Edited version of your private ruling

Authorisation Number: 1012597782753

Ruling

Subject: Income tax: Assessability of mining payments

Question 1

Does the receipt of the annual payment (adjusted yearly by CPI) in accordance with the Conduct and Compensation Agreement (CCA) constitute ordinary income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant income years?

Answer

No

Question 2

Does the receipt of the annual payment (adjusted yearly by CPI) in accordance with the CCA constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening in the relevant income years?

Answer

No

Question 3

Does the receipt of the annual payment (adjusted yearly by CPI) in accordance with the CCA reduce the cost base of the property under subsection 110-40(3) or section 110-45(3) ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX - 30 June 20XX

1 July 20XX - 30 June 20XX

1 July 20XX - 30 June 20XX

1 July 20XX - 30 June 20XX

The scheme commences on:

The scheme has commenced

Relevant facts and circumstances

You are the registered owner of the Land.

The Land is predominately used for agricultural purposes.

An entity holds a lease which covers all or a part of your land and all or part of neighbouring properties.

A Conduct and Compensation Agreement (CCA) was negotiated for the purposes of the Petroleum and Gas (Production and Safety) Act 2004 (PGPS Act).

The CCA states the entity may enter the land to carry out activities in accordance with the CCA. The activities are described in Schedule 2 and include existing activities and future activities.

The CCA states the entity will pay compensation as set out in Schedule 1.

The entity will pay an annual amount (adjusted each year for CPI) until the wells are fully rehabilitated.

The CCA recognises the need for apportionment of the annual payment between you, the owner of a neighbouring property and the occupier of the properties.

The annual payment is for the loss of use of your land, the diminution in the use made of that land, deprivation of use or possession of land and general loss of amenity.

The annual amount was calculated with reference to the activities impact on lifestyle/amenity, land use intensity and land use sensitivity.

You are an Australian resident for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-1(1).

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 section 6-5(1).

Income Tax Assessment Act 1997 subsection 6-5(2).

Income Tax Assessment Act 1997 subsection 6-10(2).

Income Tax Assessment Act 1997 section 6-25.

Income Tax Assessment Act 1997 section 102-5.

Income Tax Assessment Act 1997 section 104-10.

Income Tax Assessment Act 1997 section 104-25.

Income Tax Assessment Act 1997 subsection 108-5(1).

Income Tax Assessment Act 1997 subsection 110-40(3).

Income Tax Assessment Act 1997 subsection 110-45(3).

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

Reasons for decision

Question 1

Does the receipt of the annual payment (adjusted yearly by CPI) in accordance with the Conduct and Compensation Agreement (CCA) constitute ordinary income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the relevant income years?

Detailed reasoning

Assessable income

Subsection 6-1(1) of the ITAA 1997 states that assessable income consists of ordinary income and statutory income.

Ordinary income

Subsection 6-5(1) of the ITAA 1997 states that your assessable income includes income according to ordinary concepts (generally referred to as ordinary income). Subsection 6-5(2) of the ITAA 1997 clarifies that Australian residents assessable income in an income year includes all ordinary income derived from sources in and out of Australia in that year. The phrase income according to ordinary concepts is not defined in the legislation.

The Courts have identified a number of characteristics that indicate whether an amount has the character of income according to ordinary concepts. Amounts that are periodical, regular or recurrent, relied upon by a recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income, as are amounts that are the product in a real sense of any employment of, or services rendered by the recipient (Commissioner of Taxation v Rowe (1995) 60 FCT 99; 95 ATC 4691; (1995) 31 ATR 392).

Income versus capital distinction

Characterising amounts as income or capital is important in determining the correct tax treatment. In Scott v FCT (1966) 117 CLR 514, Windeyer J stated:

Whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

Therefore, whether amounts are income or capital will depend upon what it is that the amount is replacing in your hands. This necessitates consideration of all the circumstances surrounding the receipt. As the High Court stated in G P International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 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 the transaction, venture or business.

The motive of the payer may be relevant to this consideration (Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 at 527-528; (1966) 14 ATD 286 at 293; (1966) 10 AITR 367 at 376).

In addition to the above, two fundamental principles used to determine the appropriate taxation treatment of payments in the nature of compensation are:

• the general principle relating to the taxation of a compensation receipt is that the receipt takes on the character of the item it replaces (CoT (NSW) v Meeks [1915] HCA 34; (1915) CLR 568); and

• the fundamental question is what is the 'compensation' being paid for, that is, what is it trying to replace (Glenboig Union Fireclay Co Ltd v Inland Revenue Commissioners)

In summary, the following are the key factors identified as relevant in determining whether the payment under the CCA is income according to ordinary concepts:

• the type of agreement under which the payments are made;

• the form of the payments;

• the purpose of the payments; and

• the character of the payments in the hands of the recipient

Type of agreement under which payments are made

A CCA is an agreement that an eligible claimant and a petroleum authority holder can enter into pursuant to section 533 of the PGSP Act (however, a CCA is mandatory before private land can be entered to carry out advanced activities under section 500 of the PGPS Act). Section 534 of the PGPS Act details what CCAs must contain and section 532 of the PGPS Act makes the petroleum authority holder liable to pay compensation to the eligible claimant for certain specified effects.

