Edited version of private advice

Authorisation Number: 1051930735588

Date of advice: 13 December 2021

Ruling

Subject: Compensation

Question 1

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

Answer

No.

Question 2

Is the compensation payment regarded as an assessable allowance under section 15-2 of the ITAA 1997?

Answer

No.

Question 3

Is the compensation payment regarded as an assessable recoupment under subdivision 20-A of the ITAA 1997?

Answer

No.

Question 4

Is the compensation payment assessable as a royalty under section 15-20 of the ITAA 1997?

Answer

No.

Question 5

Will the receipt of the compensation payment be capital proceeds in relation to a capital gains tax (CGT) event D1 occurring?

Answer

No.

Question 6

Will the receipt of the compensation payment be capital proceeds in relation to a capital gains tax (CGT) event A1 occurring?

Answer

Yes.

Question 7

Is GST payable by you on the compensation you receive under the agreement to grant an Option for Easement to the Entity B?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You own property.

You are registered for GST

You have engaged in negotiations with entity A to erect an easement through several of your properties for the construction of a new facility.

Entity A acts on behalf of entity B.

As highlighted in the letter dated xxxx to you from entity A, the acquisition of easement over the property has identified the relevant property (the property).

You purchased the property in xxxx, after 1985 and is xxxx hectares of farmland. The property has been used by you over the last xx years for business activities.

The proposed easement will be xxxx metres wide on the terms set out and will be located within the boundaries of the xxxx metres wide corridor. The final easement location will be defined once the detailed design process is complete.

The letter commences the minimum negotiation period with you that is required under the relevant legislation.

To compensate you for the loss of land and limited use of those surrounding the new structure, entity A initially intended to pay you an amount of $xxxx (Offer Amount) for the easement. However the estimate of compensation was amended on xxxx to be $xxxx.

These amounts evolved from an independent valuer. The assessment related to the proposed acquisition of partial property rights by way of a new easement totalling approximately xxxx hectares of your property initially, now amended to approximately xxxx hectares. The easement is necessary for the construction of the facility. The date of the initial estimate of compensation was xxxx and totalled $xxxx.

The amended compensation as per xxxx is a total $xxxx.

Additionally entity A will pay your reasonable legal and valuation fees (should you choose to instruct a lawyer and/or valuer).

If agreement is not reached following the stated period after the initial offer or letter of intent is issued, entity A may take steps towards compulsory acquisition under the relevant legislation.

A letter to you from entity A dated xxxx provided the updated offer of compensation details and advises that they wish to upgrade the facility. It is now entity A's intention to negotiate beyond the stated minimum negotiation period.

Entity A proposes to enter into an Option for Easement Agreement (Option) with you, for which you will be paid $xxxx once you execute that agreement.

This allows flexibility for the Easement to be located anywhere within the corridor if the Option is exercised.

You advised you intend to enter into the option agreement to grant the easement.

Details of the Option and compensation are outlined in the provided documentation.

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 10-5

Income Tax Assessment Act 1997 section 15-2

Income Tax Assessment Act 1997 section 15-20

Income Tax Assessment Act 1997 Subdivision 20-A

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 section 116-20

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

A New Tax System (Goods and Services Tax) Act 1999 section 9-20

Reasons for decision

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that are earned, are expected, are relied upon, and have an element of periodicity, recurrence or regularity.

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, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

The compensation payment is not earned by you as it does not relate to services performed or from carrying on a business. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from any personal services performed or business activity. Furthermore, although the compensation relates to your property, the payment is not akin to rent.

The compensation payment is capital in nature and is not ordinary assessable income under section 6-5 of the ITAA 1997.

Statutory income

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997 and include capital gains, which are included in assessable income by virtue of the capital gains tax (CGT) provisions. These provisions also include section 15-2 of the ITAA 1997 which deals with allowances and other things provided in respect of employment or services and Subdivision 20-A of the ITAA 1997 which deals with assessable recoupments.

Whether or not a particular receipt is ordinary income or statutory income depends on its character in the hands of the recipient.

Allowances and assessable recoupment

Section 15-2 of the ITAA 1997 relates to allowances, compensation and other things provided in respect of employment of services. No part of the compensation is in respect of or related to any employment or services rendered by you. Therefore, your payment is not assessable under section 15-2 of the ITAA 1997.

