Edited version of private advice

Authorisation Number: 1051596616971

Date of advice: 25 October 2019

Ruling

Subject: Treatment of mining compensation payments

Question 1

Do the compensation receipts, under the Conduct and Compensation Agreement (CCA), that relate to permanent damage to land and improvements constitute assessable income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

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

Answer

No

Question 3

To the extent that the compensation receipts 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 1997 in respect of a CGT event happening, does the compensation, to the extent that it represents compensation for permanent damage to the land and improvements on the land, reduce the cost base of the property under section 110-40 and section 110-45 of the ITAA 1997?

Answer

Yes

Question 4

Is the compensation characterised differently if it is received as one lump sum or a combination of a lump sum and a series of periodic payments?

Answer

No

Question 5

Should the amounts received for the sale of gravel and soil taken from the land be included as ordinary income of the landholders and be assessable under section 6-5 of the ITAA 1997?

Answer

No

Question 6

Alternatively, should the amounts received for the sale of gravel and soil be considered to be a part disposal of the land with the amounts received being considered to be capital proceeds for the part disposal of the land and be assessable under the capital gains tax provisions?

Answer

No

Question 7

Will the proceeds received for the water taken from your land be ordinary income and assessable under section 6-5 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Years ended 30 June 2018 to 30 June 2029

The scheme commences on:

1 July 2017

Relevant facts and circumstances

X is the owner (Landholder) of a property (the property).

The property consists of two landholdings being 'A' (X acres) and 'B' (X acres). The A component was purchased prior to 20 September 1985 and B was purchased post 20 September 1985.

In late 20XX (Agreement Date), The Landholder entered into a Conduct and Compensation Agreement (CCA) with ABC (Authorised Holder) for the purpose of compensating for the impact of activity on their property (both landholdings) under the Petroleum Act 1923 (x), the Petroleum and Gas (Production and Safety) Act 2004 (x) and the Mineral and Energy Resources (Common Provisions) Act 2014 (MERCP Act) and applicable Regulations.

The current market value of the combined landholdings is between $X million and $X million. The constructions activity by ABC on the property is nearing completion and the market value recognises some or all of the permanent damage sustains by this property as a result of placing the infrastructure in the land.

The property is used for integrated primary production purposes.

Compensation will be paid for three categories being pre-construction compensation, construction compensation and annual compensation.

The proposed payments under the CCA are set out as follows:

The Authorised Holder must pay the compensation to the Landholder for a minimum period of twenty years from the end of the construction period.

Should the Authorised Holder require the use of water, the Authorised Holder must first contact the Landholder to check for availability. The Landholder and Authorised Holder agree that any water used must be compensated at a rate no less than $X per litre. The use of water must be at the sole discretion of the Landholder and must be sourced from a set GPS location.

Should the Authorised Holder require the use of gravel, the Authorised Holder must first contact the Landholder to check for availability. The Landholder and Authorised Holder agree that any gravel used must be compensated at a rate no less than $X per cubic metre for stockpiled gravel and $X per cubic meter for un-stockpiled gravel. The use of gravel must be at the discretion of the Landholder and must be sourced from a set GPS location.

The Landholder may use their own earthmoving equipment or hired equipment to loosen the gravel and soil and stockpile it ready to be loaded into the trucks by ABC or contractors engaged by ABC. Alternatively ABC or contractors engaged by ABC may loosen and take the gravel from the property. To enable the gravel to be taken substantial overburden needs to be removed to expose the gravel, which diminishes the amount of land available for grazing/farming.

The following table provides a summary of the different categories of land that may be identified as resulting from CSG activity on the improved farmland.

Category 1 land includes land to which no access can be made in the short or long term and will include land under the access roads, vents and drains and other land that cannot be accessed or used as a result of the activity on the land. This will represent land that the landholder is permanently deprived of the possession of the land's surface and of course the productive capacity of that land will be reduced to nil.

Category 2 land is land to which no access can be made in a short-term (three to five years) but for which access is expected to be restored at some time in the future or after the construction phase of the activity has concluded but the productive capacity is likely to be permanently compromised due to the activities carried on in the short term. This land includes temporary camps, site office, installation telecommunications infrastructure, storage areas and stockpile areas. If the degradation caused by the activity is severe then permanent damage will have occurred to this area of land. The surface of the land may be covered and graded with gravel to assist in creating a weather proof surface. Crops or pasture will not thrive in the gravel if and when the land is returned to agricultural usage and if the gravel is mixed with the topsoil then the underlying soil will be permanently degraded.

Category 3 includes land around the site to which limited access can be made in the medium and long term and the productive capacity of this land will be significantly impacted by the activity on the land in the long-term. The construction of well sites, drilling, testing, operation and ongoing access to the well sites each within a fenced area of over one hectare, together with any other necessary petroleum engineering operation carried out within the confines of the fenced well sites, including remedial work-overs and fracture stimulation/cavitation. These activities will result in limited assess being available to this land at least in the short-term and also access to this land will be denied intermittently in the long term due to regular work-overs and fracture stimulation.

