Edited version of private advice

Authorisation Number: 1051773882342

Date of advice: 30 October 2020

Ruling

Subject: Tax treatment of compensation

Question 1

Does the inclusion of the occupier of the land as a party to the Conduct and Compensation Agreement (CCA) mean that compensation needs to be apportioned between the land holder and the occupier?

Answer

No

Question 2

Will the compensation payments outlined in the CCA be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 3

Will the compensation payments outlined in the CCA be treated as capital proceeds from any capital gains tax event under Part 3-1 of the ITAA 1997?

Answer

No

Question 4

Will the compensation payments outlined in the CCA reduce the cost base of the relevant property for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997?

Answer

Yes

Question 5

Will GST apply on the compensation receipts outlined in the CCA?

Answer

No

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

Individual A and the Company B as trustee for Trust B (the "Trustee for Trust B") are the owners (together the "landowners") of the property (the "property" or the "land").

Company C as trustee for Trust C (the "Trustee for Trust C" and the "occupier") is the occupier of the property.

The property has a total land area of approximately X,XXX hectares. The property includes a number of coal seam gas ("CSG") wells.

The property is family owned.

The parties carried on cattle grazing operations from 20XX to 20XX.

From 20XX, cattle grazing activities were carried on by Trust C (controlled and operated by Individual A).

In 20XX, one of the parties assigned their interest in the property to the Trustee for Trust B.

There are currently no lease agreements or share farm agreements in place between the landowners and the occupier for cattle grazing purposes.

Conduct and Compensation Agreement

On XX XX 20XX, the owners entered into a Conduct and Compensation (CCA) Agreement with Company ABC with respect to CSG activities located on the property.

Subsequent variation agreements to the CCA were entered into.

The summary of the CCA and subsequent variation agreements are detailed in the following paragraphs.

The current parties to the CCA (as varied) are Individual A and the Trustee for Trust B (as the landowners) and the Trustee for Trust C (as the occupier) and Company ABC.

The CCA is a conduct and compensation agreement under the Petroleum Legislation. The term Petroleum Legislation means the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) and, where the context requires, the Petroleum and Gas (Production and Safety) Act 2004 (Qld) and the Petroleum Act 1923 (Qld) (as amended and replaced). Under the Petroleum Legislation, entities are granted petroleum authorities that enable them to conduct authorised petroleum activities in an authorised area on private or public land.

Section 81 of the Mineral and Energy Resources (Common Provisions) Act 2014 (Common Provisions Act) defines the general liability of the resource authority holder (in this case Company ABC) 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 defines compensatable effect as follows:

"compensatable effect", suffered by an eligible claimant because of a resource authority holder, means-

(a) any of the following caused by the holder, or a person authorised by the holder, carrying out authorised activities on the eligible claimant's land-

(i) deprivation of possession of the land's surface;

(ii) diminution of the land's 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; and

(b) consequential loss incurred by the eligible claimant arising out of a matter mentioned in paragraph (a).

Generally, before a resource company can enter private land to carry out advanced activities (authorised activities other than preliminary activities), they must have a legally binding agreement with the landholder. This can be either: a conduct and compensation agreement; a deferral agreement or an opt-out agreement. Conduct and compensation agreements set out the activities or conduct proposed to be undertaken as well as the compensation arrangements for any impacts.

The Background to the CCA sets out that Company ABC is authorised to carry out petroleum activities that are authorised under the relevant petroleum authority described in the CCA. One of the stated objectives of the CCA is to ensure the landowner is properly compensated as required by the Petroleum Legislation. The term of the CCA is from the date of the agreement until completion of the Activities or XX years and one day from the date of agreement whichever is the latter.

Clause X of the CCA provides that Company ABC must pay compensation to the landholder in the amount and time set out in Schedule X the CCA. Clause X of the CCA provides an explanation for what the compensation is designed to compensate the landholder:

X. The Landowner acknowledges that the Compensation set out in Schedule X compensates for all of the impacts of the Activities, including all impacts of noise (including the noise described in item X of the Reference Schedule), light, dust, odour, vibration, vehicular movements and loss of amenity generally but excludes any Compensatable Effect suffered by the Landowner:

a. beyond that reasonably contemplated and expected in the ordinary and usual conduct of the Activities;

b. as a result of any outbreak of Declared Weeds on the Land or any other weed on the Land which may be widely regarded as seriously prejudicial to land values and/or land use from time to time;

c. as a result of chemical contamination on the Land;

d. as a result of any significant erosion or subsidence arising as a result of the Activities.