The payment is not regarded as an assessable recoupment under subdivision 20-A of the ITAA 1997, as it does not relate to a deductible loss or outgoing.

Section 80-15 of the ITAA 1997 relates to the transfer of property affecting employees and other taxpayers receiving PAYG withholding payments. This section is not relevant in your circumstances.

Royalties

Under section 15-20 of the ITAA 1997 your assessable income includes an amount that you receive as or by way of royalty within the ordinary meaning of "royalty" (disregarding the definition of royalty in section 995-1) if the amount is not assessable as ordinary income under section 6-5.

The Commissioner's view on the definition of a royalty is set out in Taxation Ruling IT 2660: Income tax: definition of royalties. The ordinary meaning of the term royalty has been considered by the Courts on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that:

...the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken.

Paragraph 10 of IT 2660 provides that in the Commissioner's view there are four key characteristics of a common law meaning of royalty:

•         it is a payment made in return for the right to exercise a beneficial privilege or right, for example to remove minerals or natural resources such as timber (McCauley v. FC of T (1944) 69 CLR 235);

•         the payment is made to the person who owns the right to confer that beneficial privilege or right (Barrett v. FC of T (1968) 11 CLR 666);

•         the consideration payable is determined on the basis of the amount of use made of the right required (McCauley, Stanton); and

•         the consideration will usually be paid as and when the right acquired is exercised. However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired (IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272).

In your case the payment is not regarded as a royalty.

Capital gains tax and compensation

Section 102-5 of the ITAA 1997 provides that your assessable income includes a net capital gain. A capital gain or loss is made only if a CGT event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset.

An easement is a right over someone else's land or property. The taxation treatment of a payment for the granting of an easement depends on whether the easement has been created by compulsory acquisition or as a voluntary action.

Taxation Ruling TR 97/3 Income tax: capital gains: compensation received by landowners from public authorities provides relevant guidelines. Paragraphs 9 and 10 of the ruling discuss easements granted to a public authority which has the statutory power to compulsorily acquire the easement and state:

9. The acquisition of an easement by a public authority using the compulsory process provided in the relevant statute culminates in a declaration by notice in the Gazette that the easement has been acquired. However, it is possible that a public authority may acquire an easement by agreement with the landowner. One of the features which the various statutes have in common is encouragement of acquisition by agreement.

10. Because the easement is created in these circumstances by grant by the landowner there is scope for an argument that subsection 160M(6) applies. However, because the grantee of the easement (the public authority) has available, if it chooses to exercise it, the power to compulsorily acquire the easement, the amount received, in our view, takes on the same character as compensation for a compulsorily acquired easement. It is therefore appropriate that Part IIIA apply in the same way, that is, the consideration (compensation) is paid in respect of the part disposal of the land and not in respect of the grant of the easement.

160M(6) of the Income Tax Assessment Act 1936 has been replaced with section 104-35 of the ITAA 1997 and is about creating contractual or other rights and CGT event D1.

That is, as outlined in paragraph 11 of TR 97/3, CGT event D1 applies to the voluntary grant of an easement, and CGT event A1 applies to the compulsory acquisition of easements by government authorities (see paragraphs 4, 9 and 10 and TR 95/35) and where compensation is received for imposing limits on a taxpayer's use of the land (see paragraphs 12-14).

Compensation received by a landowner in respect of a reduction in the value of land resulting from limitations on the owner's use of the land imposed by statute is treated by the ruling in the same way as compensation for a compulsorily acquired easement.

TR 97/3 also makes the point that it is to be read in conjunction with Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts. In this context, TR 97/3 states that "the compensation received by a landowner from a public authority that compulsorily acquires an easement is not excluded from" the "look through approach" in TR 95/35, and that compensation received for the grant of involuntary easements will not be "consideration received for the disposal of any other asset, such as the right to seek compensation (see paragraph 7).

That is, where easements are acquired under statute, the underlying asset is your pre-existing land with its rights of ownership, including the right to exclude all others. This right to exclude all others is forfeited when the easement comes into existence.

Consequently, CGT event A1 will occur, as there will be a disposal of a CGT asset namely rights held over the land.

