Edited version of private advice

Authorisation Number: 1051816651947

Date of advice: 15 March 2021

Ruling

Subject: Income - lump sum compensation

Question 1

Will the compensation received under the Buffer Zone Conduct and Compensation Agreement (BZCCA) 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 BZCCA be treated as capital proceeds under Division 116 of the ITAA 1997 from any capital gains tax event in Division 104 of the ITAA 1997?

Answer

No.

Question 3

Will the compensation attributed to Person A received under the BZCCA reduce the cost base of the relevant property for any future capital gain under section 110-40 of the ITAA 1997?

Answer

Yes.

Question 4

Will the compensation attributed to Person B be disregarded under paragraph 118-37(1)(a)(ii) of the ITAA 1997?

Answer

Yes.

Question 5

Will the landholder incur a GST liability on the receipt of compensation amounts from ABC?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2021 to 2030

The scheme commences on:

1 July 2020

Relevant facts and circumstances

Person A and Person B have entered into a BZCCA with ABC.

The area which is outlined as the Buffer Zone area is primarily located on Property A with only a very small section crossing the entrance to Property B. The proposed well point and ongoing lease area is wholly contained within the boundaries of Property A.

The BZCCA is a conduct and compensation agreement under the Petroleum Legislation and includes an alternative arrangement for Noise Impacts under the Environmental Authority. The BZCCA compensates the landholders for all compensatable effects, disturbance impacts and noise impacts in relation to the authorised activities reasonably associated with or incidental to the construction, testing, development, operation, maintenance, decommissioning and rehabilitation of 1 Petroleum wells on the Land. The proposed activities to be carried out on the land include:

•         Using existing and/or establishing access points to the Land including turn-in areas.

•         Installing new gates, grids and fences and/or modifying existing gates, grids and fences (including cutting and reinstating existing fences).

•         Modifying existing tracks and constructing new tracks to the standard required by ABC to carry out the Activities (including constructing batters and culverts). Installing suitable materials for creek crossings and water courses.

•         Carrying out all operations within each well site area (proposed 1 production well) associated with testing for Petroleum, testing for Petroleum production, evaluating the feasibility of Petroleum production, producing Petroleum, or the Activities, including:

-        constructing well site areas including fencing or other delineation;

-        drilling a vertical well, including all activities associated with converting an existing well into another type of well;

-        carrying out Well Completion activities;

-        Well Stimulation activities;

-        installing, testing and operating a wellhead, surface facilities and Infrastructure;

-        testing (including to appraise the resource potential of Exploration Wells), monitoring and operating the wells;

-        investigating, restoring, maintaining and improving well operation including Well Intervention activities;

-        reducing and expanding the well site areas throughout the Term; and

-        Suspending the wells.

A variety of well drilling, Well Completion, Well Stimulation and Well Intervention methods and techniques may be used on a well (including alternate technologies that may be developed or deployed in the future). To avoid doubt, a well drilled for the purpose of producing Petroleum is a production well even if it does not have a wellhead and facilities to directly flow Petroleum into the Gathering System or is contained in a well site area with other wells.

•         Constructing and installing:

-        a network of underground Petroleum and water pipelines to transport Petroleum and water (referred to as the "Gathering System") from the wells on the Land to treatment, transfer, storage and/or processing facilities off the Land;

-        underground electrical lines and fibre optic cables (collectively, "Cables") to transmit power, operational data and safety data; and

-        Infrastructure associated with the Gathering System and Cables (including underground intelligent marker systems, above-ground marker signage, valves, telemetry and control systems),

-        including excavating, stringing, welding and laying pipes, back-filling trenches and temporarily stockpiling.

