Edited version of private advice

Authorisation Number: 1051922852763

Date of advice: 18 February 2022

Ruling

Subject: Compensation - mining

Issue 1: Income Tax

Question 1

Do the receipts, received under the Agreements signed on XXXX constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

To the extent that the receipts under the Agreements signed on XXXX do not constitute assessable income under 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 capital gains tax (CGT) event happening?

Answer

No.

Question 3

To the extent that the receipts under the Agreements signed on XXXX 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 Agreements reduce the cost base of the property/land under subdivision 110-A of the ITAA 1997?

Answer

Yes.

Issue 2: Goods and Services Tax

Question 1

Will the landowners (you) incur a goods and services tax (GST) liability on the receipt of compensation payments from entity A?

Answer

No.

This ruling applies for the following periods:

Years ending 30 June 20XX to 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 section 6-15

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 Subdivision 110A

Income Tax Assessment Act 1997 section 110-40

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 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

Issue 1: Income Tax - Questions 1, 2 & 3

Detailed reasoning

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, 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 to compensate for 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.

Compensation paid due to loss and damage of a capital asset in the process of a petroleum authority undertaking petroleum activities on a person's land is regarded as an isolated transaction. Whether a profit from an isolated transaction is income according to ordinary concepts depends on the circumstances of the case.

As outlined in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income, a profit from an isolated transaction will generally be income when:

a)    the intention or purpose of a 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 on a business operation or commercial transaction.

After reviewing all the relevant facts in relation to your circumstances, it is not considered that your compensation payments form part of an isolated profit-making undertaking.

Furthermore, the compensation payments 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 CGS activity on your land. The fact that amounts are received annually does not mean that such payments are ordinary income. 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. The compensation payment relates to the damage to your property and is capital in nature.

Accordingly, the compensation payments paid under the CCA's are not regarded as ordinary income and are therefore not assessable under section 6-5 of the ITAA 1997.

Compensation payments and the capital gains tax (CGT) provisions

Statutory income is not ordinary income but is included in assessable income by specific provisions of the income tax law (section 6-10 of the ITAA 1997).

These specific provisions are listed in section 10-5 of the ITAA 1997 and include capital gains, which are included in assessable income by virtue of the capital gains tax (CGT) provisions.

Lot C of the property is a CGT asset under section 108-5 of the ITAA 1997.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation payments. Why the payment was made is an important factor in determining whether an asset has been disposed of for capital gains tax purposes.

TR 95/35 discusses the various scenarios, including:

•                disposal of the underlying asset,

•                compensation for permanent damage to, or permanent reduction in value of, the underlying asset, and

•                disposal of the right to seek compensation.

As outlined in the ruling, the Commissioner adopts an ''underlying asset'' approach to determine the asset to which the compensation amount is most directly related. In concluding that the underlying asset is the most relevant asset to which an amount of compensation relates, a person must be able to show that the compensation receipt has a direct and substantial link with the underlying asset. If an asset has not been disposed of and has not been permanently damaged or permanently reduced in value by the happening or event which generated the amount of compensation, the taxpayer is not able to demonstrate that link. It follows that the compensation cannot be directly related to that asset. In those cases, the most relevant asset may be the right to seek compensation.

Paragraph 3 of TR 95/35 states that permanent damage or reduction in value does not mean everlasting damage or reduced value but refers to damage or a reduction in value which will have permanent effect unless some action is taken by the taxpayer to put it right.

Where an amount of compensation is received wholly in respect of the disposal of an underlying CGT asset, or part of an underlying CGT asset, 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 wholly in respect of permanent damage suffered to a post-CGT underlying asset or for a permanent reduction in the value of a post-CGT underlying asset, 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.

Accordingly, the total acquisition costs of the post-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 transactions which generated your compensation payments are the actions of entity A. The underlying asset in your case is the land that is being used for the coal seam gas (CSG) activities. You have not disposed of the land, however the land will suffer permanent damage or permanent reduction in value. You will receive compensation in respect of the impact of the CSG activities on the land. The compensation amounts to be paid are viewed as having a direct and substantial link or nexus with the land.

As you have not disposed of the property or other CGT assets, there are no CGT consequences at the time of entering into the CCA's or receiving the compensation payments. That is, no CGT event has occurred as a result of the CCA's and the payments received are not regarded as capital proceeds under Division 116 of the ITAA 1997.

However, as lot C of the property is considered post-CGT land, its acquisition cost will be reduced by the compensation payments (excluding any reimbursements) received in relation to that land (subdivision 110-A of the ITAA 1997). That is, the cost base of the land will be reduced by the value of the compensation payments and any gain or loss will crystallise at a later time when the post-CGT land is disposed of.

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

Issue 2: Goods and Services Tax (GST) - Question 4

Detailed reasoning

If an entity is registered for GST and receives compensation payments, the GST implications need to be considered.

In this case, you are entitled under the state mining legislation to receive compensation for certain kinds of loss caused by entity A upon entry on their land.

The amount of the compensation is determined by the CCA's and for the compensation to be subject to GST there must be a taxable supply.

Section 9-5 of the GST Act provides:

Supply

You make a taxable supply if:

a)    you make the 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 supply (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' and includes a grant, surrender of real property of (paragraph 9-10 (2)(d) of the GST Act). 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 this case of mining rights, you do not transfer or surrender your rights related to mining on the land to entity A as entity A is already the holder of these rights as they were vested in entity A (the mining company) upon the grant of the statutory authority by the State Government.

It is clear that you are not providing a right in relation to the land.

In the process of entity A carrying out its Authorised Activities on the land, significant damage and adverse effects will impact you, for which entity A must compensate you under the law.

Upon receipt of the compensation amounts under the agreement, you accept that you give up your right to pursue further compensation in relation to the Authorised Activities.

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 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.

Applying the principle in paragraphs 106 to 109 in GSTR 2001/4, it is considered that giving up of your right for further compensation is not a separate supply for GST purposes. It is, rather, considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by you.

Damages

Goods and Services Tax Ruling 2001/4 deals with the GST consequences of court orders and out of court settlements and a 'discontinuance supply'. With regards to compensation and damages at paragraph 73 it states:

The most common form of remedy is a claim for damages arising out of the termination or breach of the 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 of the damage, loss, or injury in itself does not constitute a supply under 9-10 of the GST Act.

In essence, you are not making a supply and so you cannot make a taxable supply on which you would have GST liability. This is not to say that you do not undertake anything because, upon receipt of the compensation, you confirm that the mining company does not have any further requirement to pay a compensation amount for the damages set out in the CCAs. In other words, you give up your rights to pursue further compensation in relation to the impacts set out in the CCAs.

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...

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.

Conclusion

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

The payment by entity A to you 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 entity A's Authorised Activities carried out on your Land.

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

You do not provide entity A with any supply in return for the compensation amounts. As such, the compensation payments made by entity A is not consideration for a supply from you to entity A, and accordingly no taxable supply is made by you.

Therefore, the receipt of the compensation amounts by you from entity A will not give rise to a GST liability.