Edited version of your written advice

Authorisation Number: 1013072165377

Date of advice: 25 August 2016

Ruling

Subject: CGT - compensation

Question 1

Do the receipts under the Compensation Agreement form part of your assessable income?

Answer

No.

Question 2

Will the receipts under Compensation Agreement reduce the cost base of the post-CGT Land for any future capital gain under section 110-40 or section 110-45 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

Should the amounts received that relate to the easement taken be treated as capital proceeds for the part disposal of the land?

Answer

Yes.

Question 4

Should receipts that relate to the sale of water that has been drawn from dams and artesian bores and gravel on the property be considered to be assessable income in the year of receipt?

Answer

Yes.

Question 5

Should receipts that relate to compensation for the use of water and gravel be considered to represent permanent damage to the land?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commences on

The scheme has commenced

Relevant facts and circumstances

You own Land.

You acquired a partial ownership interest in the Land prior to 20 September 1985 and the remaining ownership interest after 19 September 1985.

The land has been subject to activities undertaken by petroleum authorities.

Compensation agreement

You entered into a compensation agreement created in accordance with the Petroleum Act 1923 and the Petroleum and Gas (Production and Safety) Act 2004 ('the Petroleum legislation').

Under the compensation agreement the petroleum authority provides you with compensation in full and final satisfaction of their liability to you for:

• any compensatable effect you suffer that is caused by the activities

• consequential damages you incur because of the compensatable effect caused by the activities, and

• all other amounts that may be payable under the Petroleum legislation or otherwise for the activities.

'Compensatable effect' is defined in the agreement as meaning all or any of the following in relation to the Land:

• deprivation of the possession of its surface

• diminution of its value

• diminution of the use made, or that may be made, of the Land or any improvement on it

• severance of any part of the Land from other parts of the Land or from other land you own

• any cost or loss arising from the carrying out of the activities on the Land.

You will receive upfront, event specific and annual payments. When negotiating the compensation amounts you did not make for loss of income or economic loss from the activities on your Land.

You have not disposed of all or part of the Land.

Easement related payments

You entered into a Deed of Option for Easement with a petroleum authority that has the legislative power to compulsorily acquire easements under the Acquisition of Land Act 1967 (ALA).

Under the Option Deed you agreed to grant an option to acquire an easement or easements in respect of area of your Land.

You received a non-refundable payment for entering the Option Deed.

The option was exercised and an easement was registered against your Land.

The Easement Purchase Price is payable under the provisions of the Petroleum legislation and is full and final satisfaction of all money payable for the granting of the easement including the related compensatable effects as defined in the petroleum legislation. The easement purchase price does not include any payment for loss of income from business activities.

'Compensatable effect' is defined in the Petroleum legislation as meaning all or any of the following:

(a) all or any of the following relating to your Land

(i) deprivation of the 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 you own

(v) any cost or loss arising from the carrying out of the activities on the Land

(b) accounting, legal or valuations costs you incur to negotiate or prepare a conduct and compensation agreement, and

(c) consequential damages you incur because of a matter mentioned in (a) or (b).

Subsequent to the completion of the easement documents you became aware that the impact on your Land was significantly greater than first anticipated. You lodged additional claims with the petroleum authority.

A settlement deed was entered into and you were paid an additional amount for the compensatable effects of the petroleum activities on your Land.

Water and gravel sales

You sold water and gravel the petroleum authority and various contractors.

You were paid on a volume basis for the water and gravel used.

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 15-20

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 104-40

Income Tax Assessment Act 1997 Section110-40

Income Tax Assessment Act 1997 Section 110-45

Income Tax Assessment Act 1997 Section 116-65

Income Tax Assessment Act 1997 Section 134-1

Reasons for decision

Summary

The payments received under the compensation agreement will not form part of your assessable income. They are considered to be compensation received for the permanent reduction in value of the Land. The portion of the compensation payment attributable to your pre-CGT Land interest has no CGT consequences. The portion of the compensation payments attributable to your post-CGT Land interest will be treated as a reduction to the post-CGT Land's cost base.

