Edited version of private advice

Authorisation Number: 1051636250220

Date of advice: 01 May 2020

Ruling

Subject: Income - lump sum - compensation

Question 1

Will the compensation received under the Early Conduct and Compensation Agreement (ECCA) and the Conduct and Compensation Agreements (CCAs) 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 ECCA and CCAs 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 ECCA and CCAs 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 an amount be included in your assessable income as a result of XYZ paying for the costs associated with drilling, operating and maintaining a water bore, including costs to equip the bore and costs to maintain the functionality of the bore for the duration of the term or until it provides notice to the landowner that it no longer requires use of the bore?

Answer

No.

Question 5

Will the landholders incur a goods and services (GST) liability on the receipt of compensation amounts from XYZ?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 20XX to 30 June 2027

The scheme commenced 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.

Person A and Person B (you) (the landholders) have entered into two Conduct and Compensation Agreements (CCAs) with ABC and an additional Early Conduct and Compensation Agreement (ECCA) with XYZ.

The CCAs and ECCA seek to compensate the landholder for all activities and proposed impacts which include the placement of coal seam gas (CSG) wells by ABC and XYZ placing up to X CSG production wells and three non-production wells on the land.

You have also entered into a CCA with XYZ to enable XYZ to place a water bore on the land. The CCA Water Take Activities and Water Bore Drill agreement (Water Bore CCA) provides that XYZ will construct and equip a water bore on Person A and Person B's property for the purpose of securing for XYZ access to a reliable water supply.

Conduct and Compensation Agreements

Property A is around 1,045 acres of land with X CSG wells on the land.

The family homestead is located on Property A.

The land on Property A is high quality land and is suitable for both livestock and crop production while the land covered by the XYZ ECCA are predominately grazing properties, however some of the land has previously been cultivated and accordingly while it is currently planted with improved pasture it is more valuable given that some of the land has the capacity to support both livestock grazing and broad-acre farming enterprises.

Majority of the water needs of the livestock are met from dam water but the dams on the properties have not been full since 2012.

The presence of existing CSG activity by ABC and XYZ and the related infrastructure currently on Burnside and proposed by XYZ under the ECCA is of significant concern to you because of the permanent diminution in the productive capacity of the land from the CSG activities carried out on that land. Additionally, there is a reduction in the amount of land available for use as a result of the CST infrastructure, as well as the land that has been stranded and land rendered less productive due to the presence of CSG infrastructure on the land.

The existing infrastructure from ABC in combination with the proposed infrastructure will have an enormous and permanent impact on the ability of the landholder to carry on their existing pastoral and farming enterprises on the land. Additionally, the existence of the CSG infrastructure will impact the quiet enjoyment of the land and substantially devalue the residence on both properties.

The following compensation amounts are aggregated for the two CCAs.

The proposed pre-construction amounts are $X and $X.

The proposed construction compensation amounts are set out as follows:

The proposed annual compensation amounts are set out as follows:

Early Conduct and Compensation Agreement

The land subject to the XYZ ECCA was acquired around several years ago and is approximately X acres. It contains a residence on the property.

The ECCA acknowledges that the landholders are the only eligible claimant of the land for the activities that XYZ intends to carry out on the land under the petroleum authority. It is important to understand that the ECCA:

a. is entered into before the particular timing, location on the Land and Activities are determined;

b. sets out how XYZ may carry out the Activities on the Land;

c. sets out a process for XYZ to carry out the Activities anywhere on the Land throughout the Term provided the Activities are not a Scope Change;

d. documents each party's rights and obligations regarding the Activities; and

e. aims to:

i. foster a cooperative working relationship between the parties;

ii. compensate the Landholder for the impacts of the Activities;

iii. ensure the safety of the Landholder, the Landholder's Associates, the Landholder's Property and animals, XYZ, XYZ's Associates and the Infrastructure; and

iv. find workable solutions to minimise adverse impacts of the Activities.

