Edited version of your written advice

Authorisation Number: 1051439171160

Date of advice: 11 October 2018

Ruling

Subject: Compensation payments

Question 1

Will the one off agreement completion payment received be characterised as compensation under the relevant agreements?

Answer

Yes.

Question 2

Will the compensation received under the agreement for permanent damage to the land be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

Will the compensation received under the agreement for permanent damage to the land be treated as capital proceeds from any capital gains tax event in Division 104 of the ITAA 1997?

Answer

No.

Question 4

Will the compensation received under the agreement for permanent damage to the land reduce the cost base of the relevant property for any future capital gain under section 110-45 of the ITAA 1997?

Answer

Yes.

Question 5

Will the payments for the gravel extracted from your property reduce the cost base of the land for any future capital gain under section 110-45 of the ITAA 1997?

Answer

No.

Question 6

Will the payments for the gravel taken from your land form part of your assessable income under section 15-20 of the ITAA 1997?

Answer

Yes.

Question 7

Will the amounts received by the landholders for water taken from the land be included as ordinary income of the landholders and be assessable under section 6-5 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Superfund is the legal land owner of Property A (the Property).

The Property is leased to a Partnership which they use in their business.

The Superfund entered into an agreement with XYZ. The agreement was entered into to compensate the Superfund for the activities on the land.

There is no formal lease agreement in place between the Superfund and the Partnership. The Partnership has no entitlement to any amount of compensation that relates to the permanent damage to the land that may be paid under the agreement.

The proposed payments under the signed agreement are set out as follows:

A separate letter of offer was sent to the Superfund for a one off agreement completion payment payable within 25 business days of agreement execution date, where the Superfund chooses to sign the agreement by the specified date. This agreement completion payment was offered to encourage negotiation between the Superfund and XYZ in a fair and efficient timeframe.

The Superfund signed the agreement before the relevant date. The amount was received at the same time the pre-construction payments were received.

There is a gravel resource on the property and XYZ have indicated that they may use some of the gravel to construct the tracks and roads on the properties. The gravel will be extracted and prepared for use by the Superfund using its own bulldozer or a hired bulldozer and XYZ will then take away the prepared gravel. XYZ may be prepared to pay between $X- $X per tonne for the gravel. The gravel disposal has not been included in the agreement and there have been no previous gravel sales in the past by the Superfund.

XYZ has also advised that they may use the water from the earth tanks for dust suppression and other aspects of the construction process. The CCA provide that you will be paid $X per litre for each litre of water taken by XYZ. Water availability is dependent on weather conditions at the time that XYZ requires the water and you will be contacted prior to any water being taken by XYZ. There are no water bores on the property and the water requirements are met from nine earth tanks on the properties. The earth tanks are re-charged through overland flow.

The Superfund is concerned that the presence of the structures will permanently impact on the aesthetic value of the land.

The construction of new roads up to four meters wide will result in permanent loss of good productive land. Additionally, the construction of the gathering system will result in a diminution in the productive capacity of a significant amount of land on the properties.

A summary of the different categories of land that may be identified as resulting from the activity on the land was provided.

The negotiations took into account the negative stigma of having the activity on the land which include the concept of blight on the land where the land has an unwelcome attribute and depresses the overall value of the property. The impact of the blight on the land will include the diminution in the long-term market value of the land as a result of having industrial activities on the land. This negative stigma is particularly concerning in the context of potential consumers of the high quality products produced, where such consumers may have diminished demand for products produced in an industrial environment.

The presence of the activity has impacted and will continue to impact the existing quality of life, lifestyle, quiet enjoyment or amenity for the human inhabitants on the property. The visual impact of viewing the infrastructure will be ever present.

The noise during the construction is expected to be significant and there will be on-going noise. The negotiations included recognition of the significant construction and operational noise impact on the landowners and their acquiescence of the higher levels of noise resulting in the diminution in the value of the land.

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 110-45.

Reasons for decision

Agreement completion payment as compensation

Taxation Ruling TR 95/35 contains a broad definition of 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.

Notwithstanding the agreement completion payment is paid separately from the compensation payment and is not described as compensation, it can still meet this definition of a compensation receipt. Looked at from the totality of the relationship between the parties, the Agreement completion payment is part of the overall deal that the landowner agrees to. The Agreement completion payment along with the amounts payable under the agreement all form part of the compensation received by the landowner. The Agreement completion payment is part of what results or “moves” the landowner to agree.

There will be circumstances when an inducement payment is paid because something is provided by the recipient that is additional to agreeing to the offer of compensation. For instance, Example 21 in TR 95/35 involves a situation where an inducement payment is made to expedite the process following the conclusion of an agreement relating to the amount of compensation payable. The inducement payment is treated separately to the compensation. The compensation is treated as relating to the underlying land, while the inducement payment is treated as the right to enter on the land at an earlier time than previously agreed.

This case is however distinguishable. There is only one agreement between the parties, that being the agreed compensation. The situation would be different if the compensation amount was determined and then during subsequent dealings the parties agreed to expedite the timing of the original agreement (as is the case with Example 21).

Consequently the agreement completion payments will represent compensation received.

Compensation payment as ordinary income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident 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 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 apply in your situation. The compensation payments were made in accordance to the relevant legislative provisions.

Accordingly, the compensation payments paid do not give rise to income according to ordinary concepts or to a profit arising from a profit-making undertaking or plan pursuant to 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 your 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 the activities undertaken on your land. The term ‘compensatable effects’ is defined in the relevant legislation.

The 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 agreement 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.

Payments for gravel extraction

You conduct business activities on the land, as such it is income producing land. A gravel pit was on the land when you acquired it and you will use your own or hired equipment to loosen the gravel which prepares the gravel to make available to sell to XYZ. There is no agreement in place with XYZ for the gravel sales and the Superfund has not previously engaged in any gravel sales.

In this case the Superfund will receive a payment per tonne of gravel.

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 may receive payments for the volume of gravel extracted from your property. Gravel is a natural resource.

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

Payments for water taken

You may receive payments for the volume of water taken from a dam on your property. The amount of water taken is dependent on the available level of water in the dam which is governed by seasonal conditions. It is considered that any proceeds you receive from the sale of the water is ordinary income. Even if the proceeds were not ordinary income, they would be assessable as a royalty given that the water is a natural resource that was removed from your land.