Edited version of private advice

Authorisation Number: 1051769075979

Date of advice: 2 November 2020

Ruling

Subject: Mining compensation

Question 1

Do the receipts under the compensation agreements constitute assessable income in accordance with section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the compensation received under the compensation agreements treated as capital proceeds under Division 116 of the ITAA 1997 in respect of a CGT event happening?

Answer

No.

Question 3

Does the compensation received under the compensation agreements reduce the cost base of the properties under section 110-45(3) of the ITAA 1997?

Answer

Yes.

Question 4

Will you make a taxable supply, pursuant to section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999, on the receipt of compensation amounts?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX to Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You have entered into compensation agreements with a mining company to compensate you for the impact of the construction of coal seam gas (CSG) wells and other CSG related activities on your 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 110-45

Income Tax Assessment Act 1997 Division 116

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

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

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

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

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 1-3

Compensation payments 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.

'Ordinary income' are receipts that meet the ordinary definition of income.

Whether a profit from an isolated transaction is assessable as ordinary income depends very much 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 transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction (paragraph 6 Taxation Ruling TR 92/3).

Neither of the above elements apply in the present 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. Therefore, the compensation amounts are not considered to be profits from an isolated transaction.

Taxation Determination TD 93/58 considers under what circumstances the receipt of a compensation/settlement payment is income. It indicates that a compensation amount will be income:

(a)  if the payment is compensation for loss of income only e.g. past year profits, and/or interest; or

(b)  to the extent that a portion of the payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

The courts considered whether compensation payments received by farming landowners from mining companies for mining operations on their land were income in the cases Barrett v. Federal Commissioner of Taxation [1968] HCA 59; (1968) 118 CLR 666; 15 ATD 149; 10 AITR 685 (Barrett) and Nullaga Pastoral Company Pty Ltd v. FC of T 78 ATC 4329; (1978) 8 ATR 757 (Nullaga).

In Barrett the farmer and the mining company entered into an agreement where the farmer was to receive amounts on account of damage to and diminution in the value of the land and other loss and inconvenience suffered by the farmer as a consequence of the operations and activities of the mining company. The High Court concluded that the amounts were compensation of a capital nature rather than income.

In Nullaga, the Supreme Court considered certain compensation payments made by mining joint venturers to a taxpayer company (the Nullaga Pastoral Company), which owned and operated a successful farming property. The relevant mining legislation provided that compensation was payable to the owner or occupier for being deprived of the possession of the surface of the land or any part thereof and for damage to it, which might arise from mining operations. The area marked out on the taxpayer's farm for exploration and mining by the joint venturers was more than a third of the total area, and their activities whether exploration or mining, would considerably interfere with farm planning, operation and development. The Supreme Court was of the view that the money was paid and received as consideration for the deprivation of part of a capital asset and in order to replace that capital. It applied the earlier decision in Barrett and concluded that the amounts were of a capital rather than income nature.

The present case is similar to Barrett and Nullaga. As in those two cases, the compensation is considered to be capital rather than income in nature and the fact that some of the amounts are received periodically is not sufficient to convert the character of those compensation amounts from being capital to income. It is accepted that the compensation amounts are not ordinary income.

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.

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 compensation agreements 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. Note that in the case of land acquired before 20 September 1985, the capital gain or loss made on the later disposal of the pre-CGT land will be disregarded.

Question 4

In this reasoning, please note:

•         all legislative references are to the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)

•         all legislative terms of the GST Act marked with an asterisk are defined in section 195-1 of the GST Act

•         all reference materials referred to are available on the Australian Taxation Office (ATO) website ato.gov.au

Taxable supply

GST is payable on taxable supplies and the supplier must pay the GST payable on any taxable supplies that it makes (section 9-40).

For the receipt of compensation amounts to give rise to a GST liability there has to be a taxable supply made.

Section 9-5 provides that you make a taxable supply if:

(a) you make the supply for consideration

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

(c) the supply is connected with the indirect tax zone (Australia), and

(d) you are registered, or required to be registered for GST.

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

All the paragraphs in section 9-5 have to be satisfied in order for there to be a taxable supply.

Paragraph 9-5(a) provides that there must be a supply and consideration

Supply

'Supply' is defined in subsection 9-10(1) as 'any form of supply whatsoever.' The statutory definition of 'supply' is very broad (paragraph 42 of GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements and paragraph 33 of GSTR 2006/9 Goods and services tax: supplies). Essentially, a supply is something which passes from one entity to another, and may be one of particular goods, services or something else (paragraph 22 of GSTR 2001/4).

Consideration

Section 9-15 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 (paragraph 75 of GSTR 2001/4).

Sufficient nexus

A sufficient nexus between the compensation amounts and a supply must exist to create the 'supply for consideration' relationship.

Goods and Services Tax Ruling GSTR 2001/4 Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) deals with, amongst other things, damages.

Paragraphs 71 to 73 of GSTR 2001/4 discusses where the subject of a claim of damages is not a supply:

71. Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury.

72. When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation.

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 this case, the issue is whether you have provided something to the mining company in return for the compensation amounts paid to you.

The compensation agreements are conduct and compensation agreements under the:

•         Mineral and Energy Resources (Common Provisions) Act 2014 (Qld); and

•         Petroleum and Gas (Production and Safety) Act 2004 (Qld); and

•         the Petroleum Act 1923 (Qld).

Clauses XX of the compensation agreements provide an explanation of what the compensation is for.

Broadly, the compensation amounts received by you, under the compensation agreements, are to compensate for the Compensatable Effects, Disturbance Impacts and Noise Impacts arising from the Activities on the land. These are not payments for any supplies made by you.

As the compensation payments are not consideration for a supply, there is no taxable supply under section 9-5 made by you. Therefore, the receipt of the compensation amounts by you, from the mining company, will not give rise to a GST liability pursuant to section 9-40.