Original Agreement

The Original Agreement allowed all activities and works carried out by Company ABC and/or its Associates that are reasonably associated with the development and operation of CSG wells on the land.

All of the listed activities cause permanent damage to, or a reduction in the value of, the underlying land.

Under this Original Agreement, the landowner agreed to remove livestock from the land on the agreement date, and to keep the land free from livestock for a period of 12 months. As per Section XX and XX of Schedule X, the landowner acknowledges that the compensation set out in items X(c) and X(d) of the Schedule X (which was a once-off payment in 20XX), compensates the landowner for the loss of productivity and costs associated with removing livestock from the land for this period, and these payments were assessable income to the occupier at the time.

The compensation set out in the Original Agreement includes the following:

a)    Item X(a): $XX per annum (plus CPI) during the term of the agreement for a minimum of XX years;

b)    Item X(b): legal, accounting and valuation costs reasonably and necessarily incurred by the landowner in respect of the negotiation of the agreement; and

c)    Item X(c): $XX for matters set out in special conditions XX and XX of Schedule XX.

Variation Agreement #1

Variation Agreement #1 was entered into during the initial 12-month period while the land was destocked as outlined in Section XX and XX of Schedule X to the Original Agreement. Company ABC proposed to remove water based drilling by-products from tanks located nearby properties and undertake Landspray While Drilling (LWD) Activities on designated areas.

Additional compensation was added as follows:

a)    Item X(d): $XX per well applied during LWD activities; and

b)    Item X(e): legal, accounting and valuation costs reasonably and necessarily incurred by the landowner in respect of negotiation of Variation Agreement #1.

Variation Agreement #2

Variation Agreement #2 updates the landowner's details, and allows access to designated areas to carry out LWD activities.

No additional compensation was specifically paid as a result of this variation, however, a new item X in Schedule X was added at the request and direction of Company ABC. Schedule X item X set out that "for the avoidance of doubt, the apportionment of the compensation to be paid to the landowner as between the Owner and the occupier is as follows":

a)    For the compensation as described in Item X(a) in Schedule 1: Owner 95%, Occupier 5%

b)    For the compensation as described in Item X(c) in Schedule 1: Owner 0%, Occupier 100%

c)    For the compensation as described in Item X(d) in Schedule 1: Owner 95%, Occupier 5%

Variation Agreement #3

Variation Agreement #3 updates the CCA with respect to the regulatory requirements and allows Company ABC to carry out additional activities in respect of additional CSG wells and associated infrastructure and to provide for the payment of compensation in respect of those additional activities.

Additional compensation was added as follows:

a)    Item X(f): $XX as a one-off upfront payment;

b)    Item X(g): $XX per annum for a minimum of XX years; and

c)    Item X(h): legal, accounting and valuation costs reasonably and necessarily incurred by the landowner in respect of negotiation of Variation Agreement #3.

Item X of Schedule X was also updated to add a new row as follows:

a)    For the compensation as described in Item X(f) and X(g) in Schedule X: Owner 95%, Occupier 5%

Variation Agreement #4

Variation Agreement #4 recognises the change in ownership of the property.

Additionally, it identifies changes in procedures used for LWD activities, previously authorised to be undertaken on designated areas of the property.

Additional compensation was added as follows:

a)    Item X(i): $XX as a one-off upfront payment for the LWD activities for a number of wells; and

b)    Item X(j): legal, accounting and valuation costs reasonably and necessarily incurred by the landowner in respect of negotiation of Variation Agreement #4.

Item X of Schedule X was deleted and replaced by the following new item X:

a)    For the avoidance of doubt, clause X(e) of this schedule X does not apply to the additional wells described in clause X(i) of Schedule X. For any wells over and above the additional wells described in clause X(i) of this Schedule X, clause X(e) will apply.

