Edited version of your written advice

Authorisation Number: 1051428157852

Date of advice: 17 September 2018

Ruling

Subject: Compensation

Question 1

Is any amount of the compensation payment assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997?

Answer

No.

Question 2

Is the reimbursement payment for deductible accounting fees an assessable recoupment?

Answer

Yes.

Question 3

Are the reimbursement payments for non-deductible accounting fees, legal and valuation costs assessable?

Answer

No.

Question 4

Do the reimbursement payments for non-deductible accounting, legal and valuation costs relating to the agreement form part of the cost base of the land?

Answer

No.

Question 5

Will the compensation payments constitute capital proceeds in respect of a capital gains tax (CGT) event?

Answer

No.

Question 6

Will the compensation payments, excluding the reimbursements, reduce the cost base of the land for any future capital gain?

Answer

Yes.

Question 7

Do the compensation payments need to be apportioned between the land holder and the occupier?

Answer

No.

Question 8

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

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

Year ending 30 June 2028

Year ending 30 June 2029

Year ending 30 June 2030

The scheme commenced on

1 July 2018

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are the registered owners (Landholders) of property A.

You acquired the Land several years ago.

You are not registered for GST as individuals.

You currently occupy the Land to run a business as partners in a partnership. The partnership is registered for GST. There is no Lease or agreement in place between you as landholders and you as occupiers in partnership.

Entity B is to carry out activities on all or part of the Land.

You, as individuals and landholders have entered into an Agreement with Entity B for the use of the Land.

Under the Agreement you will receive compensation.

The Agreement was negotiated in accordance with the relevant legislation.

The prime objective of the Agreement is to ensure you as landholder are properly compensated as required under the relevant Legislation. The compensation is payable in respect of the impacts of the activities.

After negotiations with Entity B, there will be no compensation offered for the changes with regards to the business operations. Both parties agree that the business operations should not be affected by the activities which Entity B proposes to carry out.

The GST registered partnership is included for completeness only. The Agreement provides compensation amounts payable to you only in your capacity as the ‘Landholders’.

Accordingly no monetary compensation is being made relating to the business operation by the partnership.

The compensation as outlined in schedule 1 of the Agreement includes several different payments which are payable during different phases. Reimbursements are being received for legal, accounting and valuation costs reasonably and necessarily incurred by you negotiating this agreement.

The compensation in the Agreement is to compensate you for the impact of the activity on the land. The compensation is being paid in accordance with the relevant Legislation.

Under the relevant Legislation, written consent for the right to access Restricted Land must be granted by the Landowner. This right is provided by the Agreement.

For GST purposes, the provision of the right to access Restricted Land is a separate supply. In your case, there is no separately identifiable compensation provided for the right to carry out Activities on Restricted Land in the Agreement.

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 10-5

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 section 25-5

Income Tax Assessment Act 1997 subsection 110-25(5)

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

Reasons for decision

Detailed reasoning

Ordinary income

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

The compensation payment you will receive is not earned by you as it does not relate to services performed or from carrying on a business. Although the compensation relates to your property, the payment is not akin to rent. Rather the compensation is being received for the impact of the activity on your land. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from any personal services performed or business activity. The compensation payment relates to the damage to your property and is capital in nature. Accordingly, it is not regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

Statutory income

Statutory income is not ordinary income, but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997 and include capital gains, which are included in assessable income by virtue of the capital gains tax (CGT) provisions.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation payments. Why the payment was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes.

TR 95/35 discusses the various scenarios, including:

● disposal of the underlying asset,

● compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and

● disposal of the right to seek compensation.

As outlined in the ruling, the Commissioner adopts an ‘’underlying asset'' approach to determine the asset to which the compensation amount is most directly related. In concluding that the underlying asset is the most relevant asset to which an amount of compensation relates, a person 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. It follows that the compensation cannot be directly related to that asset. In those cases, the most relevant asset may be the right to seek compensation, or the notional asset.

Paragraph 3 of TR 95/35 states that permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

If an amount of compensation is received 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, 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.

The transaction which generated your compensation payments is the actions of Entity B. The underlying asset in your case is the land that has been used for the activities. You have not disposed of the land, however the land will suffer permanent damage. You will receive compensation in respect of the impact of the activities on the land. The compensation amounts to be paid are viewed as having a direct and substantial link or nexus with the land.

In this case you have received, and will continue to receive, compensation payments as a result of activities being carried out on your property. These activities have resulted in the permanent damage to, or permanent reduction in the value of, the property.

As you have not disposed of the property, there are no CGT consequences at the time of entering the Agreement or receiving the compensation payments.

