Edited version of private advice

Authorisation Number: 1051930784650

Date of advice: 10 February 2022

Ruling

Subject: Tax treatment of compensation agreement in relation to the use of the land

Question 1

Do the receipts, received under the Early 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 receipts, received under the CCA, do not constitute assessable income in accordance with 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 CGT event happening?

Answer

No

Question 3

To the extent that the receipt under the CCA do not constitute assessable income in accordance with 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; do the compensation amounts reduce the cost base of the properties under subsection 110-40(3) of the ITAA 1997?

Answer

Yes

Question 4

Will you incur a GST liability pursuant to section 9-40 of A New Tax System (Goods and Services Tax) Act 1999 on the receipt of compensation amount under the CCA?

Answer

No

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You have provided us with the following relevant facts and information:

You are the legal owner of property with X lots purchased pre 20 September 1985 and X lots being purchased after 19 September 1985. You run a business on the land.

You entered into the Early Conduct and Compensation Agreement (CCA) with B. The CCA is a conduct and compensation agreement under the Mineral and Energy Resources (Common Provisions) Act 2014 (QLD) (MERCP Act). C is the holder of a Petroleum Authority on its behalf. Broadly, the CCA allow for B and its associates to enter onto the property and the interference with your quiet enjoyment of those properties.

Key elements of the CCA

Purpose of the CCA

The background to the CCA provides an agreement, among other things, do the following:

•                     set out how B may carry out the Activities on the Land

•                     documents each party's rights and obligations regarding the Activities, and

•                     compensate you, the Landholder, for impacts of the Activities.

'Activities' is defined in Schedule 6 of the CCA and includes the activities described in Schedule 2 of the CCA and any other associated activities.

'Land' is defined in Schedule 6 of the CCA.

Duration of the CCA

Clause 5 of the CCA provide that the CCA commences on the Agreement Date and ends when B gives you notice that it has completed all of the Activities that B proposes to carry out on the Land and the Land is rehabilitated in accordance with Relevant Laws, or that it will not proceed with any Activities.

'B is not required to carry out all or any of the Activities'.

Waiver of notice of entry requirement

Clause 7 of the CCA provide that you give a waiver of the requirement for B to give a notice of entry with respect to the Activities for the duration of the CCA.

Clause 8 of the CCA provide B may without giving an entry notice, access the Land, to undertake the Activities, provided it provides you with 48 hours notice prior to entering the Land.

Compensation payable under the CCA

Clause 9 of the CCA provide that B must pay you Compensation in the amount and by the time described in Schedule 1 of the CCA.

Clause 10 of the CCA provide that if B fails to make a payment on time, you may raise a Dispute and B must pay you interest from the time payment was due at the standard default contract rate.

Clause 11 of the CCA provide that the Compensation compensates you for all of the following:

•                     'Compensatable Effects, Disturbance Impacts and Noise Impacts' arising from, among other things, the Activities, and

•                     'other amounts payable by B to the Landholder under Relevant Laws for the Activities'.

'Compensatable Effect' is defined in Schedule 6 of the CCA and has the meaning given under the MERCP Act (discussed above).

'Disturbance Impact' is defined in Schedule 6 of the CCA and refers to all impacts of light, dust, odour, vibration, vehicular movements and loss of amenity.

'Noise Impact' is defined in Schedule 6 of the CCA and refers to any interference with qualities of the acoustic environment on the Land caused or likely to be caused by noise emissions resulting from B's Activities on and off the Land, and includes the types of noises described in Schedule 5 of the CCA.

B will pay the following compensation which is detailed in Schedule 1 of the CCA.

Access to the Land and carrying out the Activities

Clause 18 of the CCA provides that you consent to B and its associates to carrying out the Activities, and you must not hinder or obstruct the Activities.

Clause 19 of the CCA provides that B may carry out the activities on the Land throughout the duration of the Agreements in accordance with the terms of the CCA.

The activities B is permitted to carry out are set out in detail in Schedule 2 of the CCA and broadly relate to construction activities and petroleum production activities. This includes the activities reasonably associated with or incidental to the construction, testing, development, operation, maintenance, decommissioning and rehabilitation of up to a maximum of 8 production wells and 2 non-production wells on the land. The activities on the property will be part of an overall network of activities carried on in the district by B.

Given that the landholder will continue to live on the property during the construction period and thereafter there is significant concern in relation to the impact that noise may have on their quiet enjoyment of the property both during the construction and operational phase.

Clause 31 of the CCA provides that Noise Impacts may occur at Affected Places.

Clause 32 of the CCA provides that If the Landholder gives B notice that is has a concern about that Noise Impacts, the parties must:

a.            promptly consult about the Landholder's noise concern; and

b.            consider if it is reasonable and practicable to employ any noise mitigation.

Clause 33 of the CCA provides that. The Compensation is in full and final satisfaction of B's Liability to Affected Persons for Noise Impacts.

Clause 34 of the CCA provides that The Landholder must ensure all Affected Persons agree to be bound by the parts of this Agreement comprising an alternative arrangement for Noise Impacts under the Environmental Authority.