Variation Agreement #5

Variation Agreement #5 recognises the owner and occupier.

Additionally, it allows Company ABC to pay the landholder additional compensation to undertake LWD for additional wells.

Additional compensation was added as follows:

a)    Item X(k): $XX as a one-off upfront payment for the LWD activities for additional wells; and

b)    Item X(l): legal, accounting and valuation costs reasonably and necessarily incurred by the landowner in respect of negotiation of Variation Agreement #5.

Additionally, item X of Schedule X was deleted and a new item X was inserted as follows:

a)    For the avoidance of doubt, clause X(d) of this Schedule X does not apply to the additional wells described in clause X(k) of this Schedule X.

Company ABC recognised as part of the negotiations for Variation Agreement #4 and Variation Agreement #5 that the landholder (landowners and occupier collectively) could appropriately allocate the compensation between themselves and that Company ABC could not identify or confirm the impact on the occupier at any given time, and as such a percentage allocation of the compensation amounts was inappropriate and therefore removed.

Since the initial destocking of the property as per the Original Agreement to allow easy access for Company ABC during the construction phase, there has been no requirement to destock or reduce stock levels on the property as a result of Company ABC carrying out the CSG activities as outlined in the agreement and subsequent variations. The business strategy of the cattle grazing operation has been to buy cattle only when the cattle commodity prices are low and expected to increase and not to carry cattle just because grass is available and as such, the property has never been stocked to full capacity. Further, the cattle grazing operation is not a breeding operation, it is just trading in cattle as a commodity and therefore the business decisions are impacted more by commodity prices. In addition, the property has suffered from ongoing drought and as such has not had the water or feed to sustain a high capacity of cattle as trading stock irrespective of the Company ABC CSG activities. The Occupier has not needed to reduce cattle numbers or agist any cattle away from the property due to the activities as outlined in the CCA or any of the subsequent variation agreements.

The landowners have been in negotiations with an unrelated third party seeking to lease a portion of the property for commercial activities (involving a solar farm operation) which is completely separate to the CSG activities on the land. The tenant accepts and acknowledges the existing activities and rights of Company ABC in relation to the carrying out of ongoing CSG activities on the land and will enter into a lease agreement which does not make them entitled to any compensation from Company ABC or the landowner in relation to Company ABC's CSG activities.

In summary, the landholder is entitled to the following amounts of compensation in relation to the 20XX and subsequent financial years to which the questions in this Ruling relate:

·           Item X(a) $XX (plus CPI) per annum - in relation to all activities and works ongoing for operation of CSG wells

·           Item X(g) $XX (plus CPI) per annum - in relation to all activities and works ongoing for operation of additional CSG wells

·           Item X(i) $XX one off payment for LWD activities for additional wells

·           Item X(k) $XX one off payment for LWD activities for additional wells

As the reimbursement for the accounting, legal and valuation fees have no net impact for tax purposes (as 100% of these costs are directly reimbursed by Company ABC), no advice is sought by the Rulee in relation to payments under items X(j) or X(l) of Schedule X.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 Section 110-45

Income Tax Assessment Act 1997 Division 116

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

A New Tax System (Goods and Services Tax) Act 1999 Subsection 9-10

A New Tax System (Goods and Services Tax) Act 1999 Subsection 9-10(1)

A New Tax System (Goods and Services Tax) Act 1999 Subsection 9-15

Reasons for Decision

Question 1

Does the inclusion of the occupier of the land as a party to the agreement mean that compensation needs to be apportioned between the land holder and the occupier?

Summary

The inclusion of occupier of the land as a party to the agreement does not mean that compensation needs to be apportioned between the landowners and the occupier.

Detailed reasoning

The variation agreements of the CCA include both the landowners and the land occupier as parties to the agreement. They do not, however, contain an apportionment between the landowners and the land occupier.