The payments received in relation to the granting of the easement are considered to be capital proceeds from the part disposal of the Land. The portion of the payments attributable to your pre-CGT Land interest has no CGT consequences. If portion of the compensation payments attributable to your post-CGT Land interest exceed the cost base of the easement related land, the excess is assessable as a capital gain.

Payments received for the extraction of water are considered to be payments of royalties and form part of your assessable income.

Detailed reasoning

Payments under the compensation agreement

Compensation payment as ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Compensation paid due to loss and damage of a capital asset in the process of a petroleum authority undertaking petroleum activities on a taxpayer's land is an isolated transaction. Whether a profit from an isolated transaction is ordinary assessable income according to ordinary concepts depends on the circumstances of the case. Profit from an isolated transaction is generally ordinary income when both of the following elements are present:

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

(b) the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 of Taxation Ruling TR 92/3).

Neither of the above elements applies in your situation. The compensation payments were made in accordance to the provisions of the Petroleum legislation.

Accordingly, the compensation payments paid under the compensation agreement do not give rise to income according to ordinary concepts or to a profit arising from an isolated transaction. They are not assessable under section 6-5 of the ITAA 1997.

Compensation payments and the capital gains tax (CGT) provisions

Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in a taxpayer's assessable income due to another provision of the tax law. These amounts are 'statutory income'. Statutory income may arise from CGT events as consequence of the eligible claimant being entitled to receive compensation and the loss or destruction of a CGT asset.

Taxation Ruling TR 95/35 provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

The underlying asset is the asset that, using a '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 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.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying post-CGT asset, or part of an underlying post-CGT asset, of the taxpayer, the compensation represents consideration on the disposal of that asset. In these circumstances, the Commissioner considers that the amount is not consideration for the disposal of any other asset, such as the right to seek compensation.

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.

Accordingly, 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 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.

Compensation received by a taxpayer has no CGT consequences if the underlying asset which as suffered permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985.

Taxation Determination TD 2000/31 states that if a taxpayer owns an interest in a CGT asset and they acquire another interest in the asset, the interests remain separate assets.

In your case, you have and will continue to receive payments for the compensatable effects of petroleum related activities undertaken on your Land. The petroleum related activities have resulted in the permanent damage to, or permanent reduction in the value of, the Land. You have not received compensation for loss of income or other economic benefits.

As you acquired an ownership interest in the Land prior to 20 September 1985 ('the pre-CGT Land') and remaining ownership interest in the Land after 19 September 1985 ('the post-CGT Land') they are considered to be separate assets. The compensation payments need to be apportioned between the two assets and treated accordingly.

Treatment of compensation relating to the pre-CGT Land

That portion of the compensation payments you receive which relate to your pre-CGT Land has no CGT consequences at the time you entered the compensation agreement, when you received the payments or when you dispose of the property in the future.

Treatment of compensation relating to the post-CGT Land

As you did not dispose of all or part of the affected Land there are no CGT consequences at the time of entering the compensation agreement or receiving the compensation payments.

However, the cost base of the post-CGT Land will be reduced by the value of the payments received and any gain or loss will crystallise at a later time when the Land is sold.

Payments relating to the QGC easements

An easement is a right over someone else's land or property. It is an asset which is created at the time it is granted.

CGT event D2 happens if you grant an option to an entity. You make a capital gain if the capital proceeds from granting the option are more than the expenditure you incurred to grant it. However, a capital gain you make from the grant of an option is disregarded if the option is exercised. In these situations, the amount you receive from the disposal of the 'asset' the option relates to, includes any payment you received for granting the option.

In your situation, you received a payment for granting option to acquire an easement over part of the Land. As the option was exercised, the payment you received forms part of the easement purchase price and will be treated in the same manner. It will be used in calculating if you have a capital gain or loss resulting from the granting of the easement.

