Edited version of private advice

Authorisation Number: 1012657828025

Ruling

Subject: Mining Compensation

Question 1

Will an incentive payment received in relation to a conduct and compensation agreement be assessable income under section 6-5 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

Income year ended 30 June 2013

Income year ended 30 June 2014

Income year ended 30 June 2015

Income year ended 30 June 2016

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You are the landholder of a property and primarily carry on a primary production business on this land.

A company is planning to conduct activities on the property.

You have entered into a compensation agreement where you will be compensated under a statutory authority.

Pursuant to the agreement you will receive a number of compensation payment as well as an incentive payment.

The incentive payment is conditional on various obligations being met during the negotiation process.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Reasons for decision

Compensation Payments Generally

Taxation Ruling TR 95/35 provides the ATO view in relation to the treatment of compensation receipts. Paragraph [6] states that:

If an amount of compensation is received by a 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 that 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.

For the purposes of TR 95/35 it is necessary to identify the underlying asset. TR 95/35 defines an underlying asset at paragraph [3]:

The underlying asset is 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.

If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset.

It is considered that the decisions in Nullaga Pastoral Company Pty Ltd v FC of T 78 ATC 4329; (1978) 8 ATR 757 and Barrett v Federal Commissioner of Taxation [1968] HCA 59; (1968) 118 CLR 666; 15 ATD 149; 10 AITR 685 are relevant in this relation to identifying the underlying asset. In both of those cases the landholders were conducting ongoing successful farming operations. The payments were held to be compensation for damage to property which formed part of the profit-yielding structure of the landholders.

It is considered that the compensation payments are clearly for damage to the underlying asset of the taxpayer and that they are for compensatable effects under one of the broad heads of damage pursuant to statutory authority. Accordingly these payments should be treated as capital in nature. In addition they will all represent a recoupment of purchase price as the compensation relates to an underlying asset that is not being disposed of.

Incentive payment

In addition to the above payments the taxpayer will also be receiving an incentive payment. It is argued that this payment could either be characterised as disposing of the right to negotiate a more generous compensation payment, or that it should be treated as relating to the underlying asset.

TR 95/35 provides that the right to seek compensation is an asset; the ruling also specifies that if there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. In the current case it is clear that it is the property that is part of the profit yielding structure of the taxpayer that is asset which leads directly to the payment of the amount of compensation. Accordingly the property is the relevant asset, and not the right to seek compensation.

It is considered that the incentive payment cannot be treated as relating to the underlying asset. As highlighted above, pursuant to the statutory compensation scheme, the taxpayer is entitled to compensation payments for the compensatable effects of the activities. To satisfy the requirements, the compensatable effects must fall within the specified heads of damage.

Clearly the incentive payment is designed to allow the compensation agreement to be completed promptly so as to enable the project to go ahead without delay. There is no indication that the incentive payment is related to any of the heads of damages. Accordingly there is no basis for concluding that the payment is linked to the property that is part of the profit yielding structure of the taxpayer.

Tax Treatment of the Incentive Payment

To determine the character of payments for income tax purposes it is necessary to look at all of the facts and consider the total situation (MIM Holdings Ltd v. Commissioner of Taxation (1997) 363 FCA, Federal Coke case (1977) 34 FLR 375, FCT v. Rowe (1997) 187 CLR 266, The Squatting Investment Co Ltd v. FCT (1953) 86 CLR 570). In looking at the facts and total situation the above analysis indicates that the incentive payment is not a compensation payment. This implies that the payment is not capital in nature; consequently it is necessary to consider whether the amount is actually revenue in nature and therefore assessable as ordinary income.

The assessable income of an entity consists of the following: amounts which are income according to ordinary concepts (ordinary income), under section 6-5 of the ITAA 1997; and amounts which are not ordinary income but are included in the assessable income of an entity by virtue of specific provisions contained in the ITAA 1997 and the ITAA 1936 (statutory income), section 6-10 of the ITAA 1997). Pursuant to section 6-15 of the ITAA 1997, if an amount received by an entity is neither ordinary income nor statutory income, the amount is not included in the assessable income of the entity.

In the context of this particular activity (where a payment is providing a benefit rather than compensation), the amount may be characterised as: a royalty; a licence fee; rent; a gift; or a reward or payment for services rendered. In the current case, the relevant options in relation to the incentive payment would be: a gift, or a reward.

There are three major High Court decisions on gifts: FCT v Dixon (1952) 86 CLR 540; 5 AITR 443; 10 ATD 82; Hayes v FCT (1956) 96 CLR 47; 6 AITR 248; 11 ATD 68; Scott v FCT (1966) 117 CLR 514; 10 AITR 367; 14 ATD 286. The decisions establish that a benefit given voluntarily will be income if it is the "product" of an income producing activity. In contrast where a voluntary payment is made because of some personal quality of the recipient it is more likely to be a mere gift and not income. The question in each case is what is the character of the receipt in the hands of the recipient; which is an objective and not a subjective test (Scott v FCT (1966) 117 CLR 514; 10 AITR 367; 14 ATD 286).

The decisions in Brown v FCT (2002) 49 ATR 301; [2002] FCA 318. and MIM Holdings Ltd v FCT (1997) 36 ATR 108; 97 ATC 4420 give examples of determining the character of the receipt where there was no close personal relationship established between the giver and the receiver of the benefits. Similarly in the current case, the taxpayer and the company do not have a close personal relationship.

In Brown v FCT the taxpayer (a former federal cabinet Minister) was provided with benefits by a developer for introducing them to a foreign company, and making representations to the Foreign Investment Review Board on the Company's behalf. The Full Federal Court held that the benefits were not gifts but were a reward for introducing and otherwise assisting the company.

In MIM Holdings Ltd v FCT the taxpayer was the holding company of Mount Isa Mines, which in addition to conducting mining operations also supplied electricity to the region through its power station. The taxpayer received payments in return for ensuring the supply of electricity, via its subsidiary, to the Queensland Government. The Federal Court found that where consideration is provided for a payment, that consideration will ordinarily supply the 'touchstone' for ascertaining whether the payment was received on a revenue account.

In the current case there are a number of conditions attached to you receiving the incentive payment. Meeting the conditions would ensure that the negotiation and completion of the agreement was completed in a timely manner; this would assist the company by enabling them to proceed with developing and implementing the project unhindered. It is considered that the payment to you is not a gift; it is a reward for meeting the conditions. Accordingly the payment is ordinary income that is assessable under section 6-5 of the ITAA 1997.