Edited version of your written advice

Authorisation Number: 1051504235660

Date of advice: 13 May 2019

Ruling

Subject: Mining compensation

Question 1

Will the proposed compensation received under the draft conduct and compensation agreements 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 2

Will the proposed compensation received under the draft conduct and compensation agreements for permanent damage to the land be treated as capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening?

Answer

No

Question 3

Will the proposed compensation received under the draft conduct and compensation agreement for permanent damage to the post-CGT land reduce the cost base of the land for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997 where the compensation is received as a lump sum payment?

Answer

Yes

Question 4

Will the proposed compensation received under the draft conduct and compensation agreement for permanent damage to the post-CGT land reduce the cost base of the land for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997 where the compensation is received as a smaller lump sum and a series of periodic payments?

Answer

Yes

Question 5

Will the proposed compensation received under the draft conduct and compensation agreement for permanent damage to the pre-CGT land have no CGT consequences for you regardless of whether the compensation is received as a single lump sum or a smaller lump sum and a series of periodic payments?

Answer

Yes

This ruling applies for the following period:

1 July 2018 to 30 June 2029

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You are the owner of a pre-CGT property and a post-CGT property.

You propose to enter into Conduct and Compensation Agreements (CCAs) with certain mining entities to compensate you for the impact of the construction of coal seam gas (CSG) wells and other CSG related activities on your land.

The CCAs state that the compensation can be taken as an upfront lump-sum or alternatively the compensation can be taken as an upfront lump-sum and annual payments.

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 and

Income Tax Assessment Act 1997 Section 110-45.

Reasons for decision

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.

‘Ordinary income’ are receipts that meet the ordinary definition of income.

Periodicity or regularity of payment is a common characteristic of income receipts, even where the receipts are not directly referrable to employment or services rendered (Commissioner of Taxation v. Citibank (1993) 44 FCR 434; 93 ATC 4691;(1993) 26 ATR 557).

Capital gains are not ordinary income in the hands of the recipient however they may still be assessable statutory income under section 6-10 of the ITAA 1997.

In G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court stated that:

To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

The character of the receipt in the hands of the recipient must be determined. It is in this context that the character of the payment is determined. If the payments are periodical, the question becomes, are the payments instalments of the capital amount or really in the nature of income.

The case Barrett v Federal Commissioner of Taxation (1968) 118 CLR 666; (1968) 15 ATD 149; (1968) 10 AITR 685 concluded the periodic nature of the compensation payments did not convert them into a revenue amount. Barrett was the owner of a farming property under which lay deposits of soapstone. The right to mine soapstone was exercised on Barrett's land. Barrett received an amount of money to compensate for damage to and loss of value to the land and inconvenience to Barrett. Mining operations were carried out on the land for a number of years, and the mining company paid the taxpayer by monthly instalments an amount calculated based on the amount of soap stone removed from the land during the year. The High Court ruled the payments were made and received for the purpose of making good the estimated diminution in value of the land and the amount of damage to it resulting from the carrying on of mining operations, and were therefore of a capital nature.

Taxation Determination TD 93/58 considers under what circumstances the receipt of a lump sum compensation/settlement payment is assessable. It indicates that a compensation amount will be assessable:

(a) if the payment is compensation for loss of income only e.g. past year profits, and/or interest; or

(b) to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

In your case, there is no portion of the compensation that is identifiable and quantifiable as compensation for loss of income.

Whether a profit from an isolated transaction is ordinary assessable income according to the ordinary concepts depends very much 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 transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 Taxation Ruling TR 92/3).

Neither of the above elements apply in your situation. You did not enter into the arrangement to make a profit. Rather, you as a landowner, entered into the arrangement in order to receive compensation for damage that will be caused by the mining activities.

It is accepted that the compensation amounts are not income according to ordinary concepts 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 for 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 regardless of whether the compensation is received as one lump-sum or a smaller lump-sum and a series of annual payments.

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.

Compensation received by a taxpayer for permanent damage or a permanent reduction in value of a pre-CGT asset has no CGT consequences for the taxpayer.

The coal seam gas activities will result in permanent damage to, or a 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 into the CCA or receiving the compensation payments. The compensation in relation to the pre-CGT land has no CGT consequences for you. The post-CGT land’s acquisition cost will be reduced by the compensation payments received in relation to that land. That is, the cost base of the post-CGT land will be reduced by the compensation payments and any gain or loss will crystallise at a later time when the post-CGT land is disposed of.