Edited version of private advice

Authorisation Number: 1051598026840

Date of advice: 9 December 2019

Ruling

Subject: Mining Compensation

Question 1

Will the compensation payments be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the compensation payments represent capital proceeds as a result of any CGT event in Division 104 of the ITAA 1997?

Answer

No

Question 3

Will the compensation payment reduce the cost base of the relevant property under section 110-40 or section 110-45 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Years ending 30 June 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

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.

The Landholders are the owners of the Land. The Landholders operate a primary production business on the Land.

The Landholders entered into a Conduct and Compensation Agreement (CCA) with ABC on X September 20XX for the purpose of compensating the Landholders for the impact of coal seam gas (CSG) activity on the Land.

A variation CCA was signed on X August 20XX to include additional CSG activities undertaken on the Land. There was an accepted understanding by the Landowners and ABC that all previous agreements (including the Original CCA) did not sufficiently compensate the landowners for the impact of the activities on the Land. To address this under-compensation the variation CCA was negotiated to ensure that the Landowners are fully compensated for the permanent damage to the Land.

The variation CCA which was signed on X August 20XX amends the original CCA to include the following activities:

1. Activities associated with the development of X pilot CSG wells on the land;

2. Enabling access to the construction activities by ABC including the construction of gates, gates, fences and access tracks (X metres wide for X kilometres);

3. Construction of the X CSG wells and the installation of and ongoing access to a flare adjacent to each well site, within a fenced area measuring approximately 40 metres by 40 metres each. The conversion of the wells to production wells.

4. Ongoing access for testing, monitoring, operation and maintenance of the wells and associated infrastructure.

5. The installation, testing and operation of water and gas gathering system pipelines from each of the well sites within the right of way with an approximate construction width of 30 metres and approximate length of 5 kilometres.

6. The installation of and ongoing access to high point vents, low point drains, valve pits and electrical pits over the gathering system pipelines within the right of way.

7. The construction, use of an ongoing access to 2 laydown areas in addition to the construction, use and ongoing access to approximately 10 temporary work areas with a combined area of 5.5 hectares. While the temporary use may be for a limited period access by ABC can be made to these areas on an ongoing basis and this will cause permanent impacts on the capacity of the landowners to use this land.

8. The construction, use of and ongoing access to a campsite measuring approximately 1.5 hectares, where the camp site will be used in relation to authorised activities carried out in the area of the authority.

9. All preliminary activities permitted to be carried out on the land and all ongoing activities reasonably necessary to carry out or ancillary or incidental to the CSG infrastructure related activities.

The additional compensation to be paid as a result of the additional activities is set out in the Variation CCA and can be summarised as follows:

1. $X payable within 30 business days of the variation date;

2. $X per annum commencing 12 months after the variation date until Peat #12 flare is decommissioned.

3. In respect of the wells and campsite, ABC will pay the landowner compensation as follows:

a. $X payable within 30 business days of the variation date;

b. $X per annum commencing 12 months after the variation date payable in advance on or before each anniversary of the variation date and the payment will:

i. Continue for the term of the Pilot Wells are converted to production wells; or

ii. If the Pilot Wells are not converted to production wells continue until the date on which ABC makes the final compensation payment in the event that ABC decides not to convert the wells to production wells and provides written notice to the landowner that the wells will not be converted and the wells are plugged and abandoned.

c. $X per annum until the campsite is fully rehabilitated commencing 12 months after the variation date and payable in advance on or before each anniversary of the variation date;

d. A payment of $X for each calendar month or part thereof that the camp is used in relation to authorised petroleum activities being carried out on another property.

e. ABC will pay the landowner's reasonable and necessary legal, accounting and valuation costs in relation to the variation CCA.

At the conclusion of the activities on the land a final compensation payment of $X less the total of all payments due and payable at the time that ABC gives written notice that it will wind up its activities and cap the wells.

It is expected that the term of the agreement will be for the life of the gas field which is understood to be a minimum of X years. Clause 10 and 11 of the CCA provide guidance as to why the compensation is being paid:

Compensation:

10. ABC will pay the Compensation as set out in Schedule 1 to the Landowner.

11. The Landowner acknowledges that the Compensation set out in Schedule 1 compensates the Landowner for the impacts of the Activities, including without limitation:

a. deprivation of possession of the surface of the Land;

b. diminution in the value of the Land;

c. diminution in the use made or that may be made of the Land or any improvements on it;

d. severance of any part of the Land from other parts of the Land or from other land that the landowner owns;

e. any cost, damage or loss arising from the carrying out of the Activities on the Land (other than any cost, damage or loss suffered by the Landowner as a result of an accident that occurs during the lawful conduct of the Activities);

f. all noise (including the noise described in Item 4 of the Reference Schedule), light, dust, odour, vibration and vehicular movements generated from and associated with the Activities carried out on the Land, loss of amenity generally and on account of this Agreement or as contemplated in any Action Plan prepared under this Agreement that constitutes an alternative arrangement for the purposes of the Environmental Authority.

The Landholders have previously received a private ruling in relation to the original CCA entered into on X September 20XX and wish to seek a further ruling period and additionally address the Variation CCA.

The on which the campsite is carried out is classified as Category 2 Land whereby there is no access in the short term (three to five years) but access is expected to be restored at some time in the future on or after the completion phase of the CSG activity has concluded. The productive capacity of this land is permanently compromised due to the activities carried on in the short term and as such compensation has been paid.

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

Income Tax Assessment Act 1997 section 110-45

Reasons for decision

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 an authority undertaking 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 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 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 compensation payments and any gain or loss will crystallise at a later time when the land is disposed of.