Edited version of private advice

Authorisation Number: 1051655998543

Date of advice: 18 May 2020

Ruling

Subject: Compensation

Question 1

Will the compensation payment received under the Agreement be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

The compensation received under the Agreement does not have the characteristics of ordinary income. The lump sum was received as compensation due to impairment caused by the coal seam gas company's activities in relation to the property's water bore and water resources. It is not profit from an isolated transaction as the arrangement was not entered into for the purpose of making a profit. The compensation is considered to be a capital receipt rather than income according to ordinary concepts.

Question 2

Will any part of the compensation payment received under the Agreement be assessable as statutory income under Subdivision 20-A of the ITAA 1997?

Answer

Yes, to the extent that expenditure on the drilling and equipping of replacement water bore is deductible.

The compensation for the impairment to the property's water bore and water resources was specifically intended to pay for a replacement water bore. The compensation will be included in assessable income as an assessable recoupment under section 20-20of the ITAA 1997 to the extent that a deduction is allowable with respect to the replacement water bore.

Question 3

If the compensation under the Agreement exceeds the expenditure incurred on the drilling and equipping of a replacement water bore, will the excess represent capital proceeds for any CGT event in Division 104 of the ITAA 1997?

Answer

No.

It is considered that any compensation in excess of the expenditure incurred on the drilling and equipping of a replacement water bore is compensation for permanent damage to, or a permanent reduction in value of, the property due to the impact on its water resources from the coal seam gas company's activities. Applying the 'look-through' approach in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts the most relevant underlying asset to which this compensation relates is the property. As the property has not been disposed of, there is no CGT event. As there is no CGT event, none of the compensation is capital proceeds for a CGT event.

Question 4

If the compensation under the Agreement exceeds the expenditure incurred on the drilling and equipping of a replacement water bore, will the excess reduce the cost base of the property under section 110-40 or section 110-45 of the ITAA 1997?

Answer

Yes

As stated previously, any excess is considered to be compensation for permanent damage to, or a permanent reduction in value of, the property due to the impact on its water resources from the coal seam gas company's activities. As the property has not been disposed of, this compensation will reduce the cost base of the property; however as the property was acquired before 20 September 1985, there are no CGT consequences (per TR 95/35).

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The property was acquired before 20 September 1985.

The property is used by the landowner to carry on a primary production enterprise.

The landowner entered into an agreement with Company X for the purposes of compensating the landowner for impairment caused by Company X's coal seam gas activities in relation to the property's water bore and water resources (the Agreement).

The landowner has entered into a separate agreement with Company X for other non-water related impacts on the property.

Under the Agreement, certain make good measures are to be undertaken by Company X including the decommissioning of the existing water bore and the payment of a lump sum amount of compensation that is intended to cover the cost of construction of a new water bore.

The Agreement provides that the landowner upon receipt of the compensation, accepts that the compensation and the decommissioning activities are in full satisfaction for the damage effected by Company X's activities to the water resource 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 20-20

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 section 110-40

Income Tax Assessment Act 1997 section 110-45

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).