Edited version of private advice

Authorisation Number: 1052174349634

Date of advice: 13 October 2023

Ruling

Subject: Taxation treatment of compensation payments

Question 1

Will the receipts under the three Conduct and Compensation Agreements (CCAs) constitute assessable income in accordance with section 6-5 Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

To the extent that the receipts under the CCAs do not constitute assessable income in according with section 6-5 of the ITAA 1997, will the receipts of these amounts constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT evening happening?

Answer

No.

Question 3

To the extent that the receipts under the CCAs do not constitute assessable income in accordance with section 6-5 of the ITAA 1997 and do not constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening does any compensation received under the CCAs reduce the cost base of the property/land under Subdivision 110-A of ITAA 1997?

Answer

Yes.

Question 4

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

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

DD MM 20XX

Relevant facts and circumstances

Person A (you) and the Partnership have entered into Conduct and Compensation Agreements (CCAs) with ABC for the construction of coal seam gas (CSG) activities on the Property.

You are the legal Owner of the Property and the Partnership, the occupier, carrying on a livestock breeding and grazing business on the Property. You and the Partnership are defined as the Landholder in each of the CCAs.

The Property comprises of X lands.

Two thirds of the Property were acquired by you prior to 20 September 1985 and the remaining one thirds was acquired by you after 19September 1985. The Property including cattle handling facilities and fencing is very well maintained and the pasture is predominantly improved so that the carrying capacity of the Land is optimised.

You advised there is no formal lease agreement in place between you and the Partnership and the arrangement could be described as a tenancy at will.

The prospect of the proposed CSG activities and related infrastructure on the Property may cause permanent diminution in the productive capacity for the primary production business and the market value of the Land. Therefore, you and the Partnership entered into CCAs with ABC prior to the construction activities to be carried out commencing during 20XX. The details of each CCAs are as below:

...

The Title and Background of the three CCAs are as follows:

...

The CCAs provide compensation for the impact of the X CSG production wells and substantial associated infrastructure, the placement of the ABC Processing Facility on the Property with associated infrastructure and the placement of the petroleum pipeline on the Property with associated infrastructure.

The CCAs define the term Petroleum Legislation to mean 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)

The CCAs are conduct and compensation agreements under the Petroleum Legislation and this includes an alternative arrangement for Nosie Impacts under the Environmental Authority and includes a Waiver of Entry Notice under Mineral and Energy Resources (Common Provisions) Act 2014 (Qld).

You advised that you had the opportunity to seek advice before signing the agreements and ABC will compensate you the professional costs under the Petroleum Legislation.

Under CCAs, the activities reasonably associated with the construction, operation, maintenance, of X wells on the Land are proposed to be carried out as follows:

...

The compensation amounts in CCAs relate to the compensatable effects of carrying out the activities listed in CCAs.

The compensation under the CCAs is paid in accordance with the Petroleum Legislation.

Subsection 81(4) of the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) defines compensatable effect as being:

(a)  all or any of the following relating to the eligible claimant's land

(i)            deprivation of possession of its surface;

(ii)           diminution of its 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 damages the eligible claimant incurs because of a matter mentioned in paragraph (a).

All of the compensation is designed to compensate you as the Owner of the Land for the permanent damage caused by the activities under the CCAs. Accordingly, all compensation payments under the CCAs will be received by you as the Owner of the Land.

You are giving up your rights for further compensation upon commencing the CCAs as states in part:

...

CCAs provides the following in relation to the minimum compensation to be received by the Landholder for the permanent damage to the Land:

...

The CSG related activities on the Property will be part of an overall network of CSG activities carried on in the district by ABC and additional work is expected to connect the CSG gathering system on the Property with the gathering system on neighbouring properties.

Under the CCAs the Landholder should not interfere with or damage the infrastructure or carry out high risk activities that have the potential to damage the underground or overground infrastructure. High risk activities may include cultivating, digging or ploughing close to CSG infrastructure including gas flow lines and water flow lines. These prohibitions may impact on the Landholder's ability to maintain good soil health in the long term and thus permanent damage to the Land.

The general conditions in the CCAs also make reference to the impact of weeds on the Property and provides that ABC have a general biosecurity obligation to ensure that their activities do not present a biosecurity risk.

No amount of the compensation received is to compensate for temporary disturbance to the cattle nor the Partnership for their temporary loss of income.

ABC has responsibility for the rehabilitation or decommissioning and rehabilitation under the CCAs.

The following table provides a summary of the different categories of land that may be identified as resulting from the proposed CGS activities under the CCAs on the Property.

Table 1: The following table provides a summary of the different categories of land that may be identified as resulting from the proposed CGS activities under the CCAs on the Property.

The CCAs further describes the Category of Land.

The terms in regards to the Goods and Service Tax (GST) are considered under CCAs. In all CCAs, these terms provide:

•         All amounts referred to in these Agreements are stated on the GST exclusive basis, unless otherwise specified.

