Edited version of your written advice

Authorisation Number: 1051448469219

Date of advice: 2 April 2019

Ruling

Subject: Assessable Income – capital gains tax - compensation - mining receipts

Question 1

Do the compensation amounts received by the landholders under a conduct and compensation agreement (CCA 1) to compensate the landholders for the temporary placement of a structure on their land constitute assessable income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the compensation amounts received under the conduct and compensation agreements (CCA 2 and CCA 3) assessable income in accordance with section 6-5 of the ITAA 1997?

Answer

No.

Question 3

To the extent that the compensation amounts under CCA 2 and CCA 3 do not constitute assessable income in accordance with section 6-5 of the ITAA 97 will the receipt of these amounts constitute capital proceeds under Division 116 of the ITAA 97 in respect of a CGT event happening?

Answer

No.

Question 4

To the extent that the compensation amounts received under CCA 2 and CCA 3 do not constitute assessable income in accordance with section 6-5 of the ITAA 97, and do not constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening, does any compensation received under the compensation agreements reduce the cost base of the property/land under subsection 110-45(3) of the ITAA 1997?

Answer

Yes.

Question 5

Do the compensation amounts received under CCA 4 in respect of coal seam gas wells constitute assessable income in accordance with section 6-5 of the ITAA 1997?

Answer

No.

Question 6

To the extent that the compensation amounts under CCA 4 do not constitute assessable income in accordance with section 6-5 of the ITAA 97 will the receipt of these amounts constitute capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening?

Answer

No.

Question 7

To the extent that the compensation amounts received under CCA 4 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 97 in respect of a CGT event happening, does any compensation received under the CCA reduce the cost base of the property/land under subsection 110-45(3) of the ITAA 1997?

Answer

Yes.

Question 8

Will the landholders incur a Goods and Services Tax (GST) liability on the receipt of compensation amounts from entity two?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2017

Year ended 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2021

The scheme commenced on

1 July 2016

Relevant facts and circumstances

Persons A and B are married.

Person C and D are family members of A and B

Persons A, B and C are partners in a partnership which is registered for GST.

Persons A, B and C are registered for GST. Person D is not.

Persons C and D are partners in a partnership which is registered for GST.

The following properties are used for farming operations:

● Property W – owned by Persons A and B (purchased prior to 20 September 1985).

● Property X– owned by Person A (purchased prior to 20 September 1985). This property includes a homestead where Persons A and B reside.

● Property Y - owned by Person C (purchased after 19 September 1985).

● Property Z – owned by Persons A, B, C and D (purchased after 19 September 1985).

Compensation Agreement – building structure (CCA 1)

Persons A and B negotiated and signed a conduct and compensation agreement with Entity 1 in respect of Property X (CCA 1).

CCA 1 provided for the drilling of water bores and the placement of associated infrastructure including a temporary accommodation structure on the land.

Under CCA 1 the Landholders are identified as Persons A and B and also noted is the Landholder must consist of all of the owners and occupiers of the land.

CCA 1 further outlines the following Activities were to be undertaken:

● Installing, using, accessing, relocating and maintaining all infrastructures associated with the construction of a temporary accommodation structure

● The temporary structure was used by entity one to provide accommodation for its workers

● Drilling of bores

● Establishing, maintaining, testing and monitoring the bores on the land

● Construction of an access road with a construction dimension of up to XX metres wide with a total disturbance area of X.XX hectares, and

● Rehabilitation and remediation of the works area and the access roads and any other areas impacted as part of the petroleum activities.

Under CCA 1 an initial upfront payment was paid to the landholder/s and further quarterly amounts adjusted by CPI were paid during the period the land was being used.

Compensation Agreements between entity 1 and Person C in respect of Property Y (CCA 2 and CCA 3)

Person C entered into CCA 2 with entity 1 in respect of Property Y.

Under CCA 2 the following activities were undertaken on Property Y:

● Drilling of a monitoring bore

● Drilling of additional monitoring bores and associated ancillary operations

● Monitoring any of the landholder’s bores on the land

● Installing monitoring equipment on the land

● Installing, using, accessing, relocating and maintaining the infrastructure on the land.

● Constructing, using and maintaining associated access roads on the land

● Carrying out all necessary works in relation to the infrastructure on the land, and

● The eventual rehabilitation of the monitoring bore sites.

Under CCA 2 Person C was paid an upfront amount per bore and an annual payment per bore adjusted for CPI.

Person C as the owner of Property Y entered into a second CCA with entity 1 (CCA 3).