Clause 10 of the ECCA provides an explanation of what the compensation is designed to compensate the landholder:

10. The Compensation:

a. compensates the Landholder for all:

i. Compensatable Effects, Disturbance Impacts and Noise Impacts:

A. of the Activities (including any Maintenance and Modifications);

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

C. from Authorised Activities off the Land except for major infrastructure constructed or operated off the land such as a compressor station or water treatment facility; and

ii. other amounts payable by XYZ to the Landholder under Relevant Laws for the Activities (collectively, the Compensation Matters);

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

The landholder is particularly concerned by the noise impacts on the property in addition to the potential biosecurity risk of weeds being introduced onto the property with certain grass species being of specific concern.

Clauses 62 to 64 of the ECCA confirm that XYZ has responsibility for the rehabilitation for decommissioning and rehabilitation.

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

Schedule 2 to the ECCA identifies construction activities and petroleum production activities to be carried out on the land. Petroleum production will include all activities reasonably associated with or incidental to the construction, testing, development, operation, maintenance, decommissioning and rehabilitation of up to a maximum of 28 wells (and three non-production wells) on the Land.

Landspray While Drilling (LWD) works may occur during and shortly after the drilling activities on the land and may take place 24 hours a day. Monitoring, surveying and sampling activities for LWD Works may take place within the first 90 days after application of the LWD Products. Given that undertaking LWD activities is a relatively new process its utilisation on the land brings with it additional risk of permanent damage to the land. Evidence of permanent damage may not be in existence immediately and may become evident over time.

A reason for XYZ entering into the ECCA in advance of CSG construction activities being carried out on the landholder's land is to enable XYZ to use the landholder's land and access tracks to provide them with access to neighbouring/adjoining properties. This is recognised in the special conditions as follows:

Thoroughfare

37. XYZ acknowledges that:

a. the Landholder has concerns about access tracks being used as a thoroughfare to conduct activities on adjoining properties;

b. any use of access tracks as a thoroughfare must be the subject of a Production Notice or Non-Production Notice which specifies the location, type and duration of the thoroughfare access; and

c. a Non-Production Notice may be issued solely for the purpose of new or amended thoroughfare access (for clarity, the Pre-Construction Steps apply).

38. XYZ will use access tracks as a thoroughfare in a manner that minimises disturbance to the Landholder and the Landholder's use of the Land. For example, minimising the number of vehicles traversing the access tracks, or using alternate access to adjoining properties where possible and using best endeavours to co-ordinate construction related activities and rig movements on adjoining properties to align with construction related activities and rig movements on the Land.

39. If the Landholder notifies XYZ that it has a concern about the thoroughfare access, XYZ agrees to meet with the Landholder and act reasonably to minimise the disturbance where practicable.

It is noted that the ECCA is described as being an Early Conduct and Compensation agreement and the reasons for XYZ wanting to enter into the contract early (in advance of construction activities on the land) is to secure the agreement of the landholder for the development activity that XYZ is carrying on in the district (neighbouring and adjoining properties). It is expected that in the short term XYZ will commence accessing the land with the objective of getting access to construction activity in neighbouring properties and in this respect the land owned by the landholder will provide access to a range of other properties and be used somewhat like a thoroughfare.

Accordingly, to enable XYZ to carry on its CSG construction on other properties it considers it necessary to enter into the ECCA with the landholder in advance of the commencement of construction on the land owned by the landholder. Notwithstanding, the compensation to be paid under the ECCA is primarily for the impact that the overall construction activities on the land and the permanent damage that will be caused by the construction activities. While no specific date has been established the actual construction on the landholder's land is likely to commence in 20XX or 20XX.

The ABC CCAs and the XYZ ECCA negotiations took into account the negative stigma of having CSG activity on the land which includes 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 the compensation payments however this temporary support disguises the fact that the actual market value of the land itself has fallen substantially/drastically as a result of the permanent damage that has been sustained by the land. However, when the ongoing compensation ceases or dries up and the permanently damaged land is valued purely on its capacity to produce crops or sustain livestock through improved pasture the full impact of the CSG activity on the land will be evident.

