Edited version of private advice

Authorisation Number: 1051774627301

Date of advice: 30 October 2020

Ruling

Subject: Income - lump sum - mining compensation

Question 1

Did CGT event D2 happen when you granted ABC the option to acquire the easement?

Answer

Yes.

Question 2

Will CGT event A1 happen when ABC exercises the option to acquire the easement?

Answer

Yes.

Question 3

Will the capital proceeds for CGT event A1 include the Option Fee and the Easement Price?

Answer

Yes.

Question 4

Will the Compensation (as defined in the Option for Easement and Conduct and Compensation Agreement (OECCA)) constitute ordinary income under section 6-5 of the (Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 5

To the extent the Compensation is capital in nature, will the Compensation be treated as a reduction in the cost base of the Land?

Answer

Yes.

Question 6

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

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You (the Landowner) own agricultural land (the Land) which has been used in a business of primary production since acquisition.

ABC wishes to construct, operate and maintain a pipeline over part of the Land.

You entered into an OECCA with ABC.

Option for Easement

Under the OECCA the Landowner has agreed to grant ABC an option to acquire the Easement to construct, operate, and maintain the pipeline on the terms set out in the OECCA.

ABC will pay a non-refundable Option Fee (exclusive of GST) in return for the granting of the option. The option is irrevocable until the Option Expire Date.

The Option Fee is $Z exclusive of GST.

Exercise of Option - Granting the Easement

Where the Option is exercised, ABC will pay the Landowner the Easement Price and Compensation within 25 Business Days after the day that the option is exercised.

The Easement Price of is $Y exclusive of GST.

Compensation

The OECCA is a Conduct and Compensation Agreement under section 83 of the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) (MERCP Act).

ABC will pay the Option Fee, Easement Price, Landowner Costs, and Compensation to the Landowner as required under the OECCA.

The Compensation is set at $X exclusive of GST.

Per the OECCA,

The Landowner agrees that the Compensation is in full and final satisfaction of:

(i)            The Compensatable Effects in respect of:

a)    All Activities, subject to clause 12(d) of the OECCA;

b)    The exercise of any rights under the OECCA; and

c)    The exercise of any rights under the Easement; and

The meaning of 'compenstable effect' is taken from section 81 of the MERCP Act to be:

(a)  Any of the following caused by the holder, or a person authorised by the holder, carrying out authorised activities in the eligible claimant's land -

(i)    Deprivation of possession of the land's surface;

(ii)   Diminution of the land's 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; and

(b)  Consequential loss incurred by the eligible claimant arising out of a matter mentioned in paragraph (a)

The Activities to be conducted by ABC include the construction and operation of the Pipeline as set out in the OECCA including Activities associated with exercise of any rights under the OECCA and under the Easement.

You and ABC have agreed in writing the conditions of access to the Land and the Construction area.

The amount of the compensation was based on an estimate of compensation having regard to the Compensatable Effects pursuant to the MERCP Act, with reference to the area of land affected.

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 104-35

Income Tax Assessment Act 1997 section 104-40

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

Question 1

CGT event D2 happens if you grant an option to an entity (section 104-40 of theITAA 1997). The time of the event is when you grant the option. You make a capital gain if the capital proceeds from granting the option are more than the expenditure you incurred to grant it. The general 50% CGT discount cannot be applied to a capital gain from CGT event D2.

In your case, CGT event C2 happened when you granted ABC the option to acquire the easement. You made a capital gain or loss at that time.

Note: A capital gain you make from the grant of an option is disregarded if the option is exercised (subsection 104-40(5) of theITAA 1997). If you granted an option to create or dispose of a CGT asset, another entity exercises the option and because of the exercise of the option you create or dispose of the CGT asset, the capital proceeds from the creation or disposal include any payment you received for granting the option (section 116-65 of the ITAA 1997).

Questions 2 & 3

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) advocates a look-through approach, which identifies the most relevant asset to which the compensation amount is most directly related.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying asset, or part of an underlying asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, we consider that the amount is not consideration received for the disposal of any other asset, such as the right to seek compensation (paragraph 4 of TR 95/35).

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-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 (paragraph 6 of TR 95/35).

Taxation Ruling TR 97/3 Income tax: capital gains: compensation received by landowners from public authorities (TR 97/3) extends the application of TR 95/35 and should be read with that ruling.

Compensation in respect of an easement created by statute in favour of a public authority cannot be said to have been received for the grant of the easement. The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation. In these circumstances, the landowner cannot be said to have created an asset as required for subsection 160M(6) of the Act to apply. The easement is created by operation of the relevant statute and is vested in the public authority. This constitutes a compulsory acquisition of the easement (paragraph 4 of TR 97/3).

Note: subsection 160(M) of the Income Tax Assessment Act 1936 has been replaced with section 104-35 of the ITAA 1997. The effect of both provisions is the same.

TR 95/35 focuses on the asset to which the compensation receipt most directly relates. In the case of easements acquired under statute, the most relevant asset is the landowner's pre-existing land with its rights of ownership including, for example, a right to exclude all others. This right to exclude all others is forfeited in part when the easement comes into existence. The loss of part of this right constitutes the disposal of part of the underlying asset (the Land) (paragraph 6 of TR 97/3).

The acquisition of an easement by a public authority using the compulsory process provided in the relevant statute culminates in a declaration by notice in the Gazette that the easement has been acquired. However, it is possible that a public authority may acquire an easement by agreement with the landowner. One of the features which the various statutes have in common is encouragement of acquisition by agreement (paragraph 9 of TR 97/3).

Because the easement is created in these circumstances by grant by the landowner there is scope for an argument that subsection 160M(6) applies. However, because the grantee of the easement (the public authority) has available, if it chooses to exercise it, the power to compulsorily acquire the easement, the amount received, in our view, takes on the same character as compensation for a compulsorily acquired easement. It is therefore appropriate that Part IIIA apply in the same way, that is, the consideration (compensation) is paid in respect of the part disposal of the land and not in respect of the grant of the easement (paragraph 10 of TR 97/3).

CGT event A1 happens if you dispose of a CGT asset (section 104-10 of the ITAA 1997).

In your case, while you voluntarily entered the OECCA with ABC, they had the power to call on the state to grant it compulsory acquisition powers to acquire the easement. In such circumstances it is The Commissioner's view that the Option Fee and the Easement Price take on the same character as compensation for a compulsorily acquired easement. These amounts are considered capital proceeds from CGT event A1 happening to your ownership interest in the Land, when you disposed of your right to exclude ABC from the Land.

Questions 4, 5 & 6

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.

Accordingly, the Compensation payment paid under the OECCA does 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 amount is 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.

As noted above, TR 95/35 provides that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-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 (paragraph 6 of TR 95/35).

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.

ABC's activities will result in permanent damage to, or a permanent reduction in the value of the remaining land following the construction of the pipeline. Consequently, the Land's acquisition cost will be reduced by the Compensation payment received in relation to that remaining land. That is, the cost base of the Land will be reduced by the Compensation payment and any gain or loss will crystallise at a later time when the land is disposed of.

If the amount of compensation exceeds your total acquisition costs (cost base) for the Land at the time of the compensation, the cost base of the Land is reduced to zero. The excess of the compensation over the costs in these circumstances does not represent a taxable capital gain derived from the disposal of the Land. There are no CGT consequences in respect of any excess. It follows that the whole consideration received on a later actual disposal of the Land will be a taxable capital gain (unless you incur additional expenditure which forms part of the cost base of the Land).