Edited version of your written advice

Authorisation Number: 1012690486763

Ruling

Subject: Mining compensation

Issue 1

Compensation receipts that relate to land

Question 1

Are the compensation receipts that relate to land assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are the compensation receipts that relate to land capital proceeds in respect of a Capital Gains Tax (CGT) event happening?

Answer

No

Question 3

Will the compensation receipts that relate to land represent a recoupment of purchase price and consequently a reduction of cost base under section 110-40 or 110-45 of the ITAA 1997?

Answer

Yes

Issue 2

Compensation receipts that relate to costs

Question 1

Do the compensation receipts that relate to estimated costs constitute assessable income under section 6-5 ITAA 1997?

Answer

No

Question 2

Do the compensation receipts that relate to estimated costs constitute assessable recoupments under section 20-20 ITAA 1997?

Answer

No

Question 3

Do the compensation receipts that relate to estimated costs constitute capital proceeds in respect of a CGT event happening?

Answer

No

Question 4

Will the compensation receipts that relate to costs represent a recoupment of purchase price and consequently a reduction of cost base under section 110-40 or 110-45 of the ITAA 1997?

Answer

Yes

Issue 3

Gravel and Water Payments

Question 1

Are the compensation receipts that relate to the use of water and gravel resources assessable income under section 6-5 of the Income Tax Assessment Act 1997?

Answer

No

Question 2

Are the compensation receipts that relate the use of water and gravel resources capital proceeds under Division 116 ITAA 1997 in respect of a CGT event happening?

Answer

No

Question 3

Will the compensation receipts that relate to the use of water and gravel resources represent a recoupment of purchase price and consequently a reduction of cost base under section 110-40 or 110-45 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 2014

Income year ended 30 June 2015

Income year ended 30 June 2016

Income year ended 30 June 2017

Income year ended 30 June 2018

Income year ended 30 June 2019

Income year ended 30 June 2020

Income year ended 30 June 2021

Income year ended 30 June 2022

Income year ended 30 June 2023

Income year ended 30 June 2024

The scheme commences on:

1 July 2013

Relevant facts and circumstances

You are the land owner of properties and you carry on a primary production business on those properties.

You have entered into compensation agreements with Companies who are planning to undertake activities on you land. Under the agreement you will receive compensation under a statutory authority for damages caused to your land by the activities.

The amount of compensation was calculated by the use of valuations. An amount was specified for reduction in value of the property and another for the estimated extra business expenses your primary production business would incur due to the activities of the companies.

Further under the agreement the companies have power to take gravel and water from your property. You expect to receive payment from those companies for taking those resources.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 section 20-25

Income Tax Assessment Act 1997 section 110-40

Income Tax Assessment Act 1997 section 110-45

Income Tax Assessment Act 1997 Division 116

Petroleum and Gas (Production and Safety) Act 2004

Reasons for decision

Compensation generally

The relevant statutory scheme to provide compensation to landowners for the impacts of petroleum and gas production activities; and requires the relevant parties to enter into a CCA. The purpose of the scheme is to ensure that landowners are not financially disadvantaged by activities carried out on their property. Landowners are entitled to compensation for any compensatable effects related to the impact of the activities on their business operations and land use.

Payments pursuant to the statutory scheme are generally treated as capital in nature where those amounts are compensation payments for compensatable effects. It is considered that characterising the payments as capital in nature is in keeping with the ATO view on the taxation treatment of compensation receipts contained in Taxation Ruling TR 95/35. For the purposes of TR 95/35 it is necessary to identify the underlying asset. TR 95/35 defines an underlying asset:

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.

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 to identifying the underlying asset in the current context. 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.

Assessable Income under section 6-5 of the ITAA 1997

Ordinary income has generally been held to include three categories, namely, income from rendering personal service, income from property and income from carrying on a business. Under the various statutory compensation schemes, mining compensation payments are generally not treated as ordinary income where the payments are compensation for the effects of the mining activities. As outlined above this is because in the case of farming operations the payments would be regarded as compensation for damage to property which forms part of the profit-yielding structure of the landholder.

For the purposes of the statutory scheme any compensation payments must be for the compensatable effects of authorised activities under one of the specified heads of damages. Where a nexus is established between the payments and the effects of the activities relating to a head of damage, the payments would be treated as being capital in nature. Conversely for amounts to be assessable as ordinary income the nexus between the payments and any activities relating to a head of damage must be broken.

In the current case you are being reimbursed for the ongoing costs incurred in relation to the construction phase of the activities. The costs that are expected to occur involve costs associated with agistment of livestock; cost of transport; additional livestock husbandry costs; additional mustering costs; vehicle costs; additional fencing costs; and additional labour costs. You have explained that the need to erect fencing for example, is to exclude animals from areas of land affected by land degradation to prevent or limit the extension or worsening of land degradation in the area and to help reclaim the area back to pasture production.

Under section x of the statutory scheme the mining company is liable to compensate you for 'any costs' arising from the authorised activities on the land. You operate a primary production enterprise; your enterprise is a profit yielding structure. The costs you are incurring are clearly associated with trying to mitigate the damage to your profit yielding structure; the damage is being caused by the activities. It is considered that a clear nexus exists between the payments and the head of damage that covers any costs arising for the landowners. Accordingly the payments would be capital in nature. As the amounts are received as compensation pursuant to the statutory scheme for damages from the activities they are not taxable as a capital gain.

It is noted that it is not a requirement under the statutory scheme that the costs are pre-determined; under section x a CCA can relate to all or part of the liability or future liability. The fact that the amount of the expenditure that will be incurred is uncertain does not change the nature of the payments. The amounts that are being reimbursed retain their character as being capital in nature and should not be re-characterised as income from rendering personal services, income from property or income from carrying on a business. It is considered that the payments to the taxpayers are not assessable as ordinary income under section 6-5.

Assessable recoupment under section 20-20 of the ITAA 1997

Certain amounts received by way of insurance, indemnity or other recoupment are assessable under Subdivision 20-A of the ITAA 1997, if the amount is not income under ordinary concepts or otherwise assessable. Recoupment includes any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery however described and a grant in respect of the loss or outgoing: subsection 20-25(1) of the ITAA 1997. An amount will be an assessable recoupment under section 20-20(2) of the ITAA 1997 if it is considered to be received by way of insurance or indemnity and the taxpayer can deduct or has already claimed a deduction for it.

The Commissioner does not consider the amounts paid to you are a recoupment of general business expenses. Rather we consider that the payments are for damages to your profit yielding structure. The receipts aim to put your primary production enterprise in the position you would have been but for extra costs incurred to your business due to the activities. Consequently the Commissioner considers you have received compensation for permanent damage or reduction in value to your profit yielding structure and accordingly considers the appropriate tax treatment as per paragraph 6 of TR 95/35 is that the compensation receipts will represent a recoupment of purchase price of the capital assets of your profit yielding structure.

Payments for gravel and water

Under the CCAs and the statutory scheme the tenement holders are given the power to access water and gravel resources on the land for purposes incidental to the activities. It is accepted that the extraction of gravel and the reduction in the volume and quality of water on the land will permanently reduce the value of the land. Consequently it is considered that any future payments for gravel and water will have sufficient nexuses between the compensatable effects under the statutory scheme and will result in a reduction of cost base as per paragraph 6 of TR 95/35.