In reviewing the consequences of this, it is important to consider who suffers a detriment when the listed activities in the CCA are undertaken by Company ABC. We note the following:

a)    There is currently no lease or Share Farm agreement in place between the landowner and the occupier

b)    The occupier operates with a business strategy that involves buying cattle only when commodity prices are low and not carrying cattle just when grass is available

c)    The property has suffered from drought for an extended period and as such has a limited carrying capacity for cattle grazing operations in the absence of significant rainfall

d)    The occupier will not need to reduce cattle numbers or agist any cattle away from the property due to the activities as outlined in the CCA or subsequent variation agreements

e)    The occupier does not own any improvements or equipment on the property which could be permanently damaged by the CSG activities carried out on the land.

Given the matters listed above, and having regard to our analysis below, we accept that no amount of the compensation payments addressed in this Ruling need be apportioned to the occupier of the land, even though they are named in the subsequent Variation Agreements.

We acknowledge that the land occupier in the Original Agreement did suffer some detriment and was compensated for loss of productivity as a result of destocking required for 12 months for the initial construction phase and the payment under Schedule X, item X(c) was specially allocated to the land occupier and treated as assessable income.

Question 2

Will the compensation payments outlined in the CCA be treated as assessable income under section 6-5 of the ITAA 1997?

Summary

The compensation under the CCA is in accordance with the Petroleum Legislation and does not constitute income according to ordinary concepts or a profit arising from a profit-making undertaking or plan.

Detailed reasoning

Section 6-5 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year.

In order to determine whether the payments received under the CCA 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 is also 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 citing Scott v. F.C. of T. (1966) 117 C.L.R. 514 (Scott), per Windeyer J. at p. 526).

The motive of the payer may also be relevant to this consideration i.e. it is necessary to inquire how and why it came about that the payment was made (Scott at 527-528 citing Kitto J. in The Squatting Investment Co. Ltd. v. Federal Commissioner of Taxation [1953] HCA 13; (1953) 86 CLR 570, at pp 627, 628).

In addition to the above, two fundamental principles used to determine the appropriate taxation treatment of payments in the nature of compensation are:

·         the general principle relating to the taxation of a compensation receipt is that the receipt takes on the character of the item it replaces: Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82; and

·         the fundamental question is what is the 'compensation' being paid for: The Glenboig Union Fireclay Co Ltd v Inland Revenue Commissioners [1922] SC (HL) 112; (1922) 12 TC 427: FC of T v. Northumberland Development 95 ATC 4483 per Beaumont J at 4492.

Barrett v. Federal Commissioner of Taxation (1968) 118 CLR 666; (1968) 15 ATD 149; (1968) 10 AITR 685 (Barrett's Case) and Nullaga Pastoral Co Pty Ltd v. Federal Commissioner of Taxation 78 ATC 4329 (Nullaga's Case) dealt with periodic on-going payments made to landowners in relation to mining operations where the quantum was determined with reference to the volume of minerals that were extracted. The Courts considered whether the payments were royalties, licence fees, rent or in the nature of rent or receipts of a general nature and therefore included in assessable income before holding (in both cases) that the payments were capital in nature because they were intended to make good the estimated diminution of the value of the land as a result of the mining operations.

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? (TD 93/58), states that a lump sum compensation payment is assessable income:

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.

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).

Application to your circumstances

The Common Provisions Act establishes the framework for land access and compensation for conducting authorised activities under resource authorities. There is a general requirement for resource authority holders to enter into conduct and compensation agreements with the owners and occupiers of private land before certain authorised activities can be undertaken on their land.

In this case, Company ABC holds a resource authority in respect of the property, which confers the right to enter the property for the purpose of CSG extraction. It is considered the payments under the CCA are payments made in accordance with Company ABC's obligations under the Common Provisions Act, as compensation for deprivation of land surface, diminution of land value and other expected losses or damages as a result of the CSG activities. The payments made to the landowner under the Agreement are not made in return for the right to extract resources or the right to occupy or use the Land.

Accordingly, no amount received under the Agreement is in the nature of royalty, licence fee or rent.

Is any amount a replacement of income?

