Authorisation Number: 1011756504765

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Ruling

Subject: Application for a Private Ruling - Compensation

Question 1

Are the initial and annual payments of compensation received for:

· the diminution of the land or any improvements or

· in satisfaction of all present and future claims

assessable in terms of section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are the initial and ongoing payments received in compensation for the diminution of the land or any improvements assessable under the CGT provisions of the ITAA 1997? What is the nature of the CGT event?

Answer

No. The payments fall for consideration under the sub-section 110-45(3) of the ITAA 1997.

Question 3

Is the initial payment of compensation received in satisfaction of all present and future claims assessable in terms of the CGT provisions? What is the nature of the CGT event?

Answer

Yes. The payment received is a capital payment assessable in terms of section 104-25 of the ITAA 1997 (CGT event C2).

Question 4

Are camp site payments received for the temporary use of land to accommodate an operations crew assessable income in terms of section 6-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

1 July 2009 to 30 June 2015

The scheme commences on:

1 July 2010

Relevant Facts

The partnership is the owner and occupier of the property which is be held by a number of partners.

The land has a tenement holder (TH) which holds a particular authority.

The TH will compensate the landowners for any loss or damage caused or to be caused by the industry operations and to otherwise meet all present and future compensation in respect of the operations.

The Compensation Agreement (CA) states that the TH shall pay or cause to be paid in full and final satisfaction of all present and future compensation liability caused by operations carried out and the consequential damages incurred because of compensable effects.

The compensable effects include:

· deprivation of possession of all or any part of the surface of the land

· diminution in value of the land or any improvements

· diminution of the use made, or that may be made, of the land and any improvements

· the severance of any part of the land from other parts of the land or from any other land that is owned by the landowner

· any cost or loss arising from the carrying out of the operations of the land

· rehabilitation of the land in satisfaction of the requirements of the Environmental Protection Act 1994 (Qld) and

· full and final satisfaction of all present and future claims resulting from the operations

In addition to the payment of compensation the TH has agreed to rehabilitate the land.

The partners and the TH agree that the compensation payable shall be in full satisfaction of all present and future claims which the partners may have resulting from the operations.

It is agreed that should there be any material change in circumstances that the CA does not affect the rights of either party to have the CA reviewed by the courts.

The compensation payment is being made as an upfront payment followed by annual payments.

The upfront payment is to be made within 30 days from the date of the agreement.

The annual payments will be made within 30 days of the end of June in each calendar year. The initial annual payment will be made if construction of an identified item of infrastructure has commenced upon the land in the 12 months preceding 30 June. The final annual payment will be made when the infrastructure has been rehabilitated and remediated in the 12 months preceding 30 June.

The property locations which are the subject of compensation are:

· X which is the subject of an upfront and annual payment.

· Y which is the subject of an upfront and annual payment.

· Z which is the subject of an annual payment only.

In the absence of an apportionment of compensation payments between the diminution of the land and any improvements and the disposal of the right to seek further compensation, the partners have apportioned $10 of the upfront payment for the disposal of the right to seek further compensation

If the TH constructs and operates on the land a temporary camp site for the purposes of a small works camp to accommodate a crew during operational activities the TH will pay the sum of $XXX within 30 days each time the camp becomes operational.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 6-5

section 104-25

section 104-35

section 110-25

section 110-45

section 116-40

Reasons for decision

Question 1

Summary

Payments received in compensation are generally treated as a substitute for that for which it is paid. The receipt of compensation for the diminution in the value of the land and in satisfaction of all present and future claims would represent payments in the nature of capital and would not be included in the ordinary income of the business.

Detailed reasoning

Section 6-5 of the ITAA 1997 deals with the receipt of ordinary income. Ordinary income is defined to mean income according to ordinary concepts. It does not operate to include in a taxpayer's assessable income amounts of a capital nature.

