Edited version of private advice

Authorisation Number: 1051532955335

Date of advice: 10 July 2019

Ruling

Subject: Mining compensation

Question 1

Will the compensation received under the varied conduct and compensation agreements (CCAs) for Property A and Property B be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

No.

Question 2

Will the compensation received under the varied CCAs for Property A and Property B be treated as capital proceeds from any CGT event happening under Part 3-1 of the ITAA 1997?

Answer

No.

Question 3

Will the compensation received under the varied CCAs for Property A and Property B reduce the cost base of the relevant properties under section 110-40 or section 110-45 of the ITAA 1997

Answer:

Yes.

Question 4

Will the compensation received under the varied CCAs for Property A and Property B be characterised differently if it is received as one lump sum or a combination of a smaller lump sum and a series of periodic payments?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX to Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own Property A and Property B.

You have previously entered into CCAs with Company Z to compensate you for Coal Seam Gas (CSG) related activities carried on these properties.

You received private rulings that ruled that compensation under the CCAs for permanent damage to the properties reduces the cost base of the properties.

Subsequent to the negotiation of the original CCAs and the issue of the private rulings, Company Z approached you with the objective of expanding the CSG activities to be carried out on the properties and the parties agreed to enter into variation agreements that were signed on XX/XX/20XX.

The variation agreements provide that further activities will take place including the development and operation of up to XX CSG wells (and associated infrastructure) on each of the two properties. Accordingly, the variation agreements increase the amount of compensation to be paid, change the timing of the compensation payments and provide for significant additional impacts on the land.

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 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 108-5(1)

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

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

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

Reasons for decision

Question 1

Summary:

The compensation received by you under the varied CCAs does not have the characteristics of ordinary income and therefore is not assessable under section 6-5 of the ITAA 1997.

Detailed reasoning

Compensation payment as ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year.

'Ordinary income' are receipts that meet the ordinary definition of income.

Periodicity or regularity of payment is a common characteristic of income receipts, even where the receipts are not directly referrable to employment or services rendered (Commissioner of Taxation v. Citibank (1993) 44 FCR 434; 93 ATC 4691;(1993) 26 ATR 557).

Capital gains are not ordinary income in the hands of the recipient however they may still be assessable statutory income under section 6-10 of the ITAA 1997.

In G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 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 in the hands of the recipient must be determined. It is in this context that the character of the payment is determined. If the payments are periodical, the question becomes, are the payments instalments of the capital amount or really in the nature of income.

In the case Barrett v. Federal Commissioner of Taxation (1968) 118 CLR 666; (1968) 15 ATD 149; (1968) 10 AITR 685, it was concluded the periodic nature of the compensation payments did not convert them into a revenue amount. Barrett was the owner of a farming property under which lay deposits of soapstone. The right to mine soapstone was exercised on Barrett's land. The mining company and Barrett entered into an agreement under which Barrett was to receive an amount of money 'for the damage to and diminution of value of the said land and other loss and inconvenience necessarily suffered by him in consequence of such operations'. Mining operations were carried out on the land for a number of years, and the mining company paid the taxpayer by monthly instalments. The High Court ruled the payments were made and received for the purpose stated in the agreement and were therefore of a capital nature.

Taxation Determination TD 93/58 considers under what circumstances the receipt of a lump sum compensation/settlement payment is assessable. It indicates that a compensation amount will be assessable:

(a)  if the payment is compensation for loss of income only e.g. past year profits, and/or interest; or

(b)  to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

In your case, there is no portion of the compensation that is identifiable and quantifiable as compensation for loss of income.

Whether a profit from an isolated transaction is ordinary assessable income according to the ordinary concepts depends very much 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 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 (paragraph 6 Taxation Ruling TR 92/3).

Neither of the above elements apply in this situation. The compensation is payable in accordance with the provisions of the petroleum and energy resources legislation.

The compensation paid under the varied CCAs does not have the character of ordinary income and therefore is not assessable under section 6-5 of the ITAA 1997.

Question 2

Summary:

The compensation paid under the CCAs is in respect of underlying assets that have not been disposed of and therefore will not constitute capital proceeds in respect of a CGT event happening.

Detailed reasoning

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 an 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.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides the Commissioner's view as to the CGT consequences of receiving a compensation payment 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.

TR 95/35 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 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 present facts, each parcel of land is the asset to which the compensation under the relevant varied CCAs most directly relates. Therefore, each parcel of land is the underlying asset and the relevant CGT asset.

As there has been no disposal of the properties, CGT event A1 does not occur.

Further, as the amounts are paid in respect of an underlying asset, CGT event C2 will not happen.

As such, the compensation you receive as the landowner of the properties under the varied CCAs does not constitute capital proceeds in respect of a CGT event happening.

Questions 3 and 4

Summary

It is considered that the compensation payable to you is primarily for the permanent damage to or reduction in value of your properties. As these properties have not been disposed of, the compensation will reduce their cost bases. Also, it is not considered that the character of the compensation will change from capital to income if it is paid as a combination of a smaller lump sum and a series of periodic payments rather than a lump sum.

Detailed reasoning

Paragraphs 6 and 7 of TR 95/35 provide that compensation received for the permanent damage or reduction in the 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 further activities permitted under the varied CCAs will cause such damage and a reduction in value to your properties and it is considered that the compensation payable to you is primarily for this damage and reduction in value.

As you have not disposed of all or part of the properties, the cost base of each property will be reduced by the compensation received for each property and any gain or loss will crystallise at a later time when the property is disposed of.

Further, as it has been determined that the compensation is for the permanent damage to or reduction in value of underlying assets, it is not considered that the character of the compensation will change from capital to income if it is paid as a combination of a smaller lump sum and a series of periodic payments rather than a lump sum.

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