Clause 35 of the CCA provides that. Where the Landholder has not complied with clause 34, B may pay some of the Compensation to settle a Claim brought by an Affected Person against B for Noise Impacts (which will be set off against amounts owing to the Landholder under this Agreement).

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 1936 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 9-40

Reasons for decision

Questions 1 to 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 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.

In summary, to be able to demonstrate that a particular amount of compensation relates to permanent damage to an underlying asset it is necessary to identify a particular amount or be able to reasonably estimate an amount that has been allocated to a particular underlying asset that has been permanently damaged. It is submitted that the payments for activities under the CCA are clearly identified and relate wholly to the permanent damage to the land and/or diminution in value of the land and do not represent any amount in the nature of income to the landholder. The table in Schedule 2 - Activities in the agreement has a full breakdown of the related impacts on the land.

In your circumstances, the amounts received from activities covered by the CCA do not have the character of ordinary income in the hands of the landholder and are more correctly classified as capital receipts. In accordance with the look through approach in Taxation Ruling TR 95/35 it is evident that the most relevant asset to which the compensation relates in this instance is the underlying asset that is, the land. It is the land which suffers permanent damage or has been permanently reduced in value as a result of the activities undertaken. In accordance with subsection 110-40(3) of the ITAA 1997 as supported by Taxation Ruling TR 95/35, the compensation payments made in relation to such activities are not assessable capital gains but reduce the cost base of the underlying land.

In this respect compensation received by the landholder 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 compensation received should be applied to reduce the cost base of Lot 2 (the property acquired after 20 September 1985) and improvements on the property. The amounts should not be included in the assessable income of the landholder.

Question 4

Summary

You are not making a taxable supply by entering into the CCA. GST is not payable on the compensation amounts received under the CCA.

Detailed reasoning

Section 9-40 provides GST is payable on taxable supplies. 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)

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.

To determine whether you are making any supplies when entering into the CCA within the meaning of the GST Act we need to examine whether any activities of yours or obligations you enter into can be characterised as a supply.

Subsection 9-10(1) provides that a supply is any form of supply whatsoever. In particular paragraph 9-10(2)(g) of the GST Act provides that a supply includes:

an entry into, or a release from, an obligation:

              i.                to do anything; or

             ii.                to refrain from an act; or

           iii.                to tolerate an act or situation.

Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9) examines the meaning of supply under section 9-10.

Paragraph 22 of GSTR 2006/9 outlines the ten propositions which may be relevant to characterising and analysing supplies. The relevant propositions include:

•                     Proposition 5: To 'make a supply' an entity must do something

•                     Proposition 6: ''Supply' usually, but not necessarily, requires something to be passed from one entity to another'.

Proposition 5 provides that an entity will make a supply whenever that entity (the supplier) provides something of value to another entity (the recipient). This is consistent with the ordinary meaning of 'supply', being to furnish or provide.

When analysing an arrangement to determine the GST consequences, it is necessary to examine the terms of the transaction documents between the parties and the facts and circumstances in which the arrangement is carried out to identify what is being supplied.

In your case, the CCA are conduct and compensation agreements under the MERCP Act. These are designed principally to facilitate the agreement of compensation payable to landowners for authorised activities done pursuant to a resource authority.

While there is provision in the CCA for access to land arrangements and consent to the activities, withholding consent or agreement to land access and the activities does not prevent B from exercising and enforcing its statutory rights to conduct the activities on your property authorised under the Petroleum Authority. A conduct and compensation agreement sets the parameters for access to land and conducting authorised activities; it is not the source of the authority to access land and conduct authorised activities. That authority comes from the resource authority, issued under statute.

The provision of access to the land is not within your control and not something you are able to supply. Therefore, when you entered into the CCA you did not supply anything to B, nor did you enter into an obligation to tolerate an act or situation that was not already authorised by statute. Rather, you agreed to the compensation that is to be paid for the damage that will be done to your property and interference to your quiet enjoyment and use of those properties by the authorised activities.

Paragraph 84 of GSTR 2006/9 provides a useful analogy to your circumstances with respect to compensation received from a compulsory acquisition of land:

84. Mere acceptance by an owner of an amount of compensation payable on the compulsory acquisition does not provide a sufficient nexus between the land which passes and the means by which it passes. The fact that the owner does not dispute the acquisition is not an activity that effects the supply of the land. Even if the owner agrees to the terms of the acquisition and the amount of compensation, the land is acquired by operation of the statute, upon publication of the acquisition notice, not by an action taken by the landowner.

Paragraph 71 to 73 of Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements discusses where the subject of a claim 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 your case, for the reasons described above, the CCA only amount to you agreeing to the amount of compensation payable to you for B exercising its statutory rights to conduct the authorised activities under the Petroleum Authority. Your agreement to the compensation and consent to the arrangements for conducting the authorised activities and land access does not alter the fact that the right to undertake the authorised activities on your property comes from the Petroleum Authority, not the CCA. Mere agreement to receive compensation is not a supply within the meaning of section 9-10.

As the compensation payments are not consideration for a supply, you are not making a taxable supply under section 9-5.

Therefore, the receipt of the compensation amounts from B will not give rise to a GST liability pursuant to section 9-40.