Edited version of your written advice

Authorisation Number: 1051324838523

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This edited version has been found to be misleading or incorrect. It does not represent the ATO’s view of the relevant law.

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Date of advice: 11 January 2018

Ruling

Subject: Compensation

Issue 1: Income tax

Question 1

Are the amounts received from the sale of gravel included in your assessable income as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Are the amounts received for ‘management time costs’ included in your assessable income as ordinary income under section 6-5 of the ITAA 1997?

Answer

Yes

Question 3

Are the compensation payments received under the conduct and compensation agreements and deed of settlement in relation to mining activities performed on your land included in your assessable income under section 6-5 of the ITAA 1997?

Answer

No

Question 4

Will the compensation payments received under the conduct and compensation agreements and deed of settlement in relation to primary production activities performed on your land reduce the cost base of the land for any future capital gain under sections 110-40 or 110-45 of the ITAA 1997?

Answer

Yes

Issue 2: Goods and Services Tax

Question 1

Will the landholders incur a GST liability on the receipt of compensation amounts?

Answer

No

Question 2

Will the supply of gravel give rise to a GST liability?

Answer

Yes

Relevant facts and circumstances

You own land. A primary production business is carried out on the land by a related entity, registered for goods and services tax (GST).

All of the land was acquired after 20 September 1985. The total size of the property is XXXX acres.

Conduct and compensation agreement A

In September 20XX the landholders signed a conduct and compensation agreement (CCA A) under the Relevant Act 2004 with Entity A.

Entity A is the registered holder of the Tenement and permitted to carry out authorised activities on the land.

The objective of the CCA A was to compensate you for the significant impact of primary production related activities carried out on your land and infrastructure placed on your land by Entity A.

The compensation payable under the CCA A will be for the compensatable effects including deprivation of land.

CCA A sets out the compensation amounts for the different infrastructure that may be placed on the land and the activities and related compensation.

You have received compensation payments in relation to the CCA A:

CCA A provides that all amounts referred to in the agreement are stated on a GST exclusive basis.

Gravel

Authorised activities may include the use by Entity A of gravel on the land, provided that the gravel is provided by you at market rates.

You own a bulldozer and accordingly push the gravel and prepare it for use as a durable road surface. You have sold the gravel to others who come and collect the gravel from the land while you load the gravel into their trucks. The sale price of the gravel is currently around $XX per cubic metre.

You require Entity A to purchase all of the gravel that Entity A used. Accordingly, during the construction of the existing infrastructure significant sales of gravel were made to Entity A and it is expected that a similar level of gravel sales will occur for the construction of the proposed infrastructure.

Deed of Settlement

In 20XX a Deed of Settlement (deed) was entered into between Entity A and you to provide further compensation amounts due to primary production activities conducted on the land.

The deed primarily provides additional compensation for additional permanent impacts on the land caused by primary production activities carried out in accordance with the 20XX CCA.

You received a compensation payment.

Conduct and Compensation Agreement B

Entity A are in the process of commencing additional primary production related activities on your land and a new conduct and compensation agreement (CCA B) has been negotiated. The CCA B will compensate you for the permanent impact that those additional activities will have on the land, enterprises carried out on the land and the people living on the land.

Entity A has used a value of $XXXX per hectare as benchmark in calculating the compensation amounts.

CCA B provides details of the compensation including the annual compensation amounts.

CCA B provides that Entity A agrees to pay for the management time of you at the rate of $XXX per hour upon the submission of a correctly rendered invoice by detailing the particulars such as the date and time you claim the management time.

Management time is defined in the CCA B as compensation payable to you for your time expended in making further claims including for loss resulting from activities over the agreed compensation. This may involve Entity A undertaking repairs to damage to the land.

Entity A will reimburse you for reasonable accounting, legal and valuation costs that are incurred in relation to the negotiation, drafting and execution of CCA B.

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

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-10

Reasons for decision

Issue 1: Income tax

Ordinary Income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the financial year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

● are earned

● are expected

● are relied upon, and

● have an element of periodicity, recurrence or regularity.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

Gravel

Primary production business activities are conducted on the land as such it is income producing land. A gravel pit was on the land when you acquired it and you use your business equipment to loosen the gravel which prepares the gravel to make available to sell at market rates.

In this case you are receiving a payment per cubic metre of gravel.

You have entered into a commercial agreement or transaction that is not solely or directly in relation to diminution of the land. By you pushing up the gravel, you are able to have some control on the impact on the property. You entered into an agreement and accepted the risk of further diminution of the land, to enable derivation of income from the sale of gravel extracted from your gravel pit.

This gravel is the sale of goods. This activity has been carried out over a number of years and on a repetitive basis. This activity forms a part of the income producing activities of the business carried out on the land. The proceeds from sale of gravel are assessable as ordinary income under section 6-5.

The receipts from the sale of gravel will be assessable income under section 6-5 of the ITAA 1997 as part of the overall business conducted on the property. As such, the stockpiled gravel has become trading stock at market value. CGT event K4 happens to a CGT asset when it becomes trading stock.

Management time costs

In the CCA B you have negotiated to receive payments for your time in relation to making further claims as a result of primary production activities on your land. Payments are received following a correctly rendered invoice issued.

