Edited version of your private ruling

Authorisation Number: 1012492632469

Ruling

Subject: Compensation payments

Question 1

Of the compensation receipts in accordance with the Agreement (CCA), will only $X per annum pro-rated for any partial years during the Construction Period and $Y per annum pro-rated for any partial years during the Operation Period be assessable income as per section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. Please see our 'Reasons for decision'.

Question 2

To the extent that the compensation receipts in accordance with the CCA do not constitute assessable income as per section 6-5 of the ITAA 1997, will the receipt of these amounts constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening?

Answer

No. Please see our 'Reasons for decision'.

Question 3

To the extent that the compensation receipts in accordance with the CCA do not constitute assessable income as per section 6-5 of the ITAA 1997 or capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening, does the compensation received reduce the cost base of the Property?

Answer

Yes. Please see our 'Reasons for decision'.

This ruling applies for the following periods:

21 December 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

1 July 2019 to 30 June 2020

1 July 2020 to 30 June 2021

1 July 2021 to 30 June 2022

1 July 2022 to 30 June 2023

1 July 2023 to 30 June 2024

1 July 2024 to 30 June 2025

1 July 2025 to 30 June 2026

1 July 2026 to 30 June 2027

1 July 2027 to 30 June 2028

The scheme commences on:

21 December 2012

Relevant facts and circumstances

1. The Taxpayer is a resident who owns land ('Property').

2. The Property also includes various fixtures that are utilised by the Taxpayer to carry out its primary production businesses.

3. On 21 December 2012, the Taxpayer entered into a CCA with another entity for a minimum term with respect to activities that will take place on the Property.

4. Upon cessation of the activities, the entity will undertake rehabilitative work to return the affected areas of the land to a standard similar to that which existed prior to the commencement of the activities.

5. In the CCA, the entity will pay the Taxpayer the following compensation amounts:

· a one-off payment of $A

· $B per annum pro-rated for any partial years during the Construction Period, and

· $C per annum pro-rated for any partial years during the Operation Period commencing on the day after the end of the Construction Period and continuing for the remainder of the term of the CCA.

6. In the CCA:

· the prime objective is to ensure the Taxpayer is properly compensated under the relevant Act, and

· the Taxpayer acknowledges that the compensation is payable by the entity in respect of all of the impacts of the activities, including the loss of use of part of the Property and loss of amenity generally.

7. The further explanatory material provided explains that there are four parts to the calculation of the compensation payable by the entity under the CCA, which can be summarised as follows:

· Part A, which is calculated to compensate for encumbrances, diminution and community.

· Part B, which is calculated to compensate for the following:

· The impact on the lifestyle/amenity of the Property.

· The impact on the business and the business assets, and the increased business risk associated with the activities on the land.

· Part C, which is calculated to compensate for the direct physical damage to the land caused by the activities on the Property.

· Part D, which is calculated to compensate for the specific impacts that apply to the Property as follows.

· $X per annum pro-rated for any partial years during the Construction Period.

· $Y per annum pro-rated for any partial years during the Operation Period.

The remainder is to compensate the Taxpayer for the permanent damage to the land and businesses carried on the land and for the diminution in the value of the land and the related businesses.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Subsection 6-5(1),

Income Tax Assessment Act 1997 Subsection 104-10(1),

Income Tax Assessment Act 1997 Paragraph 104-25(1)(b),

Income Tax Assessment Act 1997 Subsection 110-40(3),

Income Tax Assessment Act 1997 Subsection 110-45(3),

Income Tax Assessment Act 1997 Subsection 110-55(6),

Income Tax Assessment Act 1997 Division 116,

Income Tax Assessment Act 1997 Section 116-1 and

Income Tax Assessment Act 1997 Subsection 116-20(1).

Reasons for decision

Question 1

Summary

1. Of the compensation receipts in accordance with the CCA, only $X per annum pro-rated for any partial years during the Construction Period and $Y per annum pro-rated for any partial years during the Operation Period will be assessable income as per section 6-5 of the ITAA 1997.

Detailed reasoning

2. Paragraph 1 of Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? provides that a compensation payment is assessable income under subsection 6-5(1) of the ITAA 1997:

(a) if the payment is compensation for loss of income only, or

(b) to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

3. Of the compensation receipts in accordance with the CCA:

· none of Parts A to D are compensation for loss of income only, and

· only $X per annum pro-rated for any partial years during the Construction Period and $Y per annum pro-rated for any partial years during the Operation Period of Part D have been mutually agreed to by both the Taxpayer and the entity.

4. In conclusion, the Commissioner accepts that of the compensation receipts in accordance with the CCA, only $X per annum pro-rated for any partial years during the Construction Period and $Y per annum pro-rated for any partial years during the Operation Period will be assessable income as per section 6-5 of the ITAA 1997.

Question 2

Summary

5. To the extent that the compensation receipts in accordance with the CCA do not constitute assessable income as per section 6-5 of the ITAA 1997, the receipt of these amounts will not constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening.

