Edited version of your written advice

Authorisation Number: 1051483384791

Date of advice: 19 February 2019

Ruling

Subject: Compensation payment

Question 1

Is the compensation payment received taxable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the compensation payment received taxable as statutory income including under the capital gains tax (CGT) provisions?

Answer

No

Question 3

If the compensation is considered not taxable as ordinary or statutory income, will the receipt of the compensation payment reduce the cost base of the land for CGT purposes?

Answer

Yes

This ruling applies for the following period

1 July 2018 to 30 June 20YY

The scheme commences on

1 July 20XY

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 were incorporated in Australia in the 20XX income year.

You are the registered land owner.

You acquired the land post 19 September 1985.

The land comprises of 2 areas: the Operational Area and the Non-Operational Area.

You conduct a multi-use operation on the Operational Area.

You entered into an Agreement with Entity A in the 20YY income year to utilise the Non-Operational Area.

Entity A is a government owned corporation under the Government Owned Corporations Act 1993 and is declared a port authority under the Transport Infrastructure Action 1994 (TIA).

Entity A is responsible for operating a port under the TIA. Entity A will undertake a project which involves upgrading the port to improve access for larger ships.

The project requires extensive dredging of the port’s shipping channel to deepen and widen the shipping channel.

Capital dredging will remove approximately X million cubic metres of sediment material which needs to be moved to and retained in a suitable location.

The Environmental Impact Statement (EIS) indicated that the capital dredge material may contain Potential Acid Sulfate Soils (PASS) and self-neutralising material could be present within the soft clay dredge material.

If PASS is exposed to air during placement, oxidisation of material could occur which could lead to impacts of surface mater and groundwater environmental values at your site and surrounding area.

To manage the risk of PASS oxidisation, Entity A would ensure that material remains saturated at all times during dredging, delivery and placement at your site. They would ensure any PASS material is placed 1 metre below the groundwater level to prevent potential oxidation.

This process is referred to as strategic reburial which is the principle of maintaining PASS.

Soils to be reburied must have undergone zero or minimal oxidation, and their reburial location must be one that permanently precludes oxygen. The reburial location must be carefully planned to ensure void space is available when needed. Timelines for an earthworks strategy need to be calculated and met to ensure that the above conditions are consistently achieved.

Furthermore, once reburial has occurred, the presence of the sulfidic material in that location may become an issue affecting future landowners, as future activities or uses of the land that might cause exposure of the material to oxidising conditions will not be appropriate. It is important that the local government and any potentially affected landowners are consulted about this issue and have a clear understanding of any long-term implications that the reinterment may have on land use.

Entity A engaged an independent third party to undertake a selection process to determine a preferred site to place the capital dredge. This study recommended that your site was a suitable location.

As a result of the permanent placement of the dredge spoil in the Non-Operational Area, the use of the land will significantly limit its future use. The land will not be capable of use for sand mining operations and future potential use may not be possible.

The capital dredge material must be placed on shore as sea based disposal is prohibited.

It is proposed that up to X cubic metres of dredge material will be placed at the Non-Operational Area owned by you.

The Non-Operational Area site is an existing void. The prior operations have created a water filled void.

Once the project commences, you will have ceased conducting its operations on the Non-Operational Area.

The Planning Act 2016 (X) allows for a relevant party to claim compensation for an adverse planning change. An adverse planning change means a planning change that reduces the value of an interest in premises. An affected owner may claim compensation if the adverse planning change is a public purpose change which is a planning change that limits the use of premises to the purpose for which the premises were lawfully being used when the change was made or a public purpose.

Under section 18 of the Acquisition of Land Act 1967, the landowner is entitled to claim compensation for the resumption of their land while section 20 considers that compensation must be assessed taking into consideration the value of the land, damage and disturbance caused to the landowner as a result of its use.

Instead of going through the process of invoking either of these provisions in the relevant acts, Entity A and you have entered into an Agreement in order to reduce costs and for a more efficient process.

Under the Agreement, Entity A will make a number of payments to you which is defined in the Agreement as the fee payable by Entity A to you for the grant of the rights under the Agreement and represents the full and final compensation to you for:

● Loss of exclusive access and use of the Non-Operation Area during the term

● Diminution of the value of the Non-Operational Area due to the proposed use and the impacts, and

● Diminution of the use made or that be made, of the Non-Operational Area or any improvement upon it by you whether during the term or after.