CCA 3 provides that the following activities are to be carried out on Property Y:

● Pre-construction preparation and investigation activities including site scouting, survey and pegging and ecological and cultural heritage investigations

● Preparation of construction sites on the land including vegetation clearing and grading and temporary stockpiling of construction equipment and materials

● Establishment of disturbance areas to be utilised for the installation and placement of any associated equipment or infrastructure.

● Drilling of water bore, and

● Construction of fencing.

CCA 2 and CCA 3 were made under the Petroleum Legislation.

The term Petroleum Legislation means the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) and, where the context requires, the Petroleum and Gas (Production and Safety) Act 2004 (Qld) and the Petroleum Act 1923 (Qld) (as amended and replaced).

Section 81 of the Mineral and Energy Resources (Common Provisions) Act 2014 which defines the general liability of the resource authority holder entity one to compensate each owner/occupier of private and public land that is in an authorised area for any compensatable effect the eligible claimant suffers caused by authorised activities carried out by the holder or a person authorised by the holder. Subsection 81(4) of the Mineral and Energy Resources (Common Provisions) Act 2014 defines compensatable effect as follows:

Compensatable effect means all or any of the following—

(a) all or any of the following relating to the eligible claimant’s land—

(i) deprivation of 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 that the eligible claimant owns;

(v) any cost, damage or loss arising from the carrying out of activities under the resource authority on the land;

(b) accounting, legal or valuation costs the claimant necessarily and reasonably incurs to negotiate or prepare a conduct and compensation agreement, other than the costs of a person facilitating an ADR;

Examples of negotiation—

an ADR or conference

(c) consequential damages the eligible claimant incurs because of a matter mentioned in paragraph (a) or (b).

Entity 2 – Conduct and Compensation Agreement – Coal Seam Gas Wells

Persons A, B, C and D (landholder/s) and Entity 2 entered into a conduct and compensation agreement (CCA 4).

CCA 4 falls under the Petroleum Legislation.

CCA 4 relevantly provides that:

● Compensation to the landholder for the construction of coal seam gas wells on Property Z.

● A number of payments are made over a number of income years to Persons A, B, C and D.

● Clause XX of CCA 4 identifies that the Landholder/s are being compensated for the following:

i) All Compensatable Effects, Disturbance Impacts and Noise Impacts:

a) of the Activities (including any maintenance reopening the Land’s surface) and minor changes, and

b) from Authorised Activities off the Land, and

ii) other amounts payable by Entity 2 to the Landholder under Relevant Laws for the

Activities (collectively, the Compensation Matters).

● The compensation paid is in full and final satisfaction of all claims.

● The Compensation Matters exclude any claim for a Compensatable Effect suffered by the Landholder/s as a result of Entity 2 carrying out Activities on the Land:

(i) In a way that causes the Land to become 'contaminated land' within the meaning of

(ii) the Environmental Protection Act 1994 (Qld)

(iii) negligently or in breach of any Relevant Law, common law, this Agreement or the

(iv) Terms of Access

(v) in a way as to cause personal injury or death to a person, and

(vi) in a way that causes an increase in the rates or charges levied to the Landholder by

(vii) local government authority.

● The Landholder releases Entity 2 and its associates from any liability to the landholder regarding the Compensation Matters (Clause XX of CCA 4).

● Under Clause 16 of CCA 4, the landholder consents to Entity 2 and its Associates carrying out the Activities and must not hinder or obstruct the Activities, except in the event of an Emergency or without prior consultation with Entity 2

● The infrastructure remains the property of Entity 2 and that the landholder should not interfere with or damage the infrastructure or carry out high-risk activities that have the potential to damage the underground infrastructure (Clauses XX to XX of CCA 4).

● Entity 2 is responsible for rehabilitating the applicable area of activity subject to relevant laws and Landholder rehabilitation proposals remove and leave infrastructure where required subject to the relevant laws (Clauses XX to XX of the CCA 4).

● Under Clause XX of CCA 4 states that, unless expressly stated otherwise, all amounts and calculations under or in connection with this agreement are exclusive of GST.

● A Schedule to CCA 4 identifies the petroleum production activities to be carried out on Property Z includes preliminary and associated activities, construction, testing, development, operations, maintenance, decommissioning of the gas well and rehabilitation of the gas wells.

● A Schedule to CCA 4 sets out Entity 2’s responsibilities in maintaining all tracks used by Entity 2, the control of weeds, biosecurity, dust impacts accreditations, chemical and boundary realignment, and

● Schedule X to CCA 4 sets out in detail the expected noise impacts.

