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Ruling

Subject: Mining compensation payments

Questions:

1. Are the payments received under a compensation deed with XYZ assessable as ordinary income?

Answer: No.

2. Are the payments received under a compensation deed with XYZ assessable under the capital gains tax provisions as capital payments?

Answer: No.

3. Are the payments received under a compensation deed with XYZ considered to be a recoupment of the cost base of the property?

Answer: Yes.

4. Is the payment of compensation that you received subject to GST?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on

1 July 2011

Relevant facts

The individuals in the partnership purchased a property prior to 1985.

The partnership entered into a compensation deed with XYZ in the 2005-06 financial year for activities to be carried out on the property.

The compensation deed was made pursuant to the relevant state act.

The deed states that the compensation to be provided under the deed is in full and final satisfaction of all compensation payable, including but not limited to:

· deprivation of possession of its surface, or part thereof

· damage to the surface of the land, or part thereof

· severance of any part of the land from other parts,

· surface rights of way

· all consequential damage

You are registered for GST.

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 15-15

Reasons for decision

The relevant state act (the Act) sets out the general compensation provisions. The Act makes each tenure holder liable to compensate for the effect the 'eligible claimant' suffers caused by the authorised activities of a tenure holder or the carrying out of an activity by a person authorised by the holder. The eligible claimant owns private or public land included in the area of the authority; or access land for the tenure holder

What constitutes a 'compensatable effect' is defined in the Act, as all or any of the following occurring to the claimants land; 'deprivation of possession of its surface, diminution of its value, diminution of the use made, or that may be made, of the land or improvement on it, severance of any part of the land from other parts, any cost or loss arising from the carrying out of activities under the petroleum authority on the land'. As such, the types of compensatable events are not exhaustive and this list is a reflection of the nature of event that compensation is generally warranted.

Under the Act, the eligible claimant and tenure holder may enter into an agreement (a 'compensation agreement') about the holder's compensation liability to the claimant or any future compensation that the holder may have to the claimant that relates to all or part of liability or future liability.

Pursuant to the Act a compensation agreement must be in writing and signed by, or for, the holder and the eligible claimant and state whether it is for all or part of the liability. Where the agreement is for only part of the liability the agreement must state, the details of each activity, or effects of it and the period for which the agreement has effect.

It follows that where a landowner is an eligible claimant under the Act this gives rise to a right to compensation.

Ordinary income section 6-5 of the ITAA 1997

Taxation Ruling TR 95/35 considers the tax treatment of compensation receipts. 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 (paragraph 3).

Compensation paid due to loss and damage of a capital asset, or forgoing a right to sue, in the process of a X , is an isolated transaction. Whether a profit from an isolated transaction is ordinary assessable income according to the ordinary concepts depends very much on the circumstances of the case. Profit from an isolated transaction is generally ordinary 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 the transaction was entered into, and

(b) the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 Taxation Ruling TR 92/3).

Neither elements (a) or (b) as noted above, apply in the circumstances of receiving compensation where a tenure holder exercises it's powers to accesses and uses a claimants land for prosecting and mining under the Act.

The compensation payments are made in accordance with the legislative criteria outlined in the Act. Standard compensation agreements state that payments may be dissected into events, for example, damages from drilling and clearing land where payments are received by the claimant over a number of years. A receipt received this way this does not disturb the nature of the compensation payment in the hands of the claimant.

Accordingly, the compensation payments do not give rise to income according to ordinary concepts pursuant to section 6-5(1) of the ITAA 1997 or to a profit arising from a profit-making undertaking or plan within the meaning of section 15-15 of the ITAA 1997.

Statutory income under section 6-10 of the ITAA 1997

Statutory income may arise from CGT events as a consequence of an eligible claimant being entitled to receive compensation, and the loss and destruction of a CGT asset.

Compensation for loss and destruction of underlying assets

The CGT consequences of an award of damages depends on whether there is an underlying asset that damages have a direct and substantial link 'by looking through the transaction that gave rise to the compensation receipt to the most relevant asset relating to the receipt' (paragraph 76 of TR 95/35). In Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd and Graeme McDonald 93 ATC 4418; (1993) 25 ATR 192, Harper J suggested that the compensation receipt should be linked to the underlying asset in determining whether the plaintiff had received any capital gain.

The ATO view is that where there is loss or destruction of the underlying asset that is why the compensation is received, rather than for the disposal of any rights arising from that loss or destruction. Only if the insurance or settlement proceeds do not relate to the disposal of part or all of any underlying asset is it necessary to consider the policy rights or the right to seek compensation as the relevant asset (paragraph 77 TR 95/35).

The standard compensation agreements consist of an upfront payment and future ongoing payments reflective of the damages to underlying assets.

If the payment relates to permanent damage to, or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (that is, you reduce the cost base and reduced cost base by the amount of the compensation). 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, in the case of a post-CGT underlying asset, unless 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 (paragraph 7 TR 95/35).

For example, where there is an upfront lump sum payment paid by the statutory authority party to the claimant in relation to clearing land and the constructing of a dam. The consideration received is treated in respect of the underlying asset, the land. The cost base of the land is reduced to the extent of the consideration and any gain or loss will crystallise at the later time when the land is sold.

Compensation received by a taxpayer has no CGT consequences, if the underlying asset that 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 (paragraph 9 TR 95/35).

As the partnership acquired the land prior to 20 September 1985, there will be no CGT consequences when you dispose of the land.

Goods and services tax (GST)

For a supply to be subject to GST, the supply must be a taxable supply. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides: 

You make a taxable supply if:

(a) you make a 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.' 

(terms with an * are defined in section 195-1 of the GST Act. 

In determining whether the supply is a taxable supply, all the requirements under section 9-5 of the GST Act must be satisfied. The requirement of a 'supply' is the first and most relevant one to consider in this case. 

Supply

A supply is broadly defined in section 9-10 of the GST Act to include the creation, grant, transfer, assignment or surrender of any right or an entry into, or release from an obligation to refrain from an act or to tolerate an act or situation.

Goods and Services Tax Ruling, GSTR 2001/4, Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4), sets out the Commissioners view relating to the meaning of supply and paragraph 22 states:

22. Essentially, a supply is something which passes from one entity to another. The supply may be one of goods, services or something else.

In paragraph 71 of GSTR 2001/4, the Commissioner also identifies situations where the subject matter of a claim for damages or compensation cannot be regarded as a 'supply'. Examples of such claims include property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury. 

In this case, the payment is paid and received as compensation to you for losses relating to the Land including damage to the surface, deprivation of the possession of the surface or any part of the surface of the land resulting from the Activities being carried on. Consequently, the loss suffered by you is not a supply that you make to the Operator. Since there is no supply, the requirements of section 9-5 of the GST Act cannot be met.  

Therefore, GST will not apply to the compensation payments.