Edited version of your written advice

Authorisation Number: 1012918215764

Date of advice: 1 December 2015

Ruling

Subject: Income tax - Mining compensation

Question 1

Do the receipts under the Agreement constitute assessable ordinary income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Do the receipts under the Agreement constitute assessable statutory income in accordance with section 6-10 of the ITAA 1997?

Answer

No

Question 3

To the extent the receipts under the Agreement do not constitute assessable income in accordance with section 6-5 of the ITAA 1997, will the receipt of these amounts constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a Capital Gains Tax (CGT) event happening?

Answer

No

Question 4

To the extent the receipts under the Agreement do not constitute assessable income in accordance with section 6-5 of the ITAA 1997 and do not constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening, does any compensation received reduce the cost base of the property under subsection 110-45(3) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

The income year ended 30 June 2016

The income year ended 30 June 2017

The income year ended 30 June 2018

The income year ended 30 June 2019

The income year ended 30 June 2020

The income year ended 30 June 2021

The income year ended 30 June 2022

The income year ended 30 June 2023

The income year ended 30 June 2024

The income year ended 30 June 2025

The scheme commences on:

The scheme commenced in June 20XX.

Relevant facts and circumstances

Company X is an Australian resident company limited by shares. It has entered into an agreement (the Agreement), under the relevant Act with Company Y.

The Act establishes a statutory scheme to provide compensation to landowners for the impacts of petroleum and gas production activities and requires the relevant parties to enter into an agreement.

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 compensable effects (a defined term in the Act, as set out below) related to the impact of the activities on their business operations and land use.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 6-10,

Income Tax Assessment Act 1997 Division 116,

Income Tax Assessment Act 1997 Section 110-45,

Income Tax Assessment Act 1997 Section 116-20 and

Petroleum and Gas (Production and Safety) Act 2004 (X) Section 532.

Reasons for decision

Question 1

Summary

The receipts under the Agreement will not constitute assessable ordinary income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)

Detailed reasoning

Under section 6-5 of the ITAA 1997 your assessable income includes income according to ordinary concepts. This income is called 'ordinary income'.

There is no definition of 'ordinary income' in the tax law. The courts however have established the following principles to determine if an amount is ordinary income:

i) it must be determined in accordance with ordinary concepts and usages, except where statute provides otherwise;

ii) it depends on a close examination of all relevant circumstances; and

iii) it is an objective test

Taxation Determination TD 93/58 considers under what circumstances the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. Paragraph 1 of TD 93/58 indicates that a compensation amount will be assessable:

(a) if the payment is compensation for loss of income only e.g. past year profits, and/or interest; or

(b) to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

Paragraph 3 of TD 93/58 states that it is not relevant that the basis of a calculation of a lump sum amount of compensation for loss of income only (as in subparagraph 1(a) of TD 93/58) cannot be determined. Paragraph 4 of TD 93/58 further states that, under subparagraph 1(b) of that determination, it is possible to identify assessable income where the `ingredients' of the payment can be identified within a lump sum receipt of a capital nature, but the portion of the payment which relates to assessable income can be ascertained.

The payments to be made under the Agreement are not directly attributable as compensation for loss of income (in contrast to subparagraph 1(a) of TD 93/58) as they relate to the reduction in the value of the underlying asset. Paragraph 2 of TD 93/58 states that "compensation for injury to a capital asset", as applied in FC of T v. Spedley Securities Limited (1988) 88 ATC 4126 (Spedley), would not be assessable income.

As the Agreement payments are in respect of "compensation for injury to a capital asset", as held in Spedley, they are not ordinary income.

Tax Ruling TR 92/3 provides the ATO view of the income tax treatment of "those transactions outside the ordinary course of business of a taxpayer carrying on a business" (subparagraph 1(a) of TR 92/3). Paragraph 6 of TR 92/3 states that a determination of whether an isolated transaction is ordinary income depends on both of the following elements:

(a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and

(b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

The compensation for impacts provided under the Agreement are not occurring in the course of carrying on a business or in carrying out a business operation or commercial transaction. On that basis, paragraph 6 of TR 92/3 does not apply to the current circumstances and the compensation will therefore not be treated as ordinary income.

The receipts under the Agreement will not constitute assessable ordinary income on the grounds that:

• the basis for the compensation payments relates to permanent damage to, or permanent reduction in the value of, the underlying asset;

• the payments, therefore, are not occurring in the course of carrying on a business or in carrying out a business operation or commercial transaction and do not relate to the income according to ordinary concepts or profit arising from a profit-making undertaking or plan pursuant to section 6-5 of the ITAA 1997; and

• it is not possible to attribute a proportion of the compensation amount to the portion of the loss of land use that is directly attributable to the generation of assessable income.

