Edited version of your written advice

Authorisation Number: 1012724458377

Ruling

This is an edited version of a revised private ruling. It replaces the edited version of the private ruling with the authorisation number of XXXXXXXXXXXXX

Subject: Mining compensation

Issue 1

Incentive Payment

Question 1

Will the one off incentive payment received from the company be treated as assessable income under 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the one off incentive payment received from the company be treated as capital proceeds from any CGT event under Part 3-1 of the ITAA 1997?

Answer

No

Question 3

Will the one off incentive payment received from the company reduce the cost base of the relevant property for any future capital gain under section 110-40 or s110-45 of the ITAA 1997?

Answer

No

Issue 2

Pre-construction, construction and annual compensation

Question 1

Will the compensation for permanent damage to the land (pre-construction, construction and annual compensation) from the company be treated as assessable income under 6-5 of the ITAA 1997?

Answer

No

Question 2

Will the compensation for permanent damage to the land (pre-construction, construction and annual compensation) from the company be treated as capital proceeds from any CGT event under Part 3-1 of the ITAA 1997?

Answer

No

Question 3

Will the compensation for permanent damage to the land (pre-construction, construction and annual compensation) from the company reduce the cost base of the relevant property for any future capital gain under section 110-40 or s110-45 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period(s)

Income year ended 30 June 2012

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 2011

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.

The tax invoices prepared by the company were addressed to the partnership but payable to you.

The compensation was deposited into a bank account in the names of the partnership.

The agreement and the letter of offer were prepared solely in your name.

The compensation received belonged to you as the landholder and not the partnership.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 110-40

Income Tax Assessment Act 1997 section 110-45

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.

You have received:

• incentive payment

• pre-construction compensation payment

• construction compensation payment

• ongoing annual compensation

It is considered that the ongoing annual payments, and the construction and pre construction payments are clearly for damage to the underlying asset being your land and that they are for compensatable effects under one of the broad heads of damage pursuant to section 532 of the PAGA. 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 as compensation

In addition to the above payments you will also be receiving an amount referred to as the incentive payment or one-off agreement completion 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 your property that is asset which leads directly to the payment of the amount of compensation. Accordingly the farming property is the relevant asset, and not the right to seek compensation.

TR 95/35 at paragraph 3 provides the Commissioner's view of a compensation receipt:

A compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not in relation to any underlying asset, arising out of Court proceedings or made up of dissected amounts.

The source of your right to seek compensation is based on the obligation of the holder of the petroleum authority to compensate you under section 532 of PAGA. Subsection 532(4) specifically lists the heads of damage to which you are liable to compensation from the company as:

(4) In this section-

compensatable effect means all or any of the following-

(a) all or any of the following relating to the eligible

claimant's land-

(i) deprivation of possession of its surface;

(ii) diminution of its value;

(iii) diminution of the use made or that may be made of

the land or any improvement on it;

(iv) severance of any part of the land from other parts

of the land or from other land that the eligible

claimant owns;

(v) any cost, damage or loss arising from the carrying

out of activities under the petroleum authority on

the land;

(b) accounting, legal or valuation costs the claimant

necessarily and reasonably incurs to negotiate or prepare

a conduct and compensation agreement, other than the

costs of a person facilitating an ADR;

Examples of negotiation-

an ADR or conference

(c) consequential damages the eligible claimant incurs

because of a matter mentioned in paragraph (a) or (b).

It can be seen that the payment is described in the documentation as 'to encourage negotiation between landholders and the company in a fair and efficient timeframe'. There are also a number of conditions attached to you receiving the payment:

In light of the above conditions, the label of the payment and your wider factual scenario it is considered clear that the objective of the company in offering the incentive payment is to allow the compensation agreement to be completed promptly to enable the project to proceed without delay.

You have provided a number of contentions supporting the argument that the incentive payment in your hands should be characterised in the same way as the other compensation amounts payable under the CCA:

The Commissioner does not dispute that the payment is made in association with the process of seeking compensation and there is a causal connection between the receipt of compensation and the incentive payment. The fact remains that you and the company by your own free will entered into an arrangement as described in the letter of offer. If it had been in the minds of the parties that this amount was to be compensation, the CCA could have been drafted in a way that the amount was listed as compensation or, the other amounts of compensation could have been varied based on whether they meet the terms and conditions of the offer.

Instead the payment was not included in the CCA, and the letter of offer was drafted labelling the payment as an incentive conditional on you entering into the CCA on the terms specified by the company. The Commissioner concludes that the characterisation of the incentive payment in your hands is an additional payment for entering into the CCA on the terms specified by the company.

The links drawn between the conditions of the incentive payment and paragraph 532(4)(a) of the PAGA are insufficient to determine the amount is compensation. It could not be said that you have any entitlement or right to specifically receive the incentive payment under the PAGA. Nor could it be said that the incentive payment is sourced out of any other right or cause of action under common law or any other statutory authority.

Pursuant to paragraph 532(4)(b) of the PGA, compensatable effects include: accounting, legal or valuation costs necessarily and reasonably incurred by the claimant in negotiating or preparing the CCA. Publications published by the Queensland Government (see Department of Employment, Economic Development and Innovation 2010, Tips for Landholders Negotiating Agreements with Resource Companies, Department of Employment, Economic Development and Innovation, Queensland, p.p. 3) confirm that compensation payments under this head of damages are intended to cover only the accounting, legal and valuation amounts reasonably required to have been spent by the claimant. The amounts are not intended to cover all costs that may be incurred by a claimant for example, time spent in negotiating and preparing a CCA.

The incentive payment in this case does not appear to cover any actual legal, accounting or valuation costs incurred by you. Arguably there is nothing to prevent you from making a financial gain from receiving the amount. The purpose of the payment is to ensure that the compensation agreement is completed promptly so as to enable the project to go ahead without delay. The payment is designed to reduce the costs of the mining company and not to compensate you for your costs.

Whilst it is acknowledged that the incentive payment was negotiated as part of the overall arrangement, it is not accepted that the incentive payment falls within the head of damages and therefore, it is not compensation for a compensatable effect and cannot be treated as capital in nature.

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 mining compensation (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, you 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.