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 6-10 of the ITAA 1997

Reasons for decision

Question 1

Summary

The compensation payment received is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Detailed reasoning

Nature of the compensation payment

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) applies to a person who receives an amount as compensation and considers the capital gains tax (CGT) consequences for the recipient of the amount.

Paragraph 3 of TR 95/35 defines 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.

An underlying asset is defined at paragraph 3 of TR 95/35 as 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.

Permanent damage or reduction in value is defined at paragraph 3 of TR 95/35 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.

The look through approach as discussed at paragraph 3 of TR 95/35 is the process of identifying the most relevant asset. It requires an analysis of all the possible assets of the taxpayer in order to determine the asset to which the compensation amount is directly related.

As a result of the permanent placement of the capital dredge in the Non-Operational Area, the use of that land will significantly limit its future use. The land will not be capable of use for its operations and future potential use may not be possible.

As it was determined that the best location for placement of the capital dredge was on your land, a potential right to compensation arose under either the Planning Act 2016 (X) due to an adverse planning change or under the Acquisition of Land Act 1967 via a land resumption.

Rather than proceed with either subsection 31(2) of the Planning Act 2016 (X) or section 18 of the Acquisition of Land Act 1967, Entity A and you entered into an Agreement.

Under the Agreement, both parties agreed that you will receive a number of payments which represents full and final compensation to you for:

● loss of exclusive access and use of the property during the term of the project,

● diminution of the value of the property due to the use and impacts, and

● diminution of the use or that maybe made of the property or any improvement upon it by you whether during the term or after.

Consequently, the usage fee payment outlined in Agreement will represent compensation received.

Compensation payment as ordinary income

Section 6-5 of the 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 a government authority undertaking activities to relocate contaminated capital dredge 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.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) provides guidance in determining whether profits from isolated transactions are income and therefore assessable income under the ITAA 1997.

Paragraph 35 of TR 92/3 states that 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 to your situation. The compensation payments were made in accordance with the clauses in the Agreement. The taxpayer was entitled to claim compensation under either the Planning Act 2016 (X) or the Acquisition of Land Act 1967. However both parties decided it was in their best interest to enter into the agreements where the taxpayer accepted to receive compensation.

Accordingly, the compensation payments paid under the Agreement 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.

Question 2

Summary

The compensation payment received by you is not assessable as statutory income including under the CGT provisions.

Detailed reasoning

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 for the loss and destruction of a CGT asset.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (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, the underlying asset is the land comprising of the Non-Operational Area to which the compensation relates. The land is not being disposed of by you.

You will receive a number of payments representing compensation as a result of the effects of the activities undertaken on your land by Entity A pursuant to the Agreement. The payment is defined in the Agreement as compensation for:

● loss of exclusive access and use of the facility and property during the required use of the property,

● diminution of the value of the property due to the proposed use, and

● diminution of the use made or that may be made to the property during the term or after.

Based on the information provided, the proposed activities are likely to result in the permanent damage to or permanent reduction in the value of the land. You will not dispose of any part of your land as part of the project.

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.

Question 3

Summary

As the compensation is considered not assessable as ordinary or statutory income, the receipt of the compensation payment will reduce the cost base of the land for CGT purposes.

Detailed reasoning

Division 110 of the ITAA 1997 explains how to work out the cost base and reduced cost base of a CGT asset.

Subsection 110-15(3) of the ITAA 1997 states that 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.

Recoupment is defined in subsection 995-1(1) of the ITAA 1997 having the meaning given by section 20-25.

Subsection 20-25(1) of the ITAA 1997 states that a recoupment of a loss or outgoing includes:

(a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however, described, and

(b) a grant in respect of the loss or outgoing.

TR 95/35 sets out the capital gains tax consequences when a taxpayer receives a compensation payment. The payment from X is considered to be a compensation receipt in terms of paragraph 3 of TR 95/35.

TR 95/35 applies a look through approach to determine the underlying asset to which the payment relates. Applying the look-through approach it is considered that the underlying asset is the affected land itself.

Paragraph 6 of TR 95/35 states:

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage 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.

In your case, you did not suffer a loss to your land nor have you disposed of any part of your land. The placement of the capital dredge in the Non-Operational Area of your land will likely result in permanent damage to, or permanent reduction in, the value of your land. As there was no disposal of the affected land, it is considered that the usage fee payments acknowledge the permanent reduction in the value to your property.

Therefore, the land’s acquisition cost may 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 the land is sold.