It your case, entity A has the legislative power to compulsorily acquire the easement. The fact entity A can compulsory acquire, despite not having to use that power, pushes it to a CGT A1 event rather than a D1 event as per paragraph 10 of TR 97/3.

Thus, the payment of compensation to be received from entity A is considered to be capital proceeds for the part disposal of the Land. Any gain you made is assessable as a capital gain.

Accordingly, as your land was acquired after 20 September 1985, part of the cost base of the land will be attributed to the easement.

As there has been a compulsory acquisition no new asset has been created with the granting of the easement, rather rights relating to the land have been disposed of. These rights have been held for longer than 12 months so you will be eligible to the general discount under Division 115 of the ITAA 1997.

Under subsection 116-20(1) of the ITAA 1997, the capital proceeds from a CGT event are the total of:

(a) the money you have received, or are entitled to receive, in respect of the event happening; and

(b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

Therefore, even though the compensation payment breaks up the payment to include a different components, it is considered that the whole compensation payment is in respect of the disposal of your underlying asset, or part of the underlying asset and the whole compensation payment represents capital proceeds received on the disposal of that asset.

GST

GST is payable by you where you make a taxable supply.

You make a taxable supply where you satisfy the requirements of section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), which states:

You make a taxable supply if:

a)    you make the 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.[1]

Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9) reflect the principle that in order for an entity to be considered to be making a supply, it must take some action. Paragraphs 80 to 91 of GSTR 2006/9 state:

Extinguishment of real property rights

80. Various government authorities are empowered by legislation to acquire an interest in real property. Two common mechanisms employed by legislation are:

•         the vesting of the interest in the relevant government authority and extinguishing any previous interests in the real property; and

•         the particular statute may allow the government authority to acquire the real property by agreement.

Vesting in the government authority

81. An example of vesting is provided by section 20 of the Land Acquisition (Just Terms Compensation) Act 1991 (NSW), where the required acquisition notices are gazetted, the relevant land is:

•         vested in the authority of the State acquiring the land'; and

•         'freed and discharged from all estates, interests, trust, restrictions, dedications, reservations, easements, rights, charges, rates and contracts in, over or in connection with the land'.

The entity whose interest in the land is extinguished is compensated for the loss of that interest. That entity may agree to the compensation determined by the Valuer-General and execute a form of release. If the entity disputes the compensation amount, there is provision for payment of 90% of the initial valuation until the matter is resolved.

82. The effect of the gazettal notice is that the legal ownership of the land, described in the notice, is vested in the authority acquiring the land, and that the land becomes freed from any other interests. The entity's interest in the land, whether legal or equitable, is extinguished. When land vests in an authority in consequence of a gazettal notice, it is necessary to examine the relevant facts and circumstances to determine whether or not the owner makes a supply of the land to the authority. In cases where land vests in the authority as a result of the authority seeking to acquire the land, and initiating the compulsory acquisition process pursuant to its statutory right, then the owner does not make a supply because it takes no action to cause its legal interest to be transferred or surrendered to the authority.

82A. However, in other cases the owner may do something or undertake some action such that it does make a supply of the land that vests in the authority. For example, see the decision in Re Hornsby Shire Council v. Commissioner of Taxation in which the Administrative Appeals Tribunal found that, in the circumstances the owner, CSR Limited, made a supply of its land by way of entry into an obligation and the surrender of its land when it issued a notice, pursuant to statute, compelling the Hornsby Shire Council to acquire its land.

83. Some statutes provide that land remaining, where only part of the land (the 'target land') is to be compulsorily acquired, will also be compulsorily acquired if the owner and the acquiring authority agree that the remaining land will be of no practical use or value to the owner. In cases where, prior to the vesting of the target land, the owner and authority agree that the remaining land will also be acquired, and the remaining land is acquired contemporaneously with the target land, it is the Commissioner's view that the owner does not make a supply of the remaining land to the acquiring authority. Although the owner may have requested that the remaining land be acquired, the agreement reached between the parties, and the resulting acquisition of the remaining land is integral, ancillary or incidental to the compulsory acquisition of the target land.

