Edited version of private advice

Authorisation Number: 1051631498455

Date of advice: 10 February 2020

Ruling

Subject: The treatment of mining compensation

Question 1

Will the compensation received under the conduct and compensation agreement be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the compensation received under the conduct and compensation agreement be treated as capital proceeds under division 116 of the ITAA 1997 from any capital gains tax event in division 104 of the ITAA 1997?

Answer

No

Question 3

Will the compensation received under the conduct and compensation agreement reduce the cost base of the relevant property for any future capital gain under section 110-45 of the ITAA 1997?

Answer

Yes

Question 4

Will the landholders incur a GST liability on the receipt of compensation amounts from ABC?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Person A and Person B (you) are the owners of the property.

On X October 20XX, you entered into a Buffer Zone Conduct and Compensation Agreement (CCA) with ABC.

The CCA seeks to compensate the landholder and occupier for the impact of all CSG related activities and proposed impacts which include the proposed placement of X production coal seam gas (CSG) wells on the land and X non-production wells.

Person A and Person B are the landholders with Person A being the sole land occupier where they undertakes a livestock business on the property.

The property was purchased post 20 September 1985 and consists of X hectares. There is approximately X hectares of developed trees.

The current carrying capacity of the property is estimated to be X adult equivalent cattle. The current livestock activity carried out on the land is the running of a breeding herd of around X cows.

Additionally X acres of the land is suitable for growing fodder and grain crops.

The CCA is a conduct and compensation agreement 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 defines the general liability of the resource authority holder (ABC) 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 4 of section 81 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).

Clause 9 of the CCA provides that ABC must pay compensation to the landholder in the amount and time set out in Schedule 1 to the CCA. Clause 12 of the CCA provides an explanation of what the compensation is designed to compensate the landholder:

12. The Compensation:

a. compensates the Landholder for all:

i. Compensatable Effects, Disturbance Impacts and Noise Impacts:

A. of the Activities (including any maintenance reopening the Land's surface) and Minor Changes;

B. resulting from any Livestock Management Notice or Livestock Direction; and

C. from Authorised Activities off the Land; and

ii. other amounts payable by ABC to the Landholder under Relevant Laws for the Activities

(collectively, the Compensation Matters);

b. is in full and final satisfaction of all of ABC's and its Associates' Compensation Liability to the Landholder for the Compensation Matters.

The compensation to be paid is set out in Schedule 1 to the CCA and provides that ABC will pay the following compensation to the landholder:

The Buffer Zone CCA refers to a Buffer Zone where ABC may readily make changes to the location of the Activities. While the CCA sets out the activities to be carried on in relation to the land Clause 20 to 24 indicate that changes can subsequently made to the proposed activities:

Changes to the Activities

20. ABC may make changes to the Activities (including the location and timing of the Activities) inside or outside the Buffer Zone provided those changes will not likely create a material adverse impact on the Land or the Landholder's use of the Land (Minor Change(s)).

21. ABC may only make Minor Changes to the location of the Activities outside the Buffer Zone after consulting with the Landholder about the proposed change and, if reasonably practicable, giving a revised map to the Landholder showing the change in location outside the Buffer Zone.

22. ABC may only make a change to the Activities:

a. that will likely create a material adverse impact on the Land or the Landholder's use of the Land; and/or

b. include an Authorised Activity in addition to and unrelated to the activities described in Schedule 2 (Significant Change(s)),

if this Agreement is varied to allow for the change or the matter is resolved under the Dispute Resolution Process.

23. Despite clauses 18 to 20, ABC make any changes to the location of the Activities within the Buffer Zone and carry out Temporary Construction Activities within the Buffer Zone without giving prior notice to, or consulting with, the Landholder.

24. Within a reasonable period of time after the Infrastructure is brought into an operational mode, ABC must give the Landholder a map or maps of the long-term Infrastructure installed on the Land.

The CCA negotiations took into account the negative stigma of having CSG activity on the land which include the concept of blight on the land where the land has an unwelcome attribute and depresses the overall value of the property. The impact of the blight on the land will include the diminution in the long term market value of the land as a result of having industrial CSG activities on the land. This negative stigma is particularly concerning in the context of potential consumers of the high quality beef produced by the farm, where such consumers may have diminished demand for beef produced in an industrial CSG environment.

There may be some limited and temporary support for the market value of the land because of the landholder's entitlement to annual compensation payments however this temporary support disguises the fact that the actual market value of the land itself has fallen substantially/drastically.

However, when the ongoing compensation ceases or dries up and the permanently damaged land is valued purely on its substantially reduced capacity to produce income the real impact of the CSG activity on the land will be evident. It is noted that diminution also covers the concept of lesser marketability of the land as a result of the CSG activities on the land.

It is expected that greater difficulty in travelling within the property and to visit neighbouring properties will exist due to the interruptions caused by the CSG activity. Due to the general inconvenience from the presence of structures on the land it will generally take longer to undertake common pastoral and farming activities including the management and movement of livestock and undertaking common farming tasks. 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 CSG activity has on the land includes the potential limitations on the nature and range of agricultural enterprises that may be carried on the land. For example, the fact that certain activities cannot be carried out proximate to the gathering system may result in an inability to use laser levelling on the land or any other enterprise that may require deep cultivation of the soil. The reduction in the number of enterprises that may be carried out on the land is very likely to result in a reduction in the number of potential buyers interested in the property with the consequence that the market value of all of the land reduces.

The presence of the CSG mining activity will impact the existing quality of life, lifestyle, quiet enjoyment or amenity for the human inhabitants on the property. The visual impact of viewing the wells and other infrastructure will be 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. Residents can expect to feel that they live in an industrial zone where they are constantly reminded of the fact that they are in the centre of extensive CSG infrastructure with noise and visual disturbance ever present. The value of non-business assets such as the homesteads/dwellings will significantly reduce in value due to the perceived and actual lesser quality of life.

There is potential reduction to the value of farm output due to the risk of contamination to farm output (soil and other chemical contamination impacting on livestock or crops produced); risk to or reduction in the value of market status such as export beef, MSA beef, chemical free/organic crops, etc. With highly regulated commodities the public is very vigilant of the environment in which commodities are produced. If the value of farm production fell due to any of the above factors, then this would have a direct impact on the value of the business carried on the land and so result in a permanent reduction in the value of the land on which grazing and cultivation activities to produce the high quality cattle are carried on by the landholder.

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

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

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

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

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

Reasons for decision

Questions 1, 2 & 3

Summary

The compensation payments you will receive under the conduct and compensation agreement do not form part of your assessable income. They are considered to be compensation received for the permanent reduction in value and damage relating to the land and will be treated as a reduction in the land's cost base.

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.

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 CGT asset, or part of an underlying 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 CGT underlying asset of the taxpayer or for a permanent reduction in the value of a 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 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.

Question 4

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 ABC, 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 (clause 13 of the CCA), 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.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

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

The landholders giving up their right for further compensation is not a separate supply for GST purposes. It is rather considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by the landholders. We do not consider that the giving up of the landholders' rights for further compensation is a separate supply from the landholders to the company 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 ABC.

The payment by ABC 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 ABC 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 ABC on the landholders' Land, does not constitute a supply under section 9-10 of the GST Act.

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

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