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 has impacted and will continue to impact the existing quality of life, lifestyle, quiet enjoyment or amenity for the human inhabitants on the properties. 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 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 or market status of items 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 cattle grazing enterprise is carried on by the landholder.

Water Bore CCA

You and XYZ have entered into a CCA Water Take Activities and Water Bore Drill agreement (Water Bore CCA). A description of the agreement is as follows:

The parties acknowledge that this Agreement is:

a) a conduct and compensation agreement for the purposes of the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) (MERCP Act);

b) consent by the Landowner to the Water Bore Drilling as a water bore under the Water Act 2000 (Qld) (including obtaining any required registrations or licences on behalf of the Landowner).

The bore to be drilled into the Precipice Sandstone formation by XYZ under the terms of this agreement at a location within 105m of the location identified on the legend of the map attached as Schedule 1 as "Groundwater Bore"

All activities and works carried out on the Land by XYZ and its authorised contractors that are reasonably associated with and necessary for XYZ to access and take water from the Water Take Point being:

a) the construction, operation and maintenance of infrastructure and the carrying out of all reasonably necessary works to take the water from the Water Take Point including all associated activities;

b) the construction, operation and maintenance of water pipelines (polypipe or similar) to adjoining properties in consultation with the Landowner. XYZ agrees that water pipelines will be constructed in a manner that minimises disturbance to the Land such as locating the pipeline so that it traverses the least distance possible;

c) the reinstatement and rehabilitation of the Land within a reasonable time from this Agreement ending and in compliance with the Landowner's reasonable proposals, wherever possible, and any relevant laws; and

d) the construction, maintenance or modification of access points and access roads in accordance with Special Condition 1.

All property brought onto the land by XYZ for the purpose of operating the Water Bore, whether it be fixed or otherwise, remains the property of XYZ.

All activities and works carried out on the Land by XYZ and its authorised contractors that are reasonably associated with and necessary for XYZ to drill the Water Bore including:

a) the carrying out of all necessary works to drill and construct the Water Bore as a functioning water bore, including all associated activities;

b) the use of access points and access roads subject to Special Condition 1 (constructed, maintained and modified as Activities under this Agreement); and

c) the reinstatement and rehabilitation of the Land surrounding the Water Bore within a reasonable time from the completion of the drilling of the Water Bore in compliance with the Landowner's reasonable proposals, where possible, and any relevant laws.

Ownership of the Water Bore vests absolutely in the Landowner at all times.

XYZ requires water from the Water Bore (to be taken from the Water Take Point) for the purposes of carrying out Activities on and off the Land.

XYZ will drill and register on behalf of the Landowner the Water Bore as a registered water bore with the Landowner as the bore owner and licence holder.

XYZ will have the right to unlimited access to water from the Water Bore at the Water Take Point, in accordance with the terms of this Agreement, for the duration of the Term.

The bore will be drilled into the precipice aquifer and this aquifer is located a groundwater basin.

The landholders have sought to ensure that some of the conditions of the ECCA form part of the Water Bore CCA and this is set out as follows:

The Landowner and XYZ have been negotiating an Early Conduct and Compensation Agreement for petroleum activities on the Land, to be executed contemporaneously with this agreement (the ECCA).

XYZ acknowledges that:

a) Notwithstanding the fact that XYZ is not required to drill the Water Bore under this Agreement, the Landowner agreed to accept the compensation under the ECCA on the basis that XYZ will drill the Water Bore under this Agreement, with the outcome that the Landowner may use water from the Water Bore for stock and domestic purposes on the Land.

b) Before XYZ may exercise its right to terminate this Agreement prior to the commencement of the Water Bore Drilling, the parties must first negotiate, in good faith and acting reasonably, to review and vary the compensation payable under the ECCA for the Compensatable Effects of the activities permitted under the ECCA pursuant to section 81 of the MERCP Act. For the avoidance of doubt, the non-monetary compensation payable under this Agreement is not compensation for the activities permitted under the ECCA.

c) If the Water Bore Drilling has not occurred within the three years of the commencement of the Activities under the ECCA and XYZ has not terminated this Agreement, the parties must negotiate, in good faith and acting reasonably, to either review and vary the compensation payable under the ECCA pursuant to section 81 of the MERCP Act, or extend the period of time during which XYZ may commence the Water Bore Drilling.