You are an eligible claimant and, as such, have the right to negotiate your entitlement to compensation in accordance with the processes outlined in the PGSP Act.

The form of the payments

The annual payment (adjusted each year for CPI) to be paid under the CCA is an on-going periodic payment determined in accordance with specific guidelines. The fact that the payment is made on a regular or periodic basis for the term of the CCA does, in isolation, indicate that the amount is revenue in nature.

The purpose of the payments

In determining the purpose for which a payment is made, the description given to the payments by the parties does not ultimately establish the purpose. For example, in Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140; 24 ALR 57; 9 ATR 507; 53 ALJR 321 (Cliffs International Case) the High Court held that the description of the payments in the option agreement as "deferred payments" was not a decisive factor in determining the true nature of those payments. To determine the purpose of the payments it is necessary to look at all of the facts and consider the total situation.

Section 532 of the PGPS Act states holders of petroleum authorities are liable to compensate each owner or occupier of private land for any 'compensatable effect' caused by the holder's activities. Subsection 532(4) of the PGPS Act defines the term 'compensatable effect' in respect of land. Deprivation of possession of surface, diminution in value, diminution of use, severance of any part and any cost, damage or loss constitute 'compensatable effect' for the purposes of the Act.

The compensation clause in the CCA is worded in a fashion that closely reflects the definition of 'compensatable effect' provided in subsection 532(4) of the PGPS Act. The wording of the compensation clauses in the CCA suggests that the payments are made to you for the potential impacts of carrying out the mining activities on your land.

The character of the payments in the hands of the recipient

In Barrett v. Federal Commissioner of Taxation (1968) 118 CLR 666; (1968) 15 ATD 149; (1968) 10 AITR 685 (Barrett's Case) and Nullaga Pastoral Co Pty Ltd v. Federal Commissioner of Taxation 78 ATC 4329 (Nullaga's Case) dealt with periodic on-going payments where the quantum was determined with reference to the volume of minerals that were extracted. The Courts considered whether the payments were royalties, licence fees, rent or in the nature of rent or receipts of a general nature and therefore included in assessable income before holding (in both cases) that the payments were capital in nature because they were intended to make good the estimated diminution of the value of the land as a result of the mining operations.

Is the payment a royalty?

Taxation Ruling IT 2660 Income tax: definition of royalties (IT 2660) discusses the common law meaning and the extended tax meaning of the term royalty. Paragraph 11 of IT 2660 points out the expanded meaning of the term is meant to capture amounts that may not be covered by the ordinary meaning of the term royalty. The extended meaning of the term royalty is not relevant in this case.

Paragraph 10 of IT 2660 states the following:

…a common law royalty will normally have all of the following features:

(a) It is a payment made in return for the right to exercise a beneficial privilege or right (e.g. to remove minerals or natural resources…)….

(b) The payment is made to the person who owns the right to confer that beneficial privilege or right…

(c) The consideration payable is determined on the basis of the amount of use made of the right acquired…

(d) The consideration payable will usually be paid as and when the right acquired is exercised…However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired…

The PGPS Act defines coal seam gas at section 299 of the PGPS Act as 'petroleum (in any state) occurring naturally in association with coal or oil share or in strata associated with coal or oil shale'. Section 26 of the PGPS Act states that all petroleum from the surface of the land or from a natural underground reservoir in the State is property of the State.

The amount to be paid under the CCA is not a royalty. Therefore, no portion of the amount you are entitled to under the CCA is a royalty.

Is the payment for issuing a licence?

Taxation Ruling IT 2561 Income tax: grants of easements, profits a prendre and licences (IT 2561) provides the Commissioner's view on the meaning of a licence. At paragraph 2 of IT 2561 a licence is defined as:

… an authority to do something which would otherwise be unlawful. An authority to occupy land (but without exclusive possession as against others) is an example of a licence.

The petroleum licence is the authorising instrument. The CCA does not provide authority to do something which would otherwise be unlawful. No portion of the amount you are entitled to under the CCA is for the granting of a licence.

Is the amount rent or in the nature of rent?

The Macquarie Dictionary (version 5.0.0, 01/10/01) defines a lease as:

1. an instrument conveying property to another for a definite period, or at will, usually in consideration of rent or other periodical compensation.

2. the period of time for which it is made.

3. land which has been leased, as for goldmining, farming, etc.

