Edited version of your written advice

Authorisation Number: 1012691099675

Ruling

Subject: Capital gains tax - mining compensation

Question

Are the payments you received under a Standard Compensation Agreement with a mining company considered a recoupment of the purchase price and consequently a reduction of the cost base under section 110-45 of the ITAA 1997?

Answer: Yes

This ruling applies for the following period

Income year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You purchased a property some years ago with the plan to build a house and reside there, but due to various issues you sold the property during the relevant income year.

Your property was not income-producing. You resided on the property for a short period during your ownership.

A mining company approached you about constructing infrastructure on and through your property and offered compensation for the disturbance that it was to cause to you and your property.

You entered into a Standard Compensation Agreement ('the Agreement') with the mining company for compensation under the relevant state Act 2004 (the Act).

Under the agreement, you agreed to an upfront payment and annual compensation payments for:

The amount attributable to the Compensatable Effects (as defined under the Relevant Act) caused by the Tenement Holder, for example the impact on the value of the land, directly impacted by infrastructure activity, including but not limited to exploration equipment, gas well sites, pipelines and access tracks.

As part of the 'Special Conditions' of the agreement the mining company had to undertake particular activities on the property due to the location of their infrastructure.

Subsequently, the mining company decided they could not fulfil the 'Special Conditions' and instead offered and paid to you a once-only payment pursuant to the Conduct and Compensation agreement.

The activities proposed to be carried out by the mining company on the land are set out in the Agreement.

You were obliged under the Agreement to comply with the agreement and to not interfere with the mining company's activities or their right to access the land and carry out the activities described in the Agreement.

A Clause in the Agreement provides that the agreement is in full and final satisfaction of the Tenement Holder's Compensation Liability for the Compensatable Effects of the Activities described in the Agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 110-45

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

Reasons for decision

The Act sets out the general compensation provisions. The holder of each petroleum authority is liable to compensate each relevant owner or occupier of private or public land, known as the 'eligible claimant'. The Act makes each petroleum authority liable to compensate for the effect the eligible claimant suffers caused by the authorised activities of a petroleum authority or the carrying out of an activity by a person authorised by the holder.

Compensatable effect, defined in the Act, means 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, and 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 events for which compensation is generally warranted.

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.

Statutory income under section 6-10 of the ITAA 1997

Compensation payments may be assessable as statutory income under section 6-10 of the ITAA 1997 as a consequence of an eligible claimant being entitled to receive compensation for the loss and destruction of a CGT asset. The Commissioner's view on the taxation of compensation receipts is found in Taxation Ruling TR 95/35. Paragraph [6] of TR 95/35 states:

6. 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.

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.

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.

It is considered that the decisions in Nullaga Pastoral Company Pty Ltd v. FC of T 78 ATC 4329; (1978) 8 ATR 757 (Nullaga) and Barrett v. Federal Commissioner of Taxation [1968] HCA 59; (1968) 118 CLR 666; 15 ATD 149; 10 AITR 685 (Barrett) are also relevant in 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. In keeping with Nullaga and Barrett it is considered that the relevant underlying asset in your case is your property which forms your profit yielding structure.

The ATO view, in paragraphs 76 to 77 of Taxation Ruling TR 95/35, is that the loss or destruction of the asset which generates the right to seek compensation is the most relevant transaction or event producing the right to receive compensation. Accordingly, we consider that it is for the loss or destruction of the underlying asset that compensation is received, rather than the disposal of any rights arising from that loss or destruction.

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, 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.

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 as being 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.

You have received:

• an upfront payment

• annual compensation payments; and

• a once-only payment.

From the above, it is considered that the connection between the compensation receipts and the land is clear. As all of these payments were paid as compensation for damage to and interference with your land, the underlying asset, and they are for compensatable effects under one of the broad heads of damage pursuant to the Act, these payments are considered capital in nature.

Consequently, the compensation payments received directly by you in relation to the damage and loss of value of your property will represent a recoupment of purchase price and will therefore be treated as a reduction of the cost base at the time of disposal of the asset.