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Subject: Capital gains tax - compensation

Question 1

Will the lump sum payment you receive for compensation under a renewed mining lease be treated as compensation for permanent damage to, or permanent reduction in the value of the land?

Answer

Yes

Question 2

If the payment is not treated as compensation for permanent damage to, or permanent reduction in the value of the land, how will the payment be treated?

Answer

Not applicable. The payment will be treated as compensation for permanent damage to, or permanent reduction in the value of the land.

This ruling applies for the following period:

Year ending 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

You own a parcel of land.

One half of the land was acquired by you prior to 20 September 1985. The remaining half of the land was inherited by you post 20 September 1985 on the death of your spouse.

A mining company is seeking to obtain a renewal of a mining lease over part of the land.

Your property will not be disposed of as a result of the application for the renewal of a mining lease.

You will not have access to the land covered by the mining lease for the 20 year period of the lease.

As a part of the process of obtaining a mining lease, the Mineral Resources Act 1989 (MRA) requires that the landowner be adequately compensated.

You have negotiated a compensation agreement with the mining company.

Under the compensation agreement you will receive an undissected lump sum payment from the mining company.

The compensation agreement states:

The Compensation Sum will be paid by the Miner and accepted by the Landowner as compensation for:

· the loss of amenity due to Activities occurring on that part of the Land that is covered by the Mining Lease Area

· diminution of the value of the Land or any improvements thereon

· diminution of the use made or that may be made of the Land or any improvements thereon

· severance of any part of the Land from any other parts thereof or from any other land of the Landowner

· all loss or expense that arises or is likely to arise as a consequence of any matter referred to in this Agreement or as a consequence of the grant and/or conducting Activities on the Renewed Mining Lease

· all sums assessable under sub-sections 281(3) and (4) of the MRA.

You will have no further rights to seek compensation following the receipt of the payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-155 and

Income Tax Assessment Act 1997 Section 110-25.

Reasons for decision

Taxation Ruling TR 95/35 considers the treatment of compensation payments and the capital gains tax (CGT) consequences for the recipient. TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be:

· an underlying asset

· a right to seek compensation

· a notional asset in terms of section 104-155 of the ITAA 1997.

In determining which is the most relevant asset, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt.

Paragraph 3 of TR 95/35 provides definitions for some of the key terms used in the ruling. The definitions provide that 'permanent damage or reduction in value' does not mean everlasting damage or reduced value, but refers to damage or reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

'Underlying asset' is defined as 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 (TR 95/35).

Paragraphs 6 to 9 of TR 95/35 provide the following guidelines on the treatment of compensation for permanent damage to or permanent reduction in the value of the underlying asset:

If an amount of compensation is received by the taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-CGT underlying asset of the taxpayer, and there is no disposal of the 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.

Accordingly, the total acquisition costs of the post-CGT asset should be reduced in terms of section 110-25 of the ITAA 1997 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.

The adjustment of the total acquisition costs effectively reduces those costs by the amount of the recoupment as if those costs had not been incurred.

Compensation received by a taxpayer has no CGT consequences if the underlying asset which has suffered permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985 or is any other exempt CGT asset.

In your case, you are to receive a proposed compensation payment in relation to the renewed mining lease on your land from a mining company as compensation for:

· the loss of amenity due to activities occurring on that part of the land that is covered by the mining lease area

· diminution of the value of the land or any improvements thereon

· diminution of the use made or that may be made of the land or any improvements thereon;

· severance of any part of the land from any other parts thereof or from any other land of the landowner

· all loss or expense that arises or is likely to arise as a consequence of any matter referred to in this agreement or as a consequence of the grant and/or conducting activities on the renewed mining lease

· all sums assessable under sub-sections 281(3) and (4) of the MRA.

On the facts of this case, it is considered that the amount of proposed compensation to be received will have a direct and substantial link with the underlying asset, being the land. Accordingly, it is considered that the proposed compensation amount will be compensation for permanent damage to or permanent reduction in the value of the land.