The Macquarie Dictionary (version 5.0.0, 01/10/01) defines the word 'rent' as:

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

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

The CCA Agreement does not exhibit the characteristics of a lease therefore the amounts to be paid under the CCA are not received in connection with a lease.

As stated in Ex parte Lathouras; Re Vendardos [1964-1965] NSWR 254 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.

The CCA stipulates the amount is to be paid to compensate for the incidental and reasonably expected impacts resulting from the mining activity on your land and lists such impacts. The amount to be paid under the CCA for those impacts was determined in accordance with the Guidelines. No portion of the amount you are entitled to under the CCA is rent or in the nature of rent.

Is the amount a replacement of income?

The lifestyle/amenity impact measure in the guidelines is a measure of the degree to which the activities may potentially impact the existing quality of life, lifestyle aspects, quiet enjoyment or amenity of the property.

The land use intensity impact measure is a measure of the degree to which the activities potentially impact the existing or future operation and productive capacity of the property and relates directly to its primary land use. The scale used to assign a score to the measure takes into account the level of development of the land and the intensity of operations.

The land use sensitivity score is a measure of how the activities may potentially affect the characteristics of goods and commodities produced on the property and the commercial viability of a property. The scale used to assign a score to the measure takes into account the level of risk of weeds above control mechanisms, the level of production, the impact of biosecurity incidents and any sensitive or special areas of land that exist.

The amount to be paid under the CCA for the above impacts was determined by reference to the scale in the Guidelines and can be broadly stated as being for loss of amenity, deprivation of your land to use for its primary agricultural purpose and for the potential adverse impacts to your land which may affect these activities.

There is no indication from either the guidelines or the CCA that any part of the amount to be paid is a replacement of income.

Conclusion

While the annual payment (adjusted each year for CPI) is an on-going and recurrent receipt, the other relevant factors indicate that the payment is not income according to ordinary concepts and will not be included in your assessable income as ordinary income pursuant to section 6-5 of the ITAA 1997.

Question 2

Does the receipt of the annual payment (adjusted yearly by CPI) in accordance with the CCA constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening in the relevant income years?

Detailed reasoning

Under subsection 116-20(1) of the ITAA 1997, money you have received (or are entitled to receive) and the market value of any property you have received (or are entitled to receive) are the capital proceeds from a CGT event. For the annual payment under the CCA to constitute capital proceeds, there must therefore be a CGT event.

CGT events occur in respect of CGT assets. The definition of a CGT asset is contained in subsection 108-5(1) of the ITAA 1997. It provides that a CGT asset is any kind of property or a legal or equitable right that is not property. Not all things often referred to as 'rights' will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) provides the Commissioner's view on the capital gains tax consequences for the recipient of compensation receipts and whether the amount should be included in the taxpayer's assessable income. Relevantly, it states that a CGT event will occur (and any consideration form part of capital proceeds) where the amount of compensation is received by the taxpayer:

• either wholly or partly in respect of the disposal of an underlying asset (paragraph 4 of TR 95/35); or

• not in respect of any underlying asset but in relation to the disposal of the right to seek compensation (paragraph 11 of TR 95/35).

The above relate to CGT event A1 (section 104-10 of the ITAA 1997) and CGT event C2 (section 104-25 of the ITAA 1997) respectively.

The underlying asset is identified using the 'look through approach' in order to determine the asset to which the compensation amount most directly relates. Paragraph 70 of TR 95/35 states that the underlying asset is identified by looking through to the transaction which generates the compensation receipt.

Applying the look-through approach to the facts of this case, we identify the Land as the asset to which the compensation under the CCA most directly relates. The land is therefore the underlying asset and the relevant CGT asset for the purposes of this ruling.

As there has been no disposal of the land, CGT event A1 does not occur. Further, as the amount is paid in respect of an underlying asset (being the land), CGT event C2 will not occur.

No part of the annual payment (adjusted yearly by CPI) will constitute capital proceeds in respect of a CGT event happening.

Question 3

Does the receipt of the annual payment (adjusted yearly by CPI) in accordance with the CCA reduce the cost base of the property under subsection 110-40(3) or section 110-45(3) ITAA 1997?

Detailed reasoning

Paragraphs 6 and 7 of TR 95/35 provide 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) of the ITAA 1997 (for assets acquired before 7.30pm on 13 May 1997) or subsection 110-45(3) of the ITAA 1997 (for assets acquired after 7.30pm on 13 May 1997).

For the purposes of TR 95/35, permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or reduction in value that has permanent effect unless the taxpayer takes action to put it right. The activities permitted under the CCA will cause such damage and reduction in value.

The annual payment (adjusted each year for CPI) is wholly in respect of permanent damage and reduction in value of your Land and therefore reduces the cost base under subsection 110-40(3) or subsection 110-45(3) of the ITAA 1997.