Schedule 4 of the BZCCA sets out all Internal Noise Impacts and External Noise Impacts including the following types of noise:

a.    noise generated from clearing, slashing and grubbing sites;

b.    noise associated with using earthmoving equipment, excavating, trenching and backfilling equipment, compactors, dozers, graders, rollers, scrapers, generators, cranes and pumps;

c.     noise from light and heavy vehicle engines and movements (including reversing alarms);

d.    noise associated with unloading and lowering pipe into trenches;

e.    elevated noise during drilling, cementing, Well Completion, Well Intervention and Well Stimulation activities (generated on a 24-hour continuous basis for the period of activity) including:

                                      i.        noises from rigs, engines, compressors, electricity generators, pumps, public announcement systems, cranes, forklifts, wirelines, trucks and other equipment;

                                     ii.        clanging noises from fitting and moving steel tubulars;

                                    iii.        high pressure release sounds from venting and flaring gas; and

                                   iv.        using a safety horn for emergencies or training.

f.      noise similar to a diesel truck from operational wells with a pump;

g.    noise similar to gushing air and a light whistle from operational wells with a power pack;

h.    pressure release noises associated with opening pressure safety valves on separators;

i.      noise emissions from operating surface facilities;

j.      temporary elevated noise levels when pressure testing pipelines;

k.     intermittent high-pitched squeals when undertaking internal checks of pipelines (called 'pigging');

l.      noise from camp generators, pumps and inhabitants; and

m.   noises associated with LWD Activities including truck operations, truck engine sounds, pumping activities, spraying activities and reversing alarms.

The compensation to be paid is set out in Schedule 1 to the BZCCA and provides that the following compensation will be paid:

The BZCCA was negotiated between Person A, Person B and ABC over a series of meetings and discussions and the basis on which the compensation amounts were determined was outlined in more detail in an email from ABC. The compensation will be distributed as follows:

Person A:

(a)  $X paid upfront;

(b)  annual payments of $X with CPI from the agreement date;

(c)   $X per annum from year 6 with CPI from the agreement date

Person B:

(a)  $X paid upfront

(b)  $X annuity plus CPI; and

(c)   $X for the new grid

The summary of the impacts expected as a result of the activities are different for Person A to what they are for Person B. Person A will suffer permanent damages or diminution in the value of their land as a result of the well and associated activities on the land at Property A. Whilst Person B will have some minor disturbance to the land, the primary impact suffered by Person B is noise and potentially restricted or impeded access to their personal residence driveway at times. That is the impact to Person B is private or domestic in nature as it relates primarily to their personal use and enjoyment of their principle place of residence.

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 8-1

Income Tax Assessment Act 1997 section 15-20

Income Tax Assessment Act 1997 section 25-5

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 Division 116

Income Tax Assessment Act 1997 paragraph 118-37(1)(b)

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

A New Tax System (Goods and Services Tax) Act 1999 Section 11-5.

A New Tax System (Goods and Services Tax) Act 1999 Section 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 9-10(2).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-10(2)(e).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-10(2)(g).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 11-5(b).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 11-5(c).

A New Tax System (Goods and Services Tax) Act 1999 Section 11-20.

Reasons for decision

Questions 1 and 2

Compensation payment as ordinary income

Section 6-5 of the 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.

Compensation paid due to loss and damage of a capital asset in the process of a petroleum authority undertaking petroleum activities on a taxpayer's land is an isolated transaction. Whether a profit from an isolated transaction is income according to ordinary concepts depends on the circumstances of the case. Profits from an isolated transaction are 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 profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 of Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income).

c)    Neither of the above elements apply in your situation. The compensation payments were made in accordance to the legislative provisions of the petroleum legislation.

Accordingly, the compensation payments paid under the BZCCA 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. The arrangement was not entered into to make a profit. Rather the arrangement was entered into in order to receive compensation for damage that will be caused by the proposed activities to be carried out on the land.

The compensation amounts are not included in your assessable income under section 6-5 of the ITAA 1997.

Question 3

Compensation payments and the capital gains tax (CGT) provisions

Under section 6-10 of the ITAA 1997 some amounts that are not ordinary income are included in your assessable income due to another provision of the tax law. These amounts are statutory income. Statutory income may arise from CGT events as consequence of an eligible claimant being entitled to receive compensation for the loss and destruction of a CGT asset.

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. The ruling provides 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 the 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 there is more than one underlying asset, the relevant asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying CGT asset, or part of an underlying CGT asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, the Commissioner considers that the amount is not consideration for the disposal of any other asset, such as the right to seek compensation.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to an underlying asset of the taxpayer or for a permanent reduction in the value of an underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, then the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Accordingly, the total acquisition costs of the CGT asset should be reduced by the amount of the compensation. 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.