The amounts to be paid under the CCA are to compensate the landowner as required under section 81 of the Common Provisions Act. Clause X of the CCA states that the amounts compensate for all of the impacts of the Activities, including all impacts of noise, light, dust, odour, vibration, vehicular movements and loss of amenity generally. It is accepted that the payments are made by way of compensation for loss of land surface, deprivation of use of the land, permanent damage to the land, for disturbance and other potential adverse impacts to the property which will cause a reduction to the land value.

Further, we will accept having regard to the facts identified in Question 1, that no identifiable part of the payments relates to a compensation for loss of income (other than as noted with respect to the payments to be made under Item X(c) of Schedule X to the CCA). In the absence of any portion being identifiable and quantifiable as being paid for a claim of an income nature, the whole of the payments are accepted to be capital.

Further, the payments are not profit from an isolated transaction. The CCA was not entered into with the purpose of making a profit or gain. The elements identified in TR 92/3 are not present in this situation. The compensation is payable in accordance with the Petroleum Legislation.

Accordingly, the compensation payments paid under the CCA do not give rise to income according to ordinary concepts or to a profit arising from a profit-making undertaking or plan pursuant to section 6-5 of the ITAA 1997.

As such, it is accepted that these payments are not assessable income under section 6-5 of the ITAA 1997.

Question 3

Will the compensation payments outlined in the CCA be treated as capital proceeds from any capital gains tax event under Part 3-1 of the ITAA 1997?

Summary

The compensation relates to the permanent damage or reduction in the value of the land and there is no disposal of the land, therefore, the compensation under the CCA does not constitute capital proceeds in respect of a CGT event.

Detailed reasoning

Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in a taxpayer's assessable income due to another provision of the tax law. These amounts are 'statutory income'. Statutory income may arise from CGT events occurring in connection with a taxpayer receiving an amount as compensation.

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 provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. 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:

a)    either wholly or partly in respect of the disposal of an underlying asset (CGT event A1); or

b)    not in respect of any underlying asset but in relation to the disposal of the right to seek compensation (CGT event C2).

TR 95/35 states that it is necessary to identify the particular asset to which the payment relates (Paragraph 69 of TR 95/35), which may be an underlying asset or the right to seek compensation, and what has occurred in relation to that asset.

Paragraph 70 of TR 95/35 provides that in determining what is the relevant asset, it is often appropriate to use the 'look-through' approach to the transaction or arrangement which generates the compensation receipt. An underlying asset is an 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.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation (paragraph 4 of TR 95/35).

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, 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 (paragraph 6 of TR 95/35)

If the amount of compensation is not received in respect of any underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. Accordingly, any capital gain arising on the disposal of that right is calculated using the cost base of that right (TR 95/35).

Applying the look-through approach to the facts in relation to compensation payments outlined in the CCA, the land/property is the asset to which the compensation under these agreements most directly relates. As discussed in Question 2, it is considered that the relevant payments under the CCA most directly relate to the permanent damage suffered and diminution in value of the property.

There has been no disposal of the Land, and we will accept that the compensation payments under the CCA are not for part disposal of the property. Therefore, CGT event A1 does not occur. Further, as the amounts are paid in respect of an underlying assets (the land) CGT event C2 will not happen.

As such, the compensation amounts the taxpayer receives as the landowner under the CCA do not constitute capital proceeds in respect of a CGT event happening.

Question 4

Will the compensation payments outlined in the CCA reduce the cost base of the relevant property for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997?

Summary

The compensation relates to permanent damage or a reduction in value of the land, as per subsection 110-45(3) of the ITAA 1997, the total acquisition costs of the post-CGT asset should be reduced by the amount of the compensation received. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset.

Detailed reasoning

Paragraphs 6 and 7 of TR 95/35 provide that compensation received wholly in respect of permanent damage or reduction in the value of a post-CGT underlying asset that is not disposed of represents a recoupment of all or part of the total acquisition costs of the asset. Expenditure does not form part of any element of the cost base to the extent of any amount received as a recoupment (except so far as the amount is included in your assessable income) 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).

Further, compensation received by a taxpayer for the disposal or permanent damage or reduction in value of an asset has no CGT consequences if the underlying asset to which it relates was acquired by the taxpayer before 20 September 1985.

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 CCA will cause such damage and a reduction in value.