Category 4 land is described as restricted due to the fact that the landholder can undertake only a restricted number of activities on the land. This category of land may include pasture near roadways as this land's productive capacity is also significantly compromised due to the increased compaction of soils as a result of the road construction in addition to the impact of frequent traffic causing dust and other disruption to people, pasture and livestock. The long term impact on soil from excavating and burying the gathering system (seismic line) at a depth of approximately 750 millimetres on grazing land and approximately 1.2 metres on cropping land will depend on many factors including the quality of the subsoils and the extent to which the final top-soils may be contaminated by toxins such as salt which may reside in the sub-soil prior to excavating to lay the gathering system. The contamination will occur through the mixing of the top soils with the sub-soils. Where the subsoils consist of poorer quality soils then the recovery of the soil that forms part of the surface of the land post construction will take a long time and in some cases never completely recover from the contamination. Contamination from mixing will include bringing poorer quality pasty soils (with a lower level of microbial activity) to the surface. Cereal crops and pasture generally use the first 60cms of the soil depth while the roots of crops such as cotton may extend up to 1.2 metres vertically into the soil.

Under the CCA, ABC have the responsibility to perform rehabilitation as soon as possible following completion of the activities to reinstate the land as near as practicable to its condition prior to the activities and obtain Landholder sign off that they are satisfied that the Authorised Holder has completed the rehabilitation.

The negotiations for the CCA's took into account the negative stigma of having activity on the land which includes the concept of blight on the land where the land would have an unwelcome attribute and depress the overall value of the property as a result of this negative stigma. The impact of the blight on the land will include the diminution in the market value of the land as a result of the stigma of having an industrial activity on the land. Diminution also covers the concept of lesser marketability of the land as a result of the activity on the land.

There is also a diminished sense of an attractive rural community and the greater difficulty in travelling within the property and to visit neighbouring properties due to the interruptions caused by the activity and associated infrastructure. Due to the general inconvenience of the presence of structures on the land it will generally take significantly longer to undertake common pastoral and cultivation activities including the management and movement of livestock. In addition due to the short time-frames presented by the weather, these additional time consuming inconveniences may result in certain activities not being completed on time or at all.

A further restriction that the activity has on the land includes the potential limitations on the nature and range of agricultural enterprises that may be carried on the land as a result of the activity which is very likely to result in a reduction in the number of potential buyers interested in the property.

The presence of the mining activity has impacted and will continue to impact on the existing quality of life, lifestyle, quiet enjoyment or amenity for the human inhabitants on the property. In addition to wells being in relatively close proximity to residences; visual impact of viewing the wells and other infrastructure is ever present; additional people in the district during the construction period (and ongoing) and so potentially a sense of diminished personal safety in a formerly remote area; increased cost of living due to the increased costs of food and other essentials.

Reasons for decision

Question 1, 2, 3 & 4

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 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).

Neither of the above elements apply in your situation. The compensation payments were made in accordance to the legislative provisions of the petroleum legislation.

Accordingly, the compensation payments paid under the CCA 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 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.

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 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.

Question 5 & 6

Payments for gravel and soil as business income

As stated above, the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Ordinary income includes payments for services provided, business income and income from property such as rental or dividend income.

In your situation, the payments you receive for the extraction of gravel and soil from your land are not payments for services provided or income from property.

The payments will be considered business income if you are in the business of gravel and soil extraction. Taxation Ruling TR 97/11 discusses the indicators to be considered in determining if a person is carrying on a business. These indicators include:

·        whether the activity has a significant commercial purpose or character

·        whether the taxpayer has more than just an intention to engage in business

·        whether there is regularity and repetition of the activity

·        whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

·        whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

·        the size, scale and permanency of the activity, and

·        whether the activity is better described as a hobby, a form of recreation or a sporting activity.

Based on the information you have provided it is considered that you are not in the business of extracting and selling gravel or soil as you have merely agreed to the extraction requests from ABC.

Therefore the payments for the gravel and soil extracted are not assessable to you as business income.

Payments for gravel and soil as profits from an isolated transaction

Profits from an isolated transaction are 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 gravel and soil extraction payments were not made in the course of carrying on a business, a business operation or commercial transaction.

Accordingly, the gravel and soil extraction payments paid do not give rise to a profit arising from a profit-making undertaking or plan pursuant to section 6-5 of the ITAA 1997.

Payments for gravel and soil as a royalty

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 have entered into an agreement with ABC whereby ABC may require the use of gravel and soil on your land for their activities. You will receive payments for the volume of gravel and soil extracted from your property. The CCA does not give ABC unlimited access to the land to extract the gravel and soil and approval must be sought before the extraction can take place. When approval is given for ABC to access the land and extract the gravel and soil, the approval to do so creates a right to exercise a beneficial privilege or right.

Consequently, it is considered that the payment for each cubic metre of gravel and soil extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997.

Question 7

You may receive payments for the volume of water taken from your property. The amount of water taken is dependent on the available level of water on the property 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.