Whether a lump sum or other compensation payment constitutes assessable income in the hands of the recipient depends on whether it is a receipt of a capital or income nature which in turn depends upon a consideration of all the circumstances surrounding the payment. It is the character of the receipt in the hands of the recipient that must be determined. For income tax purposes, a compensation amount generally bears the character of that which it intends to replace.

There is no definition of 'ordinary income' in income tax legislation.  In determining whether an amount is ordinary income, the courts have established the following principles:

· what receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as statute dictates otherwise;

· whether the payment received is income depends upon a close examination of all relevant circumstances; and

· it is an objective test.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient (Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; Hayes v. Federal Commissioner of Taxation (1956) 96 CLR 47; Federal Coke Co Pty Ltd v. Federal Commissioner of Taxation (1977) 7 ATR 519; 77 ATC 4255).

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 Pipecoaters), the Full High Court stated at CLR 138; ATR 7; ATC 4420:

To determine whether a receipt is of an income or of 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.

Payment for the loss of a capital asset or an enduring part of a taxpayer's profit-yielding structure will be capital in nature (Glenboig Union Fireclay Co Ltd v. IR Commrs (1922) 12 TC 427). The receipt of the compensation payments are neither a normal incident of your partnership business nor is it paid for a purpose for which your partnership business was carried on.

In Barrett v FC of T (1968) 118 CLR 666; 42 ALJR 235, the right to mine soapstone was exercised on Barret's land. Barrett received an amount of money to compensate for damage to and loss of value to the land and inconvenience to Barrett. Owen J held that this amount had a capital nature.

Similarly, in Nullaga Pastoral Co Pty Ltd v FC of T 78 ATC 4329, the taxpayer owned a farming property which two other companies, as joint venturers, wished to explore for bauxite. An agreement was negotiated whereby the joint ventures were granted exploration rights for five years and, as consideration for those rights, the taxpayer was to receive $10,000 annually. Wickham J said that the agreement had hardly any of the characteristics of a lease and that in his opinion the amounts were paid and received as consideration for the deprivation of part of the capital asset and in order to replace that capital. The receipts were therefore of a capital nature notwithstanding the periodicity of the payments.

Accordingly, the initial and annual payments received as per the CA are considered a capital receipt, not ordinary income and therefore are not assessable income under section 6-5 of the ITAA 1997.

Question 2

Summary

Compensation received for the diminution of the land or any improvement is considered a reduction in the cost base of the underlying asset in terms of section 110-45(3) of the ITAA 1997

Detailed reasoning

You entered into a CA with the TH and will receive payments in recognition of the permanent effects of the TH's land usage.

Taxation Ruling TR 95/35 is the most relevant ruling dealing with compensation receipts. Paragraph 3 of TR 95/35 reads:

The look through approach is the process of identifying the most relevant asset. It requires an analysis of all 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.

Under TR 95/35 there are three main issues to contemplate:

· actual disposal of the underlying asset

· no disposal of the underlying asset but compensation for permanent damage or reduction to that asset

· no disposal of the underlying asset but compensation for giving up the right to seek compensation.

Compensation for the disposal of an underlying asset

Paragraph 4 of TR 95/35 states that 'if an amount 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'.

Therefore, it is necessary to show that there is an actual disposal of the underlying asset (in this case the land subject to the agreement), and also that the receipt is wholly in respect of that disposal.

The company has the right to use your land but we do not consider that there has been an actual disposal of the land.

No disposal of the underlying asset, but permanent damage to, or permanent reduction in the value of, the underlying asset

In the CA it is stated that the compensation relates in part to the diminution of the value of the land. This would mean that damage will be suffered as a result of the right granted which would amount to permanent reduction in the value of the land, as per the provisions of TR 95/35.

The term 'permanent damage or reduction in value' is defined in paragraph 3 of TR 95/35 as not meaning an everlasting damage or reduced value, but damage or value reduction which will have permanent effect unless some action is taken by the taxpayer to put it right.