XYZ's primary objective in having the water bore constructed is to ensure that they have a reliable source of water for their activities in the locality. While the primary benefit of having the water bore on the property vests withXYZ, the landowners will receive the benefit of having a water supply to Lot 23, and the compensation for the water bore is set out as follows:

XYZ agrees to compensate the Landowner as follows:

a) by non-monetary compensation, being the drilling the Water Bore for the Landowner and registering on the Landowner's behalf the Water Bore with the Landowner as the bore owner under the Water Act 2000 (Qld); and

b) up to $X for legal costs and up to $X for accounting costs, reasonably and necessarily incurred by the Landowner in respect of the negotiation of this Agreement, payable within 30 Business Days of the Agreement Date or receipt of an Itemised Bill invoiced to the Landowner, whichever is the later.

The Landowner acknowledges that the compensation described above compensates for all Compensatable Effects (as defined in the MERCP Act) of the Activities.

The Landowner acknowledges that XYZ is not required to drill the Water Bore or commence the Activities, subject to the terms of this agreement.

The Landowner acknowledges that nuisance (including noise and dust) may occur as a result of the Water Bore Drilling or XYZ's Activities and that this Agreement is an 'alternative arrangement' for the purposes of the Petroleum Authority's environmental authority but only in relation to the Water Bore Drilling and Activities

XYZ will obtain at its own cost all approvals required to take and use the water in accordance with this Agreement.

XYZ will obtain on the Landowner's behalf any approvals or licences required in relation to the drilling or registration of the Water Bore or any water licence required for the Landowner to use water from the Water Bore, noting that the Landowner proposes to use water from the Water Bore for stock and domestic purposes.

The Landowner will:

a) do all things reasonably necessary to assist XYZ in obtaining and complying with any such approvals; and

b) comply with all approvals in respect of allowing XYZ to take water.

At any time that XYZ has its infrastructure and equipment installed to make water from the Water Bore available at the Water Take Point:

a) XYZ will ensure that the Landowner has access to water from the Water Bore by way of an off-take at or near the Water Take Point;

b) the design and installation of the physical mechanism for the Landowner's off-take will be agreed between the parties (including XYZ taking into account the Landowner's reasonable proposals relating to the design and installation of the off-take); and

c) the Landowner's access to water from the Water Bore is not guaranteed when it is not available, for example, in the event of equipment breakdown or maintenance.

XYZ acknowledges that an intended outcome of this Agreement, if XYZ drills the Water Bore, is that the Landowner will benefit from water supply to the Land from the Water Bore. XYZ will take all reasonable and practicable steps to ensure the Landowner has access to water from the Water Bore, for example, ensuring that any tank used by the Landowner is replenished via a pressure switch or similar arrangement.

XYZ will consult with the Landowner and provide adequate notice, where possible, of any issues concerning the Water Bore which could adversely affect the Landowner's ability to access water.

If XYZ no longer requires use of the Water Bore, XYZ may remove its infrastructure and equipment from the Water Bore provided XYZ first consults with the Landowner and considers any reasonable request in relation to the removal of XYZ's infrastructure and equipment.

If XYZ no longer requires use of the Water Bore, the Landowner will be responsible for installing any infrastructure or equipment that may be required for their own use of the Water Bore.

If XYZ proposes to reinstall its infrastructure and equipment at the Water Bore or the Water Take Point, XYZ must first consult with the Landowner and consider any reasonable request in relation to the installation and/or the removal of any of the Landowner's infrastructure or equipment, if required.