This payment charged at $XXX/hour is separate to the compensation received for damage to the land, rather it is an additional sum you will invoice to receive for your time and effort in determining that compensation. As such, the application of Taxation Ruling 95/35: Income tax: capital gains: treatment of compensation receipts is not relevant because the amounts to be received are not wholly in respect of permanent damage or permanent reduction in value of a CGT asset.

This payment is not a reimbursement of costs you incurred.

This payment is earned, expected, relied upon and has the element of recurrence – where you will seek payment for your time over the course of the term of the 2017 CCA.

This payment is earned as remuneration or recompense for services you perform and is assessable as ordinary income under section 6-5 of the ITAA 1997.

Compensation payment as ordinary income

Section 6-5 of the 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 or 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

(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 apply in your situation. The compensation payments were made in accordance to the legislative provisions of the petroleum legislation.

Accordingly, the compensation payments paid under the CCA A, deed and CCA B, do not give rise to income according to ordinary concepts or to a profit arising from a profit-making undertaking or plan 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 an eligible claimant being entitled to receive compensation and the loss and 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 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 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 received 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.

In this case you will receive compensation for the compensatable effects of primary production activities undertaken on your land. The term ‘compensatable effects’ is defined in section 532 of the petroleum legislation as meaning:

● all or any of the following relating to the eligible claimant’s 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 any improvement on it

● severance of any part of the land from other parts of the land or from other land that the eligible claimant owns

● any cost, damage or loss arising from the carrying out of activities under the petroleum authority on the land

● accounting, legal or valuation costs the claimant necessarily and reasonably incurs to negotiate or prepare a conduct and compensation agreement

● consequential damages the eligible claimant incurs because of a matter mentioned above.

The primary production activities have resulted in the permanent damage to, or permanent reduction in the value of the 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 CCA A, deed and CCA B or receiving the compensation payments.

However, the land’s acquisition cost will be reduced by the compensation payments received in relation to that land. That is, the cost base of the land will be reduced by the value of the payments and any gain or loss will crystallise at a later time when each parcel of land is sold.

Issue 2: Goods and Services Tax

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if you make the supply for consideration; the supply is made in the course or furtherance of an enterprise that you carry on; the supply is connected with the indirect tax zone; and you are registered or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

A supply is broadly defined in section 9-10 of the GST Act to include the creation, grant, transfer, assignment or surrender of any right or an entry into, or release from an obligation to refrain from an act or to tolerate an act or situation.

Goods and Services Tax Ruling 2001/4 (GSTR 2001/4), sets out the Commissioner’s views relating to GST consequences of court orders and out-of-court settlements. In relation to the meaning of supply, paragraphs 22 and 25 of GSTR 2001/4 state:

22. Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else.

25. Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release.

Goods and Services Tax Ruling 2006/9 (GSTR 2006/9), examines the meaning of “supply” in the GST Act. Paragraph 71 of the GSTR 2006/9 explains that an entity will make a supply whenever that entity (the supplier) provides something of value to another entity (the recipient). This is consistent with the ordinary meaning of ‘supply’ being to furnish or provide.

In this case, Entity A is the registered holder of the tenement and permitted to carry out the authorised activities on the land. Under the CCA A, Entity A is required to compensate you for the significant impact of Primary production related activities carried out on your land and infrastructure placed on your land by Entity A. Entity A also negotiated a new Conduct and Compensation Agreement (CCA B) with you to compensate for the permanent impact that those activities will have on the land, enterprises carried out on the land and the people living on the land.

The compensation is not paid for the right to use the land by Entity A. Based on the facts provided, the right to access the land and carry out the authorised activities on the land is vested in Entity A. Under these circumstances, we consider that you do not transfer or surrender your rights related to primary production activities on the land to Entity A. Hence, there is no supply from you to Entity A of the right to access the land and carry out the authorised activities.

Discontinuance supply

According to the Deed the landholders will release and discharge Entity A from all present or future claims relating to the applicable agreements in relation to the authorised activities. However, we do not consider that the giving up of the rights is a separate supply from you to Entity A since it is not the reason the compensation is paid to you as per CCA A and CCA B.

Paragraphs 106 to 109 of GSTR 2001/4 state:

106. Where the only supply in relation to an out-of-court settlement is a 'discontinuance' supply, it will typically be because the subject of the dispute is a damages claim. In such a case, the payment under the settlement would be in respect of that claim and not have a sufficient nexus with the discontinuance supply.

107. In most instances, a 'discontinuance' supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

Damages

The payments under CCA A and CCA B are compensation in respect of any damage caused or likely to be caused to the land and any inconvenience suffered by you as a consequence of Entity A’s authorised activities carried out on the land. In paragraph 71 of GSTR 2001/4, the Commissioner identifies situations where the subject matter of a claim for damages or compensation cannot be regarded as a ‘supply’. Examples of such claims include property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury. Hence the payments under CCA A and CCA B are not consideration for supplies from you to Entity A.

Sale of gravel

The supply of gravel satisfies all the requirements of section 9-5 of the GST Act.

You receive consideration for the supply of gravel; the supply of gravel is made in the course or furtherance of your enterprise; the supply is connected with the indirect tax zone; and you are registered for GST.

The supply of gravel is neither GST-free nor input taxed.

Summary

You will not incur GST liability for the compensation payments received.

The sale of gravel will be subject to GST and you are liable to pay GST.