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

Please note, that although the partnership is a party to the agreement, no part of the compensation relates to the business operation. Therefore it is considered that no part of the compensation belongs to the partnership.

Reimbursements of accounting, legal and valuation costs

Accounting fees which relate to your tax affairs are an allowable deduction under section 25-5 of the ITAA 1997. Where the services to which the fees relate go beyond managing your tax affairs, you must apportion the fees between the various purposes and only those services that directly relate to your tax affairs are deductible (Bartlett v FC of T; Falcetta v FC of T 2003 ATC 4962; [2003] FCA 1125).

In your case, you have incurred legal and valuation expenses for the purpose of negotiating the Agreement. The expenditure was not incurred for the purpose of producing assessable income and is capital in nature. No deduction is allowed under section 8-1 of the ITAA 1997 or any other provision for your legal and valuation costs.

Under subsection 20-20(3) of the ITAA 1997, an amount received as recoupment of a loss or outgoing (except by way of insurance or indemnity) is an assessable recoupment if it is paid to cover the cost of a deductible expense listed in section 20-30 of the ITAA 1997 and the deduction can be claimed in the current year or in an earlier income year. Section 25-5 of the ITAA 1997 is listed in section 20-30 which allows a deduction for tax-related expenses.

Recoupment of a loss or outgoing includes any kind of recoupment, reimbursement, refund or recovery (subsection 20-25(1) of the ITAA 1997).

Where you are entitled to a deduction for any of the accounting costs, the associated reimbursement compensation payment is an assessable recoupment.

A reimbursement of accounting, legal and valuation fees for which you could not claim a deduction for in the current or an earlier income year will not be an assessable recoupment or ordinary income.

The legal and valuation costs incurred for the purpose or the expected effect of which is to increase or preserve the land’s value will generally form part of the fourth element of the cost base (subsection 110-25(5) of the ITAA 1997). However under subsection 110-40(3) of the ITAA 1997, expenditure does not form part of any element of the cost base to the extent of any amount you have received as recoupment of it, except so far as the amount is included in your assessable income.

In your case, the reimbursements for the legal and valuation costs are regarded as a recoupment. Therefore, the legal and valuation costs or the associated reimbursements do not form part of the cost base calculations for your land. The reimbursed legal and valuation costs are not assessable under any other provision of the ITAA 1997.

GST

For compensation amounts to give rise to a GST liability a taxable supply has to be made.

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) states that you make a taxable supply if the supply is made for consideration; in the course or furtherance of an enterprise that you carry on; 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.

‘Supply’ is a 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 GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements, sets out the Commissioner’s view 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 GSTR 2006/9 Goods and services tax: supplies, examines the meaning of ‘supply’ in the GST Act. Paragraph 71 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 your case, the resource authority holds a permit, which allows their appointed agent to enter the Land to carry out authorised activities. However, generally, resource authority holders cannot access private land to carry out certain activities unless there is an agreement in place to compensate land owners and occupiers. Pursuant to the relevant legislation, resource authority holders are required to compensate the landholders and occupiers for any compensatable effect caused by these activities carried out on the land.

You own the Land as individuals and you currently occupy the Land to run a business operation as partners in partnership. The partnership is registered for GST. There is no Lease or relevant agreement in place between you as the landholders and you as the occupiers in partnership.

You and Entity B agree that the business operations of the partnership should not be affected by the activities listed in the Agreement which Entity B proposes to carry out. Accordingly no monetary compensation (consideration) is being made to the partnership relating to the business.

As there is no consideration paid to the partnership under the Agreement, there is no taxable supply made to Entity B and you do not incur a GST liability in your capacity as a partnership.

However, under the Agreement, when you as Landowners provide the right to Entity B to carry out activities on Restricted Land, you make a supply. In your case, as there is no separately identifiable amount (consideration) paid for that supply and as you are not individually registered or required to be registered for GST, it is not a taxable supply. Accordingly, you do not incur a GST liability.

The compensation amounts detailed in the Agreement that are paid to you as Landowners are not paid for the right to enter and carry out activities on the Land by Entity B. The right to access the Land and carry out activities has already been granted. You do not create, transfer or surrender any rights related to these activities on the Land to Entity B (apart from the right to access Restricted Land detailed above). Hence, there is no further supply made by you as Landholders to Entity B, instead the payments in the Agreement are compensation in respect of any damage caused or likely to be caused to the Land, for example the diminution of the value of the Land, as a consequence of activities being carried out.

Accordingly, you did not make any other supply to Entity B (apart from the supply of access to Restricted Land) when you entered into the Agreement. Therefore, there is no taxable supply for the purpose of section 9-5 of the GST Act and consequently you have no entitlement to any input tax credits in relation to the amount described above.