XYZ acknowledges that the Landowner, as the bore owner, may enter into share bore arrangements with third parties to facilitate the provision of water from the Water Bore to third parties provided that:

a) the Landowner is responsible for obtaining any approvals required; and

b) XYZ's rights under this Agreement are not impacted.

Reasons for decision

Questions 1, 2 & 3

Summary

The compensation payments you will receive under the CCA and ECCA 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 and ECCA 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. 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.

The compensation amounts are not included in your assessable income under 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 CSG 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 CCAs and ECCA 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

Section 21A of the Income Tax Assessment Act 1936 (ITAA 1936) provides that any non-cash business benefit is to be treated as convertible to cash for the purpose of determining whether the benefit is income of a taxpayer from the carrying on of a business.

Section 21A of the ITAA 1936 does not actually deem any benefit in the form of property or services to be income. Its effect is that in the event that the non-cash benefit is already considered to be income derived in carrying on a business, subsection 21A(2) specifies that the amount to be brought to account is the amount that the taxpayer would have paid the provider for the property or services under an arm's length transaction.

In determining whether the bore is a non-cash business the following definitions must be considered:

Income derived by a taxpayer means income derived by a taxpayer in carrying on a business for the purpose of gaining or producing assessable income.

Non-cash business benefit means property or services provided after 31 August 1988:

(a) wholly or partly in respect of a business relationship; or

(b) wholly or partly for or in relation directly or indirectly to a business relationship.

The benefit is assessable only if it has the character of income derived by the partnership from the carrying on of a business and is provided in the context of a business relationship.

It cannot be said that the water bore would normally be income from carrying your primary production activities therefore the benefit of XYZ paying for the costs associated with drilling, operating and maintaining a water bore is not assessable under section 21A of the ITAA 1936.

If the water bore was a non-cash business benefit derived by the taxpayer and, if the taxpayer had, at the time the benefit was provided, incurred and paid unreimbursed expenditure in respect of the provision of the benefit equal to the amount of the arm's length value of the benefit - a once-only deduction would, have been allowable to the taxpayer in respect of a percentage of the expenditure, the benefit is reduced by the percentage (subsection 21A(3) of the ITAA 1936).

A water bore is a water facility. The decline in value of a water facility for the income year in which expenditure is incurred is the amount of the capital expenditure incurred on the construction, manufacture, installation or acquisition of the water facility.

A deduction is only available if the expenditure on the water facility is incurred primarily and principally for the purpose of conserving or conveying water for use in a primary production business conducted by the taxpayer on land in Australia. Thus, a deduction is not allowable to a person who owns land upon which a primary production business is carried on by some other person. However, the person carrying on a primary production business on the land is allowed a deduction, even if the person is only a lessee of the land.

If the water bore was a non-cash business benefit assessable to you, you would be entitled to a deduction for the full amount of the assessable income.

Question 5

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 the company, in return for the compensation amounts that are paid to them.

The landholders giving up their rights for further compensation upon commencing the agreement 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 the company carrying out its Authorised Activities on the land, significant damage and adverse effects will impact the landholders, for which the company must compensate the landholders under the law. Upon receipt of the compensation amounts under the agreement, 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 mining activities carried out on their land by the company.

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

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

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

Water bore

In the company's Questions and Issues document for the Ruling mention is made:

·        about the taxation consequences to the landowner of the company paying for the costs associated with drilling, operation and maintenance of a water bore, including costs to equip the bore and costs to maintain the functionality of the bore for the duration of the term or until it provides notice to the landowner that it no longer requires use of the bore; and

·        the application of Practical Compliance Guideline PCG 2016/18 to the situation.

Paragraph 1 of PCG 2016/18 has been reproduced below:

1.     This Guideline is concerned with 'countertrade' transactions. In this context, 'countertrade' refers to the direct exchange of things by one entity for things provided by another entity, and does not include transactions where any of the consideration is monetary.

Further paragraph 10 of PCG 2016/18 provides that the Commissioner will not apply resources to verify an entity's compliance with its GST reporting obligations for a countertrade transaction, in certain circumstances including among other things the entity engaging in countertrade transaction, under which the entity directly exchange things with another entity, at arm's length, without any monetary consideration.

