Edited version of private advice

Authorisation Number: 1051787387156

Date of advice: 10 December 2020

Ruling

Subject: Assessable income - capital gains tax - compensation - mining receipts

Question 1

Will the compensation received under the Conduct and Compensation Agreement (CCA) 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 CCA 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 CCA 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 the landholder incur a goods and services (GST) liability on the receipt of compensation amounts from under the CCA?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Landholder is the owner of land (as defined in section 12 of theMineral and Energy Resources (Common Provisions) Act 2014 (Qld) (Petroleum Legislation), a pastoral property, and owned the property prior to 20 September 1985.

Landholder is not registered for Goods and Services Tax.

The property has been utilised for primary production activities.

Landholder has negotiated a Conduct and Compensation Agreement (CCA) with Entity A. The CCA is a conduct and compensation agreement for the purposes of the Petroleum Legislation.

The CCA is in relation to Entity A carrying on Activities on the Land as defined.

This CCA sets out the terms upon which Entity A will:

a) enter the Land for the purpose of conducting the Activities; and

b) compensate the Landholder for the impacts of the Activities.

Subject to the terms of the CCA, the Landholder acknowledges that the compensation compensates for all of the impacts of the Activities, including the loss of use of the Land for a period, all impacts and loss of amenity generally as the activities will cause permanent damage to, or permanent reduction in the value of, the Land.

The compensation as outlined in the CCA includes several different payments which are payable during different phases. Reimbursements are being received for legal, accounting and valuation costs reasonably and necessarily incurred by the Landholder negotiating the CCA.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(2)

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 subsection 110-40(3)

Income Tax Assessment Act 1997 subsection 110-45(3)

Income Tax Assessment Act 1997 Division 116

Income Tax Assessment Act 1997 paragraph 118-37(1)(b)

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

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 section 9-15

Reasons for decision

Question 1

Summary

The compensation received by the you under the terms of the CCA will not be treated as assessable income under section 6-5 of the ITAA 1997.

Detailed reasoning

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that are earned, are expected, are relied upon, and have an element of periodicity, recurrence or regularity.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

The compensation payment you will receive is not earned by you as it does not relate to services performed or from carrying on a business. Although the compensation relates to your property, the payment is not akin to rent. Rather the compensation is being received for the impact of the LWD activity on your land. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from any personal services performed or business activity.

Accordingly, the compensation payments paid under the terms of 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. As such, these payments are not assessable income under section 6-5 of the ITAA 1997.

Questions 2 and 3

Summary

The compensation payments received by you under the terms of the CCA will not cause a capital gains tax event to happen. The compensation payments will reduce the cost base of the relevant property for any future capital gain in accordance with section 110-40 of the ITAA 1997.

Detailed reasoning

Capital proceeds in respect of a CGT event happening

Under subsection 116-20(1) of the ITAA 1997, money you have received (or are entitled to receive) and the market value of any property you have received (or are entitled to receive) are the capital proceeds from a CGT event.

For the compensation payments under an agreement to constitute capital proceeds, there must be a CGT event.

CGT events occur in respect of CGT assets. The definition of a CGT asset is contained in subsection 108-5(1) of the ITAA 1997. It provides that a CGT asset is any kind of property or a legal or equitable right that is not property. Not all things often referred to as 'rights' will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law.

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 and relevantly, it states that a CGT event will occur (and any consideration form part of capital proceeds) where the amount of compensation is received by the taxpayer:

•         either wholly or partly in respect of the disposal of an underlying asset (CGT event A1); or

•         not in respect of any underlying asset but in relation to the disposal of the right to seek compensation (CGT event C2).

The above relate to CGT event A1 (section 104-10 of the ITAA 1997) and CGT event C2 (section 104-25 of the ITAA 1997) respectively.

TR 95/35 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 identified using the 'look-through approach' in order to determine the asset to which the compensation amount most directly relates. Paragraph 70 of TR 95/35 states that the underlying asset is identified by looking through to the transaction which generates the compensation receipt.

Applying the look-through approach to the facts the Land is the asset to which the compensation under the CCA most directly relates. The Land is therefore the underlying asset and the relevant CGT asset.

As there has been no disposal of the Land, CGT event A1 does not occur.

Further, as the amounts are paid in respect of an underlying asset (being the Land) CGT event C2 will not happen.

As such, the compensation amounts you receive under the terms of the CCA, do not constitute capital proceeds in respect of a CGT event happening.

Reduction in the cost base of the Land

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.

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 CCA or at the time of receiving the compensation payments.

Question 4

Summary

The receipt of the compensation amounts by you under the terms of the CCA will not give rise to a GST liability.

Detailed reasoning

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 you have provided something to Entity A, in return for the compensation amounts that are paid to you.

In regards to you giving up your rights for further compensation upon commencement of the agreement, this raises the issue of whether giving up of your rights would be a separate supply or as termed in the 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.

GSTR 2001/4 sets out the Commissioner's view relating to GST consequences of court orders and out-of-court settlements. The following is stated in relation to discontinuance supplies at paragraphs 106 to 109:

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 Entity A carrying out its Authorised Activities on the Land, damage and adverse effects will impact the Land, for which Entity A must compensate you under the law. Upon receipt of the compensation amounts under the CCA, you accept that you give up your right to pursue further compensation in relation to the Authorised Activities.

You, giving up your right for further compensation is not a separate supply for GST purposes. Rather, it is considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by you.

Damages

Paragraph 73 of GSTR 2001/4 states the following in relation to damages:

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. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.

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.

You received the amounts under state mining legislation, as compensation for any economic loss, hardship and inconvenience as a result of mining activities carried out on your land by the company.

The payment by Entity A is compensation in respect of any damage caused or likely to be caused to the Land and any inconvenience suffered by you as a consequence of the authorised activities carried out on the Land.

In applying the above principles in GSTR 2001/4 to the present circumstances, the compensation amounts are paid to you to resolve a potential damages claim. A claim for damages (or payment that you receive as a consequence of such claim) due to activities conducted by the company on the Land, does not constitute a supply under section 9-10 of the GST Act.

Under the terms of the CCA, when you provide the right to Entity A to carry out activities on the Land, you make a supply. In this case, as there is no separately identifiable amount (consideration) paid for that supply and as you are not registered or required to be registered for GST, it is not a taxable supply. Accordingly, you do not incur a GST liability.

You do not create, transfer or surrender any rights related to these activities on the Land to Entity A (apart from the right to access the land detailed above). Hence, there is no further supply made by you as a landholder to Entity A, instead the payments in the CCA are compensation in respect of any damage caused or likely to be caused to the Land, for example the diminution of the value of the Land, as a consequence of LWD activities being carried out.

You do not provide Entity A 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 you to the company, and accordingly no taxable supply will be made by you.

Therefore, the receipt of the compensation amounts by you from Entity A will not give rise to a GST liability. Further, you are not registered nor required to be registered for GST as a result of this agreement.