Edited version of private advice

Authorisation Number: 1051755796949

Date of advice: 23 October 2020

Ruling

Subject: Income - lump sum

Question 1

Do the annual compensation payments received under the Conduct and Compensation Agreement (CCA) 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 annual compensation payments received under the CCA do not constitute assessable income in accordance with section 6-5 of the ITAA 1997, do the annual compensation payments reduce the cost base of the Land under section 110-45(3) of the ITAA 1997?

Answer

Yes.

Question 3

If the Compensation for the compensatable effects exceeds the cost base of the Land, does a taxable capital gain arise?

Answer

No.

Question 4

Are the Landholder Costs amounts received as a reimbursement of deductible accounting fees included in your assessable income?

Answer

Yes.

Question 5

Are the Landholder Costs amounts received as a reimbursement of non-deductible accounting, legal and similar professional costs included in your assessable income?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 20XX to year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

You (the Landholder) own vacant land (the Land).

ABC, an energy company, intends to carry out Authorised Activities under the Petroleum Authority.

You have entered into a CCA with ABC. The agreement is entered into before the precise location of the Activities on the Land are determined and refers to a Buffer Zone where ABC may readily make changes to the location of the Activities.

Compensation

The CCA is a Conduct and Compensation Agreement under the Petroleum Legislation (being the Mineral and Energy Resources (Common Provisions) Act 2014 (QLD) (MERCP Act), the Petroleum and Gas (Production and Safety) Act 2004 (Qld), and the Petroleum Act 1923 (Qld).

ABC will pay Compensation to you as required under the CCA.

The Compensation is as follows:

·         Landholder costs: $XX,XXX (this amount is non-refundable)

·         Years 1 and 2: $XX,XXX per annum

·         Years 3 and ongoing: $X,XXX per annum

The Landholder Costs component of the Compensation is considered by ABC to fairly compensate the Landholder for the Landholder Costs (being costs incurred by the Landholder in respect of negotiating and executing the CCA including legal, accounting and other Professional Costs). You expect to only incur legal and accounting fees at this stage.

The CCA states:

The Compensation:

1. 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 Origin to the Landholder under Relevant Laws for the Activities

(collectively, the Compensation Matters

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

The CCA also notes that:

The Landholder releases Origin and its Associates from any Liability to the Landholder regarding the Compensation Matters

Item 81 of the MERCP Act states that Compensatable Effects means:

(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 owners;

(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;

(c)   Consequential damages the eligible claimant incurs because of a matter mentioned in paragraph (a) or (b).

The Authorised Activities to be conducted by ABC include the construction, testing, development, operation, maintenance, decommissioning and rehabilitation of two Petroleum wells on the Land.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 section 110-40

Income Tax Assessment Act 1997 section 110-45

Income Tax Assessment Act 1997 Division 116

Reasons for decision

Questions 1-3

Compensation payment as ordinary income

Section 6-5 of the 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 income according to ordinary concepts depends on the circumstances of the case. Profits from an isolated transaction are generally ordinary income when both of the following elements are present:

a)    the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain, and

b)    the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 of Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income).

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

In your case, the compensation payments you receive 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. 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 Income tax: capital gains: treatment of compensation receipts provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling provides 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 an underlying asset of the taxpayer or for a permanent reduction in the value of an underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, then 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.

In your case, it is considered that the Authorised 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.

Questions 4 & 5

Subsection 20-20(3) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss of outgoing is an assessable recoupment if:

·         you can deduct an amount for the loss or outgoing in the current year, or

·         you have deducted or can deduct an amount for the loss or outgoing for an earlier income year under a provision listed in section 20-30 of the ITAA 1997.

To determine if the compensation for the expected Professional Costs of accounting and legal fees are an assessable recoupment, we must first determine if those fees are deductible and under what provisions.

Deductibility of accounting and legal fees

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income or a provision of the taxation legislation excludes it.

Section 25-5 of the ITAA 1997 allows a deduction for expenditure you incur to the extent that it is for:

·         managing your tax affairs

·         complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity

·         the general interest charge or shortfall interest charge

·         a penalty under Subdivision 162-D of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) which relates to situations where a taxpayer varies their instalment rate too low, or

·         obtaining a valuation in accordance with section 30-212 (gifts of properties to deductible gift recipients) or 31-15 (entering into conservation covenants).

Accountancy fees which relate to your tax affairs are an allowable deduction. Where the services to which the fees relate go beyond managing your tax affairs, you must apportion the fees between the various purposes and only those services that directly relate to your tax affairs are deductible (Bartlett v FC of T; Falcetta v FC of T 2003 ATC 4962; [2003] FCA 1125)

Legal fees will be deductible where the nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses (Hallstroms Pty Ltd v FC of T [1946] HCA 34; (1946) 72 CLR 634) (Hallstroms).

Where accounting and legal costs are not incurred in managing your tax affairs they are capital in nature and not deductible.

Assessability of reimbursements for accounting and legal

As noted above, only those accounting fees which relate to managing your tax affairs are deductible. Section 20-30 of the ITAA 1997 includes tax-related expenses deductible under section 25-5 of the ITAA 1997 as assessable recoupments.

A reimbursement of accounting fees for which you deducted, or could claim a deduction for, in the current or earlier income year, will be an assessable recoupment and are included in your assessable income in the year in which the reimbursement is received.

A reimbursement of accounting and legal fees for which you cannot claim a deduction are not an assessable recoupment or ordinary income.

Where the Landholder Costs payment exceeds the accounting and legal fees incurred, the excess amount is additional compensation which will reduce the cost base of the land.