Miscellaneous Taxation Ruling MT 2012/1 sets out the Commissioner's views on the application of the income tax and goods and services tax (GST) provisions upon entry into an immediate transfer farm-out arrangement.

Paragraph 62 of MT 2012/1 provides that monetary consideration is provided if an entity makes cash payments to third parties to meet expenses incurred by another entity thereby relieving the entity from meeting those expenses.

According to the information provided the company agrees to compensate the landowner as follows:

a) by non-monetary compensation, being the drilling the Water Bore for the Landowner and registering on the Landholder's behalf the Water Bore with the Landowner as the bore owner under the Water Act xxx; and

b) up to $xxx for legal costs and up to $xxx for accounting costs, reasonably and necessarily incurred by the Landowner in respect of the negotiation of this Agreement, payable...

Further, the company's Questions and Issues document for the ruling at a paragraph of the submission under the heading Taxation analysis - Water Bore specifies that no cash amount will be received under the Water Bore CCA. However;the relevant foot note(footnote xx) refers to the following:

Other than the recoupment of reasonable legal and accounting costs.

PCG 2016/18 indicates that countertrade does not include transactions where any of the consideration is monetary. Further, MT 2012/1 provides that monetary consideration is provided if an entity makes cash payments to third parties to meet expenses incurred by another entity thereby relieving the entity from meeting those expenses.

In this case the company agrees to compensate the landholders by part non-monetary compensation under (a) above and part monetary compensation under (b) above.

Therefore, in this case whether the company provides consideration for legal and accounting costs directly to the landholders or to their lawyers and or accountants the guideline does not apply if money is used by either party to settle the account (i.e. in addition to the exchange of things).

Further the company acknowledges in the Water Take Activities and Water Bore Drill agreement that the landholders will use the water bore for stock and domestic purposes.

Example 2 below has been reproduced from PCG 2016/8:

Example 2

20. A cabinetmaker supplies new cabinetry to the home of an interior designer. The cabinetry is installed in a home office and also in the home's living area. In return the designer supplies design services.

21. The cabinetmaker and the interior designer are both registered for GST and are sole traders. The supply by the cabinetmaker is a wholly taxable supply and the supply by the interior designer is also a wholly taxable supply - the parties have declared this to each other.

22. Countertrade transactions account for less than 10% of the total number of supplies for both the cabinetmaker and the interior designer respectively.

23. There is an exchange of emails that records the transaction. The parties agree that the price of their supplies to each other under the transaction is $3,300. There is no evidence of fraud or evasion.

24. The cabinetmaker uses the design services for a fully creditable purpose in the course of their enterprise, and makes a fully creditable acquisition of those services. However the interior designer acquires the cabinetry partly for a creditable purpose, because some of the cabinetry is installed in the designer's private living area.

Therefore the designer does not make a wholly creditable acquisition of the cabinetry.

25. The Commissioner would apply this compliance approach to the cabinetmaker for this countertrade transaction because the requirements of this Guideline are met.

26. The Commissioner would not apply this compliance approach to the interior designer because they do not meet the requirements of this Guideline. Specifically, they have not acquired the cabinetry for a wholly creditable purpose.

Subsection 11-15(1) of the GST Act, an entity acquires a thing for a creditable purpose to the extent that it acquires the thing in carrying on its enterprise.

However, subsection 11-15(2) of the GST Act provides that an entity does not acquire the thing for a creditable purpose to the extent that:

·        the acquisition relates to making supplies that would be input taxed, or

·        the acquisition is of a private or domestic nature.

Therefore, as the landholders will use the water from the water hole for stock and domestic purposes they would not have acquired the waterhole for a wholly creditable purpose. Consequently, as discussed at paragraph 26 of PCG 2016/8 the Commissioner will not apply the compliance approach discussed in PCG 2016/8 to the landholders.

Moreover, as explained above, as monetary compensation will be provided the guidance will not apply in this instance.