The proposed activities to be carried out on the land will result in permanent damage to, or a permanent reduction in the value of the land owned by Person A.

As Person A did not dispose of all or part of the affected land there are no CGT consequences at the time of entering into the BZCCA or receiving the compensation payments. The land's acquisition cost will be reduced by the compensation payments received in relation to that land. That is, the cost base of the land will be reduced by the compensation payments and any gain or loss will crystallise at a later time when the land is disposed of.

Question 4

Paragraph 118-37(1)(b) allows a capital gain to be disregarded if it is compensation or damages you receive for any wrong, injury or illness you suffer personally.

The amounts received for the Noise Impacts have been paid to Person B to compensate them for the impacts of the activities on their personal use and enjoyment of the principle place of residence and their personal displacement generally.

Adopting the 'look through' approach the relevant asset to which these compensation amounts relate is your right to seek compensation and not any other underlying asset, such as the land.

Normally, a payment for surrendering the right to seek compensation would be assessable as a capital gain; however, in this instance, the right relates to a wrong which Person B have suffered personally. Therefore, the capital gain incurred by Person B will be disregarded under paragraph 118-37(1)(b) of the ITAA 1997.

Question 5

Where a business receives compensation the question to address is whether this receipt gives rise to a GST liability to a business that is registered for GST. The starting point with respect to GST is to determine if the compensation is consideration for any supplies that the business has made. The landholder has become entitled under the state mining legislation to receive compensation for certain kinds of loss caused by Origin upon entry to their land. The relevant section of the state mining legislation provides that the owner of any land upon which mining operations are carried out is entitled to receive compensation for any economic loss, hardship and inconvenience suffered by the landholder as a consequence of mining operations.

In determining the compensation payable under the mining legislation, regard is given to a number of matters including any damage caused to the land by the mining operator. The amount of the compensation is an amount determined by agreement between the landholder and the mining operator. The quantum of compensation payable is not dependent on a landholder's time and effort in being a party to any of the agreements.

For a supply to be subject to GST, the supply must be a taxable supply. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides:

You make a taxable supply if:

(a) you make a supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is connected with Australia; and

(d) 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.'

(as defined in section 195-1 of the GST Act)

The meaning of 'supply' is defined in subsection 9-10(1) GST Act as any form of supply whatsoever. Subsection 9-10(2) GST Act then provides a non-exhaustive list of types of supplies. It is evident that for there to be a taxable supply, the landholder must make a 'supply for consideration' under paragraph 9-5(a) GST Act.

The term 'supply' is defined in subsection 9-10(1) GST Act as 'any form of supply whatsoever' and includes a grant, assignment or surrender of real property (paragraph 9-10(2)(d) GST Act). Goods and Services Tax Ruling GSTR 2001/4 deals with the GST consequences of court orders and out of court settlements and discusses the meaning of 'supply'. Paragraph 22 of that ruling provides that a supply is essentially 'something which passes from one entity to another'. Paragraph 25 of GSTR 2001/4 goes on to state:

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.

Therefore, the term 'supply' covers not only the subject of the transaction - the thing that passes - but also includes the action by which the thing passes from one entity to another. In addition, by using the word 'make' in the phrase 'you make the supply' in paragraph 9-5(a) GST Act, there is a requirement for a supplier to take some action to cause a supply to be made. As such the landholder must take some positive action or do something for a supply to occur.

The key issue is whether the landholder makes any supply when they receive compensation. Normally the transfer or surrender of the legal interest in land is covered by the definition of supply in section 9-10 of the GST Act. Of course landholders can only transfer or surrender rights in land that they own. In the case of mining rights, the landholder does not transfer or surrender their rights related to mining on the land to the mining company because the mining company is already the holder of these rights as they were vested in the mining company upon the grant of the statutory authority by the State Government.

Based on the facts, the payment to the landholder is in respect of compensation for any damages caused or likely to be caused to their land and any inconvenience suffered by the landholder as a consequence of the activities carried out by the mining company on their land.

Goods and Services Tax Ruling GSTR 2001/4 states, in relation to compensation and 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.

In conclusion, 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.

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