•         If GST is imposed in relation to any supply under CCAs by one party to another, the party receiving the supply (Recipient) must pay the GST amount imposed to the party providing the supply (Supplier) at the same time as the party is required to pay the Supplier for the supple, provided:

(i)            the Recipient issues a valid recipient created Tax invoice to the Supplier;

(ii)           the Recipient is satisfied that the Supplier is registered for GST; and

(iii)          for the avoidance of doubt, notice of the GST status of the Supplier will be deemed to have been received by the Recipient when written confirmation of GST status of a Supplier is received and recorded by the Recipient.

•         The Recipient is not obliged to pay GST to the Supplier until 30 Business Days after the recipient created Tax Invoice is issued.

Relevant legislative provisions

Income tax Assessment Act 1997 section 6-5

Income tax Assessment Act 1997 section 6-10

Income tax Assessment Act 1997 Subdivision 110-A

Income tax Assessment Act 1997 Division 116

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

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

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

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

Reasons for decision

Question 1,2 and 3

Summary

The compensation payments you will receive under the CCAs do not form part of your assessable income. They are considered to be compensation received for the permanent reduction in value and damage relating to the land and will be treated as a reduction in the land's cost base.

Detailed reasoning

Compensation payment as ordinary income

Section 6-5 of the ITAA 1997 states that 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.

Paragraph 6 of Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides:

6. Whether a profit from an isolated transaction is income according to ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally 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.

Compensation payments and the capital gains tax (CGT) provisions

Under section 6-10 of the ITAA 1997 provides 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 (TR 95/35) provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset. TR 95/35 provides the following:

3. For the purposes of this ruling the following terms are used:

Compensation receipt

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.

...

Look-through approach

The look-through approach is the process of identifying the most relevant asset. It requires an analysis of all of the possible assets of the taxpayer in order to determine the asset to which the compensation amount is most directly related. It is also referred to in this Ruling as the underlying asset approach.

...

Underlying 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.

...

Compensation for the disposal of an underlying asset

4. 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.

...

Compensation for permanent damage to, or permanent reduction in the value of, the underlying asset

6. If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a CGT underlying asset of the taxpayer or for a permanent reduction in the value of a 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.

Furthermore, under paragraphs 130 to 133 of TR 95/35, it is explained the total acquisition costs of the post-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.

Based on relevant paragraphs of TR 95/35, depending on the type of compensation payments received, those compensations may be capital proceeds under Division 116 of the ITAA 1997 or reduce the cost base of the relevant property/land pursuant to Subdivision 110-A of the ITAA 1997.

Application to your circumstances

In your case, the prospect of the proposed CSG activities and related infrastructure conducted by ABC on the Property may cause permanent diminution in the productive capacity for the primary production business and the market value of the land.

Paragraph 6 of TR 92/3 provides the two elements that are present in determining whether profit from an isolated transaction is ordinary income. For your case, you did not enter into the CCAs to make a profit. Rather, you entered into the CCAs in order to receive compensation for damage that will be caused by the CSG activities.

Accordingly, the compensation payments paid under the CCAs 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 you did not dispose of all or part of the affected land, there are no CGT consequences at the time of entering into the CCAs or receiving the compensation payments.

In addition, the compensation in relation to the pre-CGT land has no CGT consequences for you. The post-CGT land's acquisition cost will be reduced by the compensation payments received in relation to that land. That is, the cost base of the post-CGT land will be reduced by the compensation payments and any gain or loss will crystallise at a later time when the post-CGT land is disposed of.

Conclusion

The compensation payments you will receive under the CCAs are for the permanent reduction in value and damage to the land, and they do not form part of your assessable income pursuant to section 6-5 of the ITAA 1997. In addition, they are not determined as capital proceeds under Division 116 of the ITAA 1997 and will reduce the cost base of the post- CGT land (excluding the pre-CGT lands) when it is disposed under Subdivision 110-A of ITAA 1997.

Question 4

Summary

You will not incur any GST liability on the receipt of compensation amounts under the CCAs since there has been no taxable supply made to ABC.

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 has to be a taxable supply made.

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) explains 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 a consideration for a supply if the payment is 'in connection with' a supply and 'in response to' or 'for the inducement' of a supply of anything. 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.

Paragraphs 106 to 109 of theGoods and Services Tax Ruling GSTR 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (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.

Damages

Paragraph 73 of the GSTR 2001/4 states the following in relation to damages:

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.

Application to your circumstances

In relation to sufficient nexus, the issue is whether you have provided something to ABC, in return for the compensation amounts that you received. You giving up your rights for further compensation upon commencing the agreements raises the issue of whether giving up of a landholder's rights would be a separate supply or as termed in paragraphs 106 to 109 of GSTR 2001/4.

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

You are giving up your 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 you. We do not consider that the giving up of the rights for further compensation is a separate supply from you to ABC since it is not the reason for which the compensation amount is paid.

In regards to damages under the CCAs, you will receive the compensation amounts as a Landholder under state mining legislation, as compensation for any economic loss, hardship and inconvenience as a result of CSG mining activities carried out on the Land by ABC.

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

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

You do not provide ABC with any supply in return for the compensation amounts. As such, the compensation payments made by ABC is not consideration for a supply from you to ABC, and accordingly no taxable supply will be made.

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

Conclusion

You, as the Landholder of the Land, will not incur a GST liability on the receipt of compensation amounts under the CCAs as there has been no taxable supply made to ABC.

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).