83A. In contrast to the circumstances described in paragraph 83 of this Ruling, the land owner may, at a time subsequent to the authority's acquisition of the target land, request that the authority acquire the remaining land on the basis that it is of no practical use or value to the owner. Consistent with the decision in Re Hornsby Shire Council v. Commissioner of Taxation, in these circumstances it is the Commissioner's view that the owner has taken some action by requesting that the remaining land be acquired and makes a supply of the remaining land by way of surrender to the authority. In such cases, the acquisition of the remaining land is not integral, ancillary or incidental to the authority's compulsory acquisition of the target land.

84. Mere acceptance by an owner of an amount of compensation payable on the compulsory acquisition does not provide a sufficient nexus between the land which passes and the means by which it passes. The fact that the owner does not dispute the acquisition is not an activity that effects the supply of the land. Even if the owner agrees to the terms of the acquisition and the amount of compensation, the land is acquired by operation of the statute, upon publication of the acquisition notice, not by an action taken by the landowner.

Example 1: compulsory acquisition

85. A government authority is compulsorily acquiring land and interests relating to that land, including the native title rights under a particular statute. The effect of compulsory acquisition is that every registered and unregistered interest in the land is extinguished, and each person who formerly held such an interest has that holding converted into a claim for compensation.

86. As required by the statute, the authority has made a public announcement that it is acquiring the land, and as a result, a number of groups of claimants have registered their respective native title over the land.

87. The authority has negotiated with each of the claimant groups as required by the statute, as to just compensation for the extinguishment of their rights over the land, and has entered into a deed with them. The deed sets out, among other things, that:

•         the claimants accept the compulsory acquisition and extinguishment of any and all native title rights and interests in the land and agree to withdraw a related objection made under the statute to compulsory acquisition; and

•         the authority undertakes to provide compensation to the native title claimants in the form of funding, land and certain services.

88. Although the claimants have agreed to accept the compulsory acquisition and the amount of the compensation, the agreement does not cause claimants' rights to be extinguished. These rights over the land are extinguished when all the limitations, reservations and restrictions over the land are revoked by the operation of the statute. The claimants are not making a supply of surrendering their rights.

89. It may be argued that the native title claimants are making a supply of entering into an obligation to withdraw any objections made under the relevant native title statute. However, no part of the compensation is consideration for a supply of withdrawing objections to the compulsory acquisition. The compensation relates to the loss suffered by the claimants on the extinguishment of their interest in the land.

90. In contrast, the extinguishment of an owner's interest by statute needs to be distinguished from the doing of a thing that is compelled by statute.

Acquisition by agreement under a standard land contract

91. It may transpire that, before a compulsory acquisition under a statute is made, an owner and an authority enter into negotiations that result in the owner selling land under a standard land contract. The land in this case is not vested in the authority through the compulsory acquisition process. Instead, the interest in the land transfers as a result of settlement of the contract and execution of a transfer instrument. As such, the owner makes a supply of land to the authority.

Entity B could have legally compulsorily acquired the easements in your case. In accordance with the principles in paragraphs 80 to 91 of GSTR 2006/9, if it had done so, you would not have been considered to have taken any action to supply the easement to entity B. Therefore, under such circumstances, you would not have made a supply of easements.

However, in your case you have specified that you intend to accept the option agreement, instead of entity B exercising their compulsory acquisition powers.

Therefore, in this case, there is a supply, being the granting of the easements. There is a sufficient nexus between the supply of the easement and the compensation because these monies are paid for the granting of the easements.

Therefore, the compensation payment is consideration for a supply. Hence, the requirement of paragraph 9-5(a) of the GST Act is met.

You make this supply in the course or furtherance of your enterprise as the supply is incidental to your enterprise given that you are granting an easement over your land. Hence, the requirement of paragraph 9-5(b) of the GST Act is met. The supply is connected with Australia. Therefore, the requirement of paragraph 9-5(c) of the GST Act is met. You are registered for GST. Therefore, the requirement of paragraph 9-5(d) of the GST Act is met.

Therefore, as all the requirements of section 9-5 of the GST Act are satisfied, and the supply does not satisfy any of the GST-free or input tax provisions in the GST Act, you are making a taxable supply. Therefore, you are liable to remit 1/11^th of the compensation payment you receive for this taxable supply.

[1] *Denotes a term defined in section 195-1 of the GST Act.

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