Edited version of private advice

Authorisation Number: 1052015581914

Date of advice: 1 September 2022

Ruling

Subject: Compensation - permanent damage/reduction in the value of an underlying pre-cgt asset

Question

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

Answer

No

Question 2

Will the annual payment from the company under the compensation agreement be assessable as a capital gain under Part 3-1 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

Year ending 30 June 20YY

The scheme commences on:

DD MM YYYY

Relevant facts and circumstances

Prior to 1985 you acquired land.

From the time of acquiring the land you have used it to produce income.

You and a company entered into various agreements where:

•                     the parties agreed various rights and obligations between them with respect to activities on your land

•                     you consented to the company carrying out activities on the land, and

•                     the company agreed to pay compensation to you in respect of those activities.

In accordance with the agreements some of the activities have been completed while other activities are ongoing.

You entered into a subsequent agreement under which you will receive an annual compensation payment.

The compensation payment was framed with reference to:

•                     the deprivation of use of part of the natural surface of the land

•                     the damage to the natural surface of part of the land

•                     the severance of part of the land from other parts of the land, and

•                     social disruption, including traffic and conveyor noise, dust and visual pollution.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Ordinary Income

Your assessable income includes income according to ordinary concepts, which is called ordinary income under section 6-5 of the ITAA 1997.

Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Statutory income is separate to ordinary income and includes payments relating to capital.

Compensation payments may be assessable as statutory income under section 6-10 of the ITAA 1997 if a CGT event happens. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) considers the CGT consequences for a recipient of compensation, and whether the amount should be included in the assessable income of the recipient under Part 3-1 of the ITAA 1997.

According to paragraph 5 of the TR 95/35, a compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

•                     in relation to any underlying asset;

•                     arising out of Court proceedings; or

•                     made up of dissected amounts.

To determine the correct taxation treatment of a compensation receipt, the Commissioner adopts a look-through approach to the transaction or arrangement which generates the compensation receipt.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to an underlying pre-CGT asset of the taxpayer, or for permanent reduction in the value of an underlying pre-CGT asset, there will be no CGT consequence of the compensation payment. Paragraph 2 of TR 95/35 states that permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right. Alternatively, if the 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.

It is considered that the decisions in Nullaga Pastoral Company Pty Ltd v FC of T 78 ATC 4329; (1978) 8 ATR 757 and Barrett v Federal Commissioner of Taxation [1968] HCA 59; (1968) 118 CLR 666; 15 ATD 149; 10 AITR 685 are relevant in relation to identifying the most relevant underlying asset. In both of those cases the landholders were conducting ongoing successful farming operations. The payments were held to be compensation for damage to property which formed part of the profit yielding structure of the landholders.

Having regard to your entire circumstances we consider that the annual compensation payment you receive the agreement relates to a reduction in the value of, and/or permanent damage to, an underlying asset (the land) which forms part of your profit yielding structure. In reaching this conclusion we have had regard to the following:

•                     compensation under subsection 123(2) of the Mining Act 1978 (WA) (the Mining Act) is only available to you by virtue of your ownership of the land

•                     the large majority of the heads of damage for which you can receive compensation relate clearly to the effect of the mining activities on the land, see subsection 123(4) of the Mining Act:

•                     the compensation clearly relates to damage to the land and this has been relied on in negotiating the compensation amount. As per paragraph 3 of TR 95/35 permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

•                     The annual payment was negotiated as part of a broader lump sum amount in relation to the value of the land and for a XX year period.

In considering all of the factors in this case, the annual payment is not income in nature and will not be assessable under section 6-5 of the ITAA 1997.

Question 2

Summary

The annual payments will not form an assessable capital gain as the payments relate to a pre-CGT asset.

Detailed reasoning

Statutory Income

The compensation payment you receive under the agreement relates to a reduction in the value of, and/or permanent damage to, an underlying asset (the land) which forms part of your profit yielding structure. Consequently, as the land is pre-CGT the payment will take the same character of the asset and be pre-CGT in nature.

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