when a receipt is ordinary income.

In G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (GP International) the High Court stated that:

‘To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.’

The character of the receipt also is assessed by reference to its character in the hands of the recipient. It is in this context that the character of the payments is determined (GP International).

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142).

Application to your circumstances

Under the relevant legislation there is a general requirement for resource authority holders to enter into an agreement with owners of private land before certain authorised activities can be undertaken on their land.

Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts (TR 95/35) considers the tax treatment of compensation receipts. A compensation receipt, or compensation, includes any amount (whatever 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 dissected amounts.

In broad terms, compensation receipts take the character of the item they replace. Accordingly, a payment which is compensation for an item that would have been assessable income is itself assessable income.

Whether a one off payment constitutes ordinary assessable income according to ordinary concepts depends on the circumstances of the case. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) states at paragraph 6 that 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 transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

The above do not apply to any amounts you receive under the Agreement as there is no profit making intention by you. The payments are to compensate you for damages caused by the activities and are made in accordance with the requirements of the relevant legislation.

The amounts you receive under the Agreement are not in the nature of royalty, licence fee or rent as they are payments made to compensate you for deprivation of land surface, diminution of land value and other expected losses or damages as a result of the activities carried out by Company A.

In addition, the amounts to be paid under the Agreement were determined based on loss of land surface and deprivation of land to use for its primary production purposes, permanent damage to productivity of agricultural land, disturbance and damage to crops and livestock and other potential adverse impacts to the Property which will cause a reduction to the land value.

The negotiation of the Agreement between you and Company A was made on the basis of diminution to the land value. There is no indication on the Agreement that any part of the payments is paid as a replacement of income.

Question 3

Under subsection 116-20(1) of the ITAA 1997, money you have received (or are entitled to receive) and the market value of any property you have received (or are entitled to receive) are the capital proceeds from a CGT event.

For the compensation payments under the Agreement to constitute capital proceeds, there must be a CGT event.

CGT events occur in respect of CGT assets. The definition of a CGT asset is contained in subsection 108-5(1) of the ITAA 1997. It provides that a CGT asset is any kind of property or a legal or equitable right that is not property. Not all things often referred to as ‘rights’ will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law.

TR 95/35 provides the Commissioner’s view on the CGT consequences for the recipient of compensation receipts and relevantly, it states that a CGT event will occur (and any consideration form part of capital proceeds) where the amount of compensation is received by the taxpayer:

● either wholly or partly in respect of the disposal of an underlying asset (paragraph 4); or

● not in respect of any underlying asset but in relation to the disposal of the right to seek compensation (paragraph 11).

The above relate to CGT event A1 (section 104-10 of the ITAA 1997) and CGT event C2 (section 104-25 of the ITAA 1997) respectively.

The underlying asset is identified using the ‘look-through approach’ in order to determine the asset to which the compensation amount most directly relates. Paragraph 70 of TR 95/35 states that the underlying asset is identified by looking through to the transaction which generates the compensation receipt.

Applying the look-through approach to the facts of this case, the Property is the asset to which the compensation under the Agreement most directly relates. The Property is therefore, the underlying asset and the relevant CGT asset for the purposes of this ruling.

As there has been no disposal of the Land, CGT event A1 does not occur. Further, as the amount is paid in respect of an underlying asset (being the Land), CGT event C2 will not occur.

The compensation amounts you receive under the Agreement will not constitute capital proceeds in respect of a CGT event happening.

Question 4

Paragraphs 6 and 7 of TR 95/35 provide that compensation received wholly in respect of permanent damage or reduction in value of a post-CGT underlying asset that is not disposed of represents a reduction in either the CGT cost base under either subsection 110-40(3) of the ITAA 1997 (for assets acquired before 7.30pm on 13 May 1997) or subsection 110-45(3) of the ITAA 1997 (for assets acquired after 7.30pm on 13 May 1997).

For the purposes of TR 95/35, permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or reduction in value that has permanent effect unless the taxpayer takes action to put it right. The activities permitted under the Agreement will cause such damage and reduction in value.

The compensation amounts in the Agreement are paid to you in respect of permanent damage and reduction in value of the Property and therefore, reduce the cost base of the Land under subsection 110-40(3) or 110-45(3) of the ITAA 1997.

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