Question 2

Summary

The receipts under the Agreement do not constitute assessable statutory income in accordance with section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)

Detailed reasoning

Statutory income may arise from CGT events as a consequence of an eligible claimant being entitled to receive compensation in respect of the loss and/or destruction of a CGT asset.

The CGT consequences of an award of damages depend on whether there is an underlying asset to which the damages have a direct and substantial link. Paragraph 76 of TR 95/35 states this should be determined "by looking through the transaction that gave rise to the compensation receipt to the most relevant asset relating to the receipt".

In the current circumstances the underlying asset is the freehold and leasehold land and improvements specified in the Agreement.

The Agreement does not provide for the acquisition of any of the specified land, nor does it provide for Company Y or any party other than the taxpayer to undertake any improvements to the land related to the activities addressed in the Agreement.

Paragraph 78 of TR 95/35 refers to Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd and Graeme McDonald 93 ATC 4418 Harper J and states that the compensation receipt should be linked to the underlying asset in determining whether the plaintiff had received any capital gain.

Paragraph 77 of TR 95/35 states that where there is loss or destruction of the underlying asset then that is why the compensation is received, rather than for the disposal of any rights arising from that loss or destruction.

The compensation payments under the Agreement consist of an upfront payment and future ongoing payments reflective of the damage to underlying assets. The payments, however, relate to compensatable effects as provided for in section 532 of the relevant Act and other impacts relating to the use and surrounding environment of the asset.

Overall the compensation is not based solely on the direct impact on the underlying asset value but all the effects that the activities of the tenement holder may cause.

Paragraph 82 of TR 95/35 states that:

In concluding that the underlying asset is the most relevant asset to which an amount of compensation relates, the taxpayer must be able to show that the compensation receipt has a direct and substantial link with the underlying asset. If an asset has not been disposed of and has not been permanently damaged or permanently reduced in value by the happening or event which generated the amount of compensation, the taxpayer is not able to demonstrate that link.

Paragraph 147 of TR 95/35 states that

If the compensation is received wholly for the permanent damage to, or permanent reduction in value of, the underlying asset, that receipt should be applied to reduce the total acquisition costs (including the cost of repairing any permanent damage to the underlying asset) in terms of subsection 160ZH(11). If the compensation is received partly for the permanent damage to, or permanent reduction in value of, the underlying asset and partly for some other purpose, the compensation should be apportioned between the different amounts, and the total acquisition costs adjusted accordingly.

Paragraph 150 of TR 95/35 provides, in part, that:

if the compensation is received wholly for the permanent damage to, or permanent reduction in value of, the underlying asset…. There is no disposal of the underlying asset at that time.

Given the payments are for compensation for damage to and interference with Company X's land, there will be a permanent reduction in the value of the underlying asset. As there is no disposal of the underlying asset, there is no CGT event. There will therefore be no statutory income assessable under section 6-10 of the ITAA 1997.

Question 3

Summary

To the extent the receipts under the Agreement do not constitute assessable income in accordance with section 6-5 of the ITAA 1997, the receipt of these amounts will not constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening.

Detailed reasoning

Section 116-20 in Division 116 of the ITAA 1997 defines capital proceeds from a CGT event.

The fundamental question is whether there has been a CGT event from which capital proceeds can be identified. In the current circumstances, the Agreement does not provide for the acquisition of the specified land constituting the underlying asset that is the subject of the compensation, nor does it provide for Company Y or any party, other than the taxpayer, to undertake any improvements to the land related to the activities addressed in the Agreement.

Conclusion

It is therefore concluded that, where there is no acquisition of an asset, there is no disposal of an asset that would constitute a CGT event. The proceeds from the Agreement are not the capital proceeds of a CGT event for the purpose of Division 116 of the ITAA 1997.

Question 4

Summary

To the extent the receipts under the Agreement do not constitute assessable income in accordance with section 6-5 of the ITAA 1997 and do not constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening, any compensation received will reduce the cost base of the property under subsection 110-45(3) of the ITAA 1997.

Detailed reasoning

Section 110-45 of the ITAA 1997 specifies what does not form part of the cost base of an asset for the purpose of determining a CGT liability. Subsection 110-45(3) of the ITAA 1997 specifies that the cost base of an asset will not include expenditure to the extent that expenditure has been recouped.

Paragraph 6 of Taxation Ruling TR 95/35 states that compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset or for a permanent reduction in the value of a post-CGT underlying asset represents a recoupment of all or part of the total acquisition costs of the asset.

Paragraph 7 of Taxation Ruling TR 95/35 requires the total acquisition costs of the post-CGT asset be reduced by the amount of the compensation.

In this instance, as there is no disposal of the underlying asset and the compensation receipts effectively represent the recoupment of expenditure on the acquisition of the underlying asset, the receipts will amount to a reduction of the cost base of the relevant asset under subsection 110-45(3) of the ITAA 1997.