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

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

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-10(1)

A New Tax System (Goods and Services Tax) Act 1999 subsection 9-15

Reasons for decision

Entity 1 – Conduct and Compensation Agreement – temporary accommodation structure on Property X (CCA 1)

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.

The courts have identified a number of factors which indicate whether an amount has the character of income. A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity. However, these characteristics are not always essential as in some circumstances proceeds from an isolated transaction received as a lump sum may also be income

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 this case, the compensation amounts received under CCA 1 are not solely or directly in relation to the diminution of Property X. Specifically, CCA 1 allows Entity 1 access to use part of the property temporarily to erect a campsite for their employees. The payments received are akin to rent or lease payments and are ordinary income. Accordingly, the payments are assessable under section 6-5 of the ITAA 1997.

Question 2

CCA 2 and CCA 3 - Compensation payments 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, or forgoing a right to sue, 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 Income tax: whether profits on isolated transactions are income).

In this case, neither of the above elements applies to Person C as the owner of the Property Y. The compensation payments are made in accordance with the legislative provisions of the Petroleum Legislation.

Accordingly, the compensation payments paid under CCA 2 and CCA 3 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. As such, these amounts are not assessable under section 6-5 of the ITAA 1997.

Question 3

CCA 2 and CCA 3 - Compensation payments as capital proceeds

Under subsection 116-20(1) of the ITAA 1997, money you have received (or are entitled to receive) and the market value of any property you have received (or are entitled to receive) are the capital proceeds from a CGT event.

For the compensation payments under an agreement to constitute capital proceeds, there must be a CGT event.

CGT events occur in respect of CGT assets. The definition of a CGT asset is contained in subsection 108-5(1) of the ITAA 1997. It provides that a CGT asset is any kind of property or a legal or equitable right that is not property. Not all things often referred to as ‘rights’ will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides the Commissioner’s view as to the CGT consequences of receiving a compensation payment and relevantly, it states that a CGT event will occur (and any consideration form part of capital proceeds) where the amount of compensation is received by the taxpayer:

● either wholly or partly in respect of the disposal of an underlying asset (paragraph 4); or

● not in respect of any underlying asset but in relation to the disposal of the right to seek

compensation (paragraph 11).

The above relate to CGT event A1 (section 104-10 of the ITAA 1997) and CGT event C2 (section 104-25 of the ITAA 1997) respectively.

TR 95/35 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 identified using the ‘look-through approach’ in order to determine the asset to which the compensation amount most directly relates. Paragraph 70 of TR 95/35 states that the underlying asset is identified by looking through to the transaction which generates the compensation receipt.

Applying the look-through approach to the facts the properties X and Y are the assets to which the compensation under the CAs most directly relates. The properties X and Y are therefore, the underlying asset and the relevant CGT asset.

As there has been no disposal of the properties X and Y, CGT event A1 does not occur. Further, as the amounts are paid in respect of an underlying asset (being properties X and Y), CGT event C2 will not occur.

The compensation amounts Persons A and C receive as the land owner of the properties X and Y respectively under the CAs will not constitute capital proceeds in respect of a CGT event happening.

Question 4

CCA 2 and CCA 3 – reduction in cost base

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.

Paragraphs 6 and 7 of TR 95/35 provide that compensation received wholly in respect of permanent damage or reduction in value of a post-CGT underlying asset that is not disposed of represents a reduction in either the CGT cost base under either subsection 110-40(3) of the ITAA 1997 (for assets acquired before 7.30pm on 13 May 1997) or subsection 110-45(3) of the ITAA 1997 (for assets acquired after 7.30pm on 13 May 1997).

Further, compensation received by a taxpayer for the disposal or permanent damage or reduction in value of an asset has no CGT consequences if the underlying asset to which it relates was acquired by the taxpayer before 20 September 1985.

For the purposes of TR 95/35, permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or reduction in value that has permanent effect unless the taxpayer takes action to put it right. The activities permitted under the Santos’ CCAs will cause such damage and reduction in value.

Accordingly, pursuant to subsection 110-45(3) of the ITAA 1997, 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, Person C as the land owner of the property Y has received, and will continue to receive, compensation payments as a result of petroleum activities being carried out on property Y. These activities have resulted in the permanent damage to, or permanent reduction in the value of the property Y.

As Person C did not dispose of all or part of the affected Property Y there are no CGT consequences at the time of entering CCA 2 and CCA3 or receiving the compensation payments under those agreements.

However, the property’s acquisition cost will be reduced by the compensation payments 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.