Detailed reasoning

6. Section 116-1 of the ITAA 1997 states that Division 116 of the ITAA 1997 tells you how to work out what the capital proceeds from a CGT event are. Subsection 116-20(1) of the ITAA 1997 then defines capital proceeds from a CGT event to include the total of the money you have received, or are entitled to receive, in respect of the event happening.

7. Therefore, the compensation receipts paid to the Taxpayer that are not considered to be assessable income, will only constitute capital proceeds if those receipts are in respect of a CGT event.

8. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for a taxpayer who receives an amount as compensation, and whether the amount should be included in the taxpayer's assessable income under Part 3-1 of the ITAA 1997.

9. There are two CGT events that are considered within TR 95/35, being Disposal of a CGT asset: CGT event A1 ('CGT event A1') and Cancellation, surrender and similar endings: CGT event C2 ('CGT event C2').

10. Subsection 104-10(1) of the ITAA 1997 states that CGT event A1 happens if you dispose of a CGT asset. Paragraph 4 of TR 95/35 relevantly provides that CGT event A1 will occur if the amount of compensation is received by a taxpayer either wholly or partly in respect of the disposal of an underlying asset, as the compensation represents consideration received on the disposal of that asset.

11. Paragraph 104-25(1)(b) of the ITAA 1997 states that CGT event C2 happens if your ownership of an intangible CGT asset (such as a right to compensation) ends by the asset being released, discharged or satisfied. Paragraph 11 of TR 95/35 relevantly provides that if the amount of compensation is not received in respect of any underlying asset, the amount related to the disposal by the taxpayer of the right to seek compensation, meaning that CGT event C2 will occur.

12. It is evident that the term underlying asset is central to determining whether either CGT events A1 or C2 will occur when the Taxpayer receives the compensation payments under the CCA. Paragraph 70 of TR 95/35 provides that the underlying asset is identified by adopting a look-through approach to the transaction or arrangement which will generate the compensation receipt to determine the most relevant asset.

13. By adopting the look-through approach to the CCA, the Commissioner considers that the underlying asset will be the land of the property based on the following relevant facts.

· The prime objective of the CCA is to ensure the Taxpayer is properly compensated under the relevant Act for:

· Deprivation of possession of its surface.

· Diminution of its value.

· Diminution of the use made or that may be made of the land or any improvement on it.

· Severance of any part of the land from other parts of the land.

· Any cost, damage or loss from the carrying out of activities on the land.

· Each of the four parts (i.e. Parts A to D) to the calculation of the compensation payable by the entity under the CCA, with the exception of the specified amounts of Part D that have been mutually agreed to by both the Taxpayer and the entity as income as reward for the personal services provided by the Taxpayer, are with respect to the:

· permanent damage to the land

· diminution of the value of the land, and

· loss of use of the land.

14. Therefore:

· CGT event A1 will not happen, as the relevant amount of compensation receipts will not be in respect to any disposal of the underlying asset, and

· CGT event C2 will not happen as the relevant amount of compensation receipts will be wholly in respect of the damage and diminution/reduction in value to the underlying asset.

15. In conclusion, to the extent that the compensation receipts in accordance with the CCA do not constitute assessable income, the Commissioner accepts that receipt of these amounts will not constitute capital proceeds in respect of a CGT event happening.

Question 3

Summary

16. To the extent that the compensation receipts in accordance with the CCA do not constitute assessable income as per section 6-5 of the ITAA 1997 or capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening, the compensation received will reduce the cost base of the Property.

Detailed reasoning

17. Paragraphs 6 and 7 of TR 95/35 relevantly provided that compensation received wholly in respect of permanent damage or reduction in value of a post-CGT underlying asset that is not disposed of, represents a reduction in either the CGT cost base (under either subsection 110-40(3) or 110-45(3) of the ITAA 1997) or the reduced cost base (under subsection 110-55(6) of the ITAA 1997).

18. Having already accepted that the compensation receipts under the CCA, to the extent they do not constitute assessable income, are in wholly in respect of the damage and reduction in value to the underlying asset (i.e. the land) of the Property, the Commissioner now needs to consider whether that damage and reduction in value is permanent.

19. Paragraph 3 of TR 95/35 provides 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.

20. It is evident that upon the CCA ending, the damage and reduction in value to the land of the Property will remain unless action is taken by the Taxpayer, by expending the compensation receipts that do not constitute assessable income, to rehabilitate the land to the condition it was in before the activities commenced. The rehabilitative work that the entity will undertake on the affected areas of land of the Property upon the cessation of the activities:

· will only return those affected areas to a standard similar to that which existed prior to the commencement of the activities

· will only be with respect to the physical damage to the land, and

· will in no way rehabilitate the reduction in value of the land caused primarily by the negative stigma associated with the activities

21. Therefore, the compensation received by the Taxpayer, to the extent that it is not assessable income, will be wholly in respect of permanent damage or reduction in value of the land of the Property.

22. In conclusion, the Commissioner accepts that to the extent that the compensation receipts in accordance with the CCA do not constitute assessable income or capital proceeds in respect of a CGT event happening, the compensation received will reduce the cost base of the Property as a direct result of the reduction in the cost base of the underlying asset (i.e. the land).