Where the compensation received relates to land acquired after 19 September 1985 (post CGT land) and using the 'look through' approach, if the compensation relates to permanent damage to it, or a permanent reduction in its value, then the cost base of the asset is reduced accordingly.

Section 116-40 of the ITAA 1997 states that where a payment is received in connection with a transaction that relates to more than one CGT event, the capital proceeds from each event are so much of the payment as is reasonably attributable to that event.

It is on the basis of this section of legislation that you have made an apportionment based on reports that indicate that the infrastructure on the land significantly reduces the value of the land and its ability to be sold.

The amount of compensation received (by upfront or annual payment) attributed to the permanent reduction in the value of the land would be treated as a recoupment of the asset's acquisition cost under subsection 110-45(3) of the ITAA 1997. This means that the cost base of the land is reduced for the purposes of calculating the capital gain or loss of any future capital gains tax event involving the land which is the subject of the compensation payments.

Question 3

Summary

There has been no disposal of an underlying asset but there has been a disposal of the right to seek compensation which is assessable in terms of section 104-25(1) of the ITAA 1997.

Detailed reasoning

Section 116-40 of the ITAA 1997 states that where a payment is received in connection with a transaction that relates to more than one CGT event, the capital proceeds from each event are so much of the payment as is reasonable attributable to that event.

It is on the basis of this section of legislation that the receipt of compensation has been attributed to the extent of $10 of the initial upfront payment for the disposal of the right to seek compensation. The right to seek compensation is an asset for the purposes of the CGT provisions. The creation of the right caused CGT event D1 to happen under section 104-35 of the ITAA 1997.

CGT event C2 (section 104-25 of the ITAA 1997) happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered and this can include when compensation is paid to discharge the right to seek compensation. 

Subsection 104-25(1) of the ITAA 1997 states:

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

(a) being redeemed or cancelled; or

(b) being released, discharged or satisfied; or

(c) expiring; or

(d) being abandoned, surrendered or forfeited; or

  ...

Any capital gain arising on the disposal of that right is calculated using the cost base of that right.

The cost base of a CGT asset is determined in accordance with the provisions of Division 110 of the ITAA 1997. Section 110-25 of the ITAA 1997 lists the elements comprising the cost base of an asset.

TR 95/35 states that the cost base of the right to seek compensation includes the total acquisition costs incurred as a result of which the right to seek compensation arose. Money and/or property given in respect of the acquisition of the asset come within the cost base if there is a direct and substantial link between the expenditure and the arising of the right to seek compensation.

As the right is acquired at the time of the breach or injury, then any costs incurred on or after that time and which have a substantial link to the acquisition of the right are included in the cost base.

Question 4

Summary

The receipt of $XXX from the intermittent use of land as a temporary camp site to accommodate a working crew during operational activities is income in the nature of rent and as such is assessable in terms of section 6-1(1) of the ITAA 1997.

Detailed reasoning

Section 6-1(1) of the ITAA 1997 states that assessable income consists of ordinary and statutory income. Section 6-5(1) ITAA 1997 states that ordinary income is defined to mean income according to ordinary concepts.

The courts have identified a number of characteristics which indicate whether an amount has the character of income according to ordinary concepts, which include:

· element of periodicity;

· attributable to employment or services rendered or an interest in property;

· being expected and relied upon.

The Macquarie Dictionary defines rent as:

· a return or payment made periodically by a tenant to an owner for the use of land or building.

· a similar return or payment for the use of property of any kind.

· to grant the possession and enjoyment of (property) in return for payments to be made at agreed times.

The camp site payments will be received in exchange of the use of the premises. The payments are not for the granting of a lease nor for anticipated damages caused to the property to utilised.

It is generally accepted that rent is ordinary income and included in assessable income under section 6-5 of the ITAA 1997. In determining whether or not a payment is rent, it is the reality or substance of the matter, rather than the label given by the parties to the transaction which is decisive (Ex parte Lathouras; Re Vendardos [1964-1965] NSWR 254).