Question 5

See our detailed reasons for Question 2 above.

Question 6

See our detailed reasons for Question 3 above.

Question 7

See our detailed reasons for Question 4 above.

Question 8

Summary

The payment from Entity 2 to the landholders (Persons A, B, C, and D) is paid and received as compensation to the landholders for damage/effects caused or likely to be caused to the Land as a consequence of Entity 2’s Authorised Activities being carried out on the Land under the Petroleum Legislation. Any loss suffered by the landholders is not a supply that the landholders make to Entity 2.

The landholders are being compensated for effects caused as a result of obligations imposed on Entity 2 by Statute. The landholders do not make a supply to Entity 2 for which the compensation payment is consideration, when Entity 2 pays them compensation under CCA 4. As the landholders are not making a supply, it follows that they are not making a taxable supply. Consequently, the landholders will not be liable for GST in relation to the compensation amounts that they receive from Entity 2.

Detailed reasoning

GST is payable on taxable supplies and the supplier must pay the GST payable on any taxable supplies that it makes. For the receipt of compensation amounts to give rise to a GST liability there has to be a taxable supply made.

Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that an entity makes a taxable supply if, amongst other requirements, the entity makes the supply for consideration.

The existence of a 'supply' itself is an essential element in determining whether there is a taxable supply under section 9-5 of the GST Act.

Supply

'Supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever'. The statutory definition of 'supply' is very broad. Essentially, a supply is something which passes from one entity to another, and may be one of goods, services or something else.

Consideration

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is 'in connection with' a supply and 'in response to' or 'for the inducement' of a supply. Thus, there must be a sufficient nexus between a particular supply and a particular payment, which is provided for that supply, for there to be a supply for consideration.

Sufficient nexus

A sufficient nexus between the compensation amounts and a supply must exist to create the 'supply for consideration' relationship.

The issue is whether the landholders have provided something to Entity 2, in return for the compensation amounts that are paid to them.

In regards to the landholders giving up their rights for further compensation upon commencing the agreement, this raises the issue of whether giving up of a landholder’s rights would be a separate supply or as termed in Goods and Services Tax Ruling 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) a 'discontinuance supply'. Paragraphs 106 to 109 in GSTR 2001/4 discuss discontinuance supplies as follows:

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.

In the process of Entity 2 carrying out its Authorised Activities on the Land, significant damage and adverse effects will impact the landholders, for which Entity 2 must compensate the landholders under the law. Upon receipt of the compensation amounts under CCA 4, the landholders accept that they give up their right to pursue further compensation in relation to the Authorised Activities.

Giving up your right for further compensation is not a separate supply for GST purposes but rather is considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by the landholder. However, we do not consider that the giving up of the landholder’s rights for further compensation is a separate supply from the landholders to Entity 2 since it is not the reason for which the compensation amount is paid to the landholders.

Damages

GSTR 2001/4 states the following in relation to damages, at paragraph 73:

The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss or injury in itself does not constitute a supply under section 9-10 of the GST Act.

Paragraphs 110 and 111 of GSTR 2001/4 further explain:

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party…

111. If a payment is made under an out-of-court settlement to resolve a damages claim and there is no earlier or current supply, the payment will be treated as payment of the damages claim and will not be consideration for a supply at all, regardless of whether there is an identifiable discontinuance supply under the settlement.

Although the above explanation in GSTR 2001/4 is made in respect of court orders and out-of-court settlements, the underlying principles are equally relevant in this case.

The landholders received the amounts as a landholder under state mining legislation, as compensation for any economic loss, hardship and inconvenience as a result of Coal Seam Gas mining activities carried out on their Land by Entity 2.

The payment by Entity 2 to the landholders is compensation in respect of any damage caused or likely to be caused to the Land and any inconvenience suffered by the landholders as a consequence of Entity 2’s Authorised Activities carried out on the Land.

In applying the above principles in GSTR 2001/4 to the present circumstances, we consider that, the compensation amounts are paid to the landholders to resolve a damages claim. A claim for damages (or payment that the landholders receive as a consequence of such claim) due to activities conducted by Entity 2 on the landholders’ Land, does not constitute a supply under section 9-10 of the GST Act.

The landholders do not provide Entity 2 with any supply in return for the compensation amounts. As such, the compensation payments made by Entity 2 is not consideration for a supply from the landholders to Entity 2, and accordingly no taxable supply will be made by the landholders.

Therefore, the receipt of the compensation amounts by the landholders from Entity 2 will not give rise to a GST liability.