Edited version of private advice

Authorisation Number: 1051654876900

Date of advice: 18 May 2020

Ruling

Subject: Compensation

Issue 1: Income Tax

Question 1

Do the receipts under the Agreement 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 receipts under the Agreement do not constitute assessable income in accordance with section 6-5 of the ITAA 1997 will the receipt of these amounts constitute 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 receipts under the Agreement do not constitute assessable income under 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 any compensation received under the Agreement reduce the cost base of the property under subsection 110-45(3) of the ITAA 1997?

Answer

Yes

Issue 2: Goods and Services Tax

Question 4

Will the landholder incur a GST liability on receipt of compensation payments?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The property was acquired before 20 September 1985.

The property is currently used to carry on an enterprise by the landholders.

The landholders have entered into an Agreement with Company A for compensation for Coal Seam Gas (CSG) related activities to be carried on by Company A on the property.

There will be permanent damage to, and reduction in value of, the land from the activities carried out on the property.

Registered valuers were engaged to value the permanent damage to the land and this created the framework within which the compensation negotiations took place.

The negotiations and determination of compensation under the Agreement were on the basis that the compensation was for the permanent damage to the land and none of the compensation was for the loss of business income or for additional business expenditure.

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 11-5.

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 Subsection 9-10(2).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-10(2)(e).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-10(2)(g).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 11-5(b).

A New Tax System (Goods and Services Tax) Act 1999 Paragraph 11-5(c).

A New Tax System (Goods and Services Tax) Act 1999 Section 11-20.

Reasons for decision

Issue 1: Income tax

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. You did not enter into the arrangement to make a profit. Rather, the arrangement was entered into in order to receive compensation for damage to the property that will be caused by the mining activities.

Compensation for loss of income or additional business expenses may also be income according to ordinary concepts. However, in this case none of the compensation was for loss of income or for additional business expenditure.

Accordingly, the compensation payments paid under the Agreement 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 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.

Compensation received by a taxpayer has no CGT consequences if the underlying asset which has suffered the permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985 or is any other exempt CGT asset.

The activities will result in permanent damage to, or a permanent reduction in the value of the property. As the property was acquired before 20 September 1985, there are no CGT consequences at the time of entering into the Agreement or at the time of receiving the compensation payments.

Issue 2: Goods and Services Tax

Where a business receives compensation, the question to address is whether this receipt gives rise to a GST liability to a business that is registered for GST. The starting point with respect to GST is to determine if the compensation is consideration for any supplies that the business has made. The landholder has become entitled under the relevant legislation to receive compensation for certain kinds of loss caused by activity upon their land. The relevant section of the relevant legislation provides that the owner of any land upon which activities are carried out is entitled to receive compensation for any economic loss, hardship and inconvenience suffered by the landholder as a consequence of the activities.

In determining the compensation payable under the relevant legislation, regard is given to a number of matters including any damage caused to the land by the activities. The amount of the compensation is an amount determined by agreement between the landholder and other party (the Agreement). The quantum of compensation payable is not dependent on a landholder's time and effort in being a party to any of the agreements.

For a supply to be subject to GST, the supply must be a taxable supply. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides:

You make a taxable supply if:

(a) you make a supply for consideration; and

(b) the supply is made in the course or furtherance of an enterprise that you carry on; and

(c) the supply is connected with Australia; and

(d) you are registered or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.'

(as defined in section 195-1 of the GST Act)

The meaning of 'supply' is defined in subsection 9-10(1) of the GST Act as any form of supply whatsoever. Subsection 9-10(2) of the GST Act then provides a non-exhaustive list of types of supplies. It is evident that for there to be a taxable supply, the landholder must make a 'supply for consideration' under paragraph 9-5(a) of the GST Act.

The term 'supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever' and includes a grant, assignment or surrender of real property (paragraph 9-10(2)(d) of the GST Act). Goods and Services Tax Ruling GSTR 2001/4 deals with the GST consequences of court orders and out of court settlements and discusses the meaning of 'supply'. Paragraph 22 of that ruling provides that a supply is essentially 'something which passes from one entity to another'. Paragraph 25 of GSTR 2001/4 goes on to state:

Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release.

Therefore, the term 'supply' covers not only the subject of the transaction - the thing that passes - but also includes the action by which the thing passes from one entity to another. In addition, by using the word 'make' in the phrase 'you make the supply' in paragraph 9-5(a) of the GST Act, there is a requirement for a supplier to take some action to cause a supply to be made. As such the landholder must take some positive action or do something for a supply to occur.

The key issue is whether the landholder makes any supply when they receive compensation. Normally the transfer or surrender of the legal interest in land is covered by the definition of supply in section 9-10 of the GST Act. Of course landholders can only transfer or surrender rights in land that they own. In the case of X activity rights, the landholder does not transfer or surrender their rights related to X activity on the land to the other party because the other party is already the holder of these rights as they were vested in the other party upon the grant of the statutory authority by the State Government.

Based on the facts, the payment to the landholder is in respect of compensation for any damages caused or likely to be caused to their land and any inconvenience suffered by the landholder as a consequence of the activities carried out on their land.

Goods and Services Tax Ruling GSTR 2001/4 states, in relation to compensation and 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.

In summary, the landholder is not making a supply and so the landholder cannot make a taxable supply on which they would have a GST liability. This is not to say that landholders do not undertake anything because they generally upon receipt of the compensation confirm that the company does not have any further requirement to pay a further compensation amount for the damages set out in the Agreement. In other words, they give up their rights to pursue further compensation in relation to the impacts set out in Schedule 2 to the PCCA.

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 GSTR 2001/4 a 'discontinuance supplies'.

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 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 current case, if we apply the principle to the receipts by the landholder in accordance with the Agreement, then the undertaking made by landholder not to seek further compensation for the activities set out in the Agreement being as it is a subordinate aspect of the settlement, without its own consideration, will not be a supply and consequently not a taxable supply.

As the compensation relates to damages then reference to paragraphs 110 to 111 of GSTR 2001/4 is relevant:

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.

In other words, in relation to the landholder, as there is no 'earlier or current supply' that is related to the payment of compensation then the damages claim does not give rise to any supply.

Notwithstanding that the landholder's acceptance of the terms contained in the compensation agreement may amount to supplies within the meaning of paragraphs 9-10(2)(e) or 9-10(2)(g) of the GST Act, no part of the amount paid as compensation is consideration for these supplies. The subject of the dispute, being the settlement of damages claims between the parties in relation to the activities conducted on the land, is not lacking in substance and is what the compensation is paid for.

In conclusion, the compensation received relates to damages suffered by the landholder as a result of activities carried out by the other party on their land and is not consideration for a supply and accordingly no taxable supply will be made by the landholder. In addition, as no part of the compensation is attributable to discontinuance supplies, there are no GST consequences for the discontinuance supplies.

Given that a small amount of the compensation is for the recoupment of expenses a question could be raised as to whether the recoupment of expenses would give rise to a GST liability. This matter was considered in the Victorian Supreme Court decision in Millington v Waste Wise Environmental Pty Ltd [2015] VSC 167 which confirmed that a damages award should generally be calculated on a GST exclusive basis in circumstances where the plaintiff is entitled to a full input tax credit (GST credit) for a cost or expense. This decision is consistent with the New South Wales Supreme Court decision which similarly held that a damages award should be calculated on a GST exclusive basis where a plaintiff was entitled to full input tax credits for a cost or expense (Gagner Pty Ltd v Canturi Corporation Pty Ltd [2009] NSWCA 413).