Accordingly, pursuant to subsection 110-45(3) of the ITAA 1997, the total acquisition costs of the post-CGT asset should be reduced by the amount of the compensation received. No capital gain or loss arises in respect of that asset until the taxpayer actually disposes of the underlying asset. If 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.

In this case, the landowners will receive, and continue to receive, compensation payments as a result of mining activities being carried out on the land. These activities will result in permanent damage to, or a permanent reduction in the value of, the land. The compensation as outlined in the CCA for the permanent damage to the property will reduce the cost base of the property at a later time when the land is disposed of.

Question 5

Will GST apply on the compensation receipts outlined in the CCA?

Summary

The compensation for permanent damage to or reduction in the value of the land is a loss suffered by the landowner and not a supply the landowner makes to Company ABC. As the taxpayer is not making a supply, there is no taxable supply and therefore the taxpayer will not be liable for GST in relation to the compensation.

Detailed reasoning

GST is payable on taxable supplies and the supplier must pay the GST payable on any taxable supplies that it makes. For the receipt of compensation amounts to give rise to a GST liability there must be a taxable supply made.

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that an entity makes a taxable supply if, amongst other requirements, the entity makes the supply for consideration.

The existence of a 'supply' itself is an essential element in determining whether there is a taxable supply under section 9-5 of the GST Act.

Supply

'Supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever'. The statutory definition of 'supply' is very broad. Essentially, a supply is something which passes from one entity to another, and may be one of goods, services or something else.

Consideration

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is 'in connection with' a supply and 'in response to' or 'for the inducement' of a supply. Thus, there must be a sufficient nexus between a particular supply and a particular payment, which is provided for that supply, for there to be a supply for consideration.

Sufficient nexus

A sufficient nexus between the compensation amounts and a supply must exist to create the 'supply for consideration' relationship.

The issue is whether the landholders have provided something to Company ABC, in return for the compensation amounts that are paid to them.

In regards to the landholders giving up their rights for further compensation upon commencing the agreement (clause XX of the CCA), 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 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (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.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

In the process of Company ABC carrying out its Authorised Activities on the land, significant damage and adverse effects will impact the landholders, for which Company ABC must compensate the landholders under the law. Upon receipt of the compensation amounts under the CCA, the landholders accept that they give up their right to pursue further compensation in relation to the Authorised Activities.

The landholders giving up their right for further compensation is not a separate supply for GST purposes. It is rather considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by the landholders. We do not consider that the giving up of the landholders' rights for further compensation is a separate supply from the landholders to Company ABC since it is not the reason for which the compensation amount is paid to the landholders.

Damages

GSTR 2001/4 states the following in relation to damages, at paragraph 73:

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.

Paragraphs 110 and 111 of GSTR 2001/4 further explain:

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party...

111. If a payment is made under an out-of-court settlement to resolve a damages claim and there is no earlier or current supply, the payment will be treated as payment of the damages claim and will not be consideration for a supply at all, regardless of whether there is an identifiable discontinuance supply under the settlement.

Although the above explanation in GSTR 2001/4 is made in respect of court orders and out-of-court settlements, the underlying principles are equally relevant in this case.

The landholder receives the amounts as a landholder under state mining legislation, as compensation for the compensatable effects as a result of CSG mining activities carried out on their Land by Company ABC.

The payment by Company ABC to the landholders is compensation in respect of any damage caused or likely to be caused to the Land and any inconvenience suffered by the landholders as a consequence of Company ABC Authorised Activities carried out on the Land.

In applying the above principles in GSTR 2001/4 to the present circumstances, we consider that, the compensation amounts are paid to the landholders to resolve a damages claim. A claim for damages (or payment that the landholders receive as a consequence of such claim) due to activities conducted by Company ABC on the landholder's Land, does not constitute a supply under section 9-10 of the GST Act.

The landholder does not provide Company ABC with any supply in return for the compensation amounts. As such, the compensation payments made by Company ABC is not consideration for a supply from the landholders to Company ABC, and accordingly no taxable supply will be made by the landholders.

Therefore, the receipt of the compensation amounts by the landholder from Company ABC will not give rise to a GST liability.

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).