After granting of the easement you sought additional compensation for the detrimental effects the easement had on your Land. You were paid an additional amount under a settlement agreement. After reviewing the agreement, it is considered the additional amount forms part of the easement purchase price and should be treated in the same manner.

The taxation treatment of a payment for the granting of an easement depends on whether the easement has been created by compulsory acquisition or as a voluntary action.

Taxation Ruling TR 93/7 at paragraph 4 states:

Compensation in respect of an easement created by statute in favour of a public authority cannot be said to have been received for the grant of the easement. The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation. In these circumstances, the landowner cannot be said to have created an asset as required for subsection 160M(6) of the Act to apply. The easement is created by operation of the relevant statute and is vested in the public authority. This constitutes a compulsory acquisition of the easement.

Note: subsection 160(M) of the Income Tax Assessment Act 1936 referred to in the above paragraph has been replaced with section 104-35 of the ITAA 197. The effect of both provisions is the same.

As stated above, TR 95/35 examines the treatment of any amount received in respect of a right to seek compensation in relation to an underlying asset. Where easements are acquired under statute, the underlying asset is the landowner's pre-existing land with its rights of ownership, including the right to exclude all others. This right to exclude all others is forfeited when the easement comes into existence.

Compensation received by a landowner for the loss of part of the rights of ownership is accepted as being consideration received in respect of the part disposal of the underlying asset (the land) (paragraph 8 of TR 93/7).

It is possible that a public authority that has the power to compulsorily acquire an easement by exercising a statutory power may enter into an agreement with the landowner to acquire the easement.

The Commissioner's view, in these situations, is the amount received takes on the same character as compensation for a compulsorily acquired easement. Thus, the consideration (compensation) for granting the easement is treated as being paid in respect of the part disposal of the land and not in respect of granting the easement (paragraphs 9 and 10 of TR 93/7).

Whilst you have voluntarily entered into an agreement with the petroleum authority for the easement, it is accepted that the petroleum authority had the legislative power to compulsorily acquire the easement. Thus, the payments you received as are considered to be capital proceeds for the part disposal of the Land. These payments include the option payment, the easement purchase price and the additional payment made under the settlement deed.

Treatment of easement payments relating to the pre-CGT Land interest

That portion of the easement payments you receive which relate to your pre-CGT Land interest has no CGT consequences at the time you entered the option, agreement or settlement or when you received the payments.

Treatment of easement payments relating to the post-CGT Land interest

The portion of the easement payments relating to your post-CGT Land interest are capital proceeds for the purposes of the CGT legislation. If this amount exceeds the post-CGT interest component of the cost base of the easement related land, the excess is assessable as a capital gain.

Payments for water and gravel extraction

Payments for water and gravel as a royalty

Section 15-20 of the ITAA 1997 states your assessable income includes an amount that you receive as or by way of royalty if the amount is not assessable as ordinary income under section 6-5 of the ITAA 1997. Royalties are statutory income.

The Commissioner's view on the definition of a royalty is provided by Taxation Ruling IT 2660. The ordinary meaning of the term 'royalty' has been considered by the Courts on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that:

… the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken.

Paragraph 10 of IT 2660 provides that in the Commissioner's view there are four key characteristics of a common law royalty:

• it is a payment made in return for the right to exercise a beneficial privilege or right, for example to remove minerals or natural resources such as timber (McCauley v. FC of T (1944) 69 CLR 235)

• the payment is made to the person who owns the right to confer that beneficial privilege or right (Barrett v. FC of T (1968) 11 CLR 666)

• the consideration payable is determined on the basis of the amount of use made of the right required (McCauley, Stanton), and

• the consideration will usually be paid as and when the right acquired is exercised. However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired (IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272).

In your case you have agreed to receive payments for the volume of water and gravel extracted from your property and sold to the petroleum authority and contractors. Water and gravel are natural resources.

It is considered that the payment for each cubic metre of gravel and mega litre of water extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997.

Alternatively, the sale of the gravel and water would be considered ordinary income of the existing business carried out on the property and simply be the sale of resources surplus to the business's needs.