Edited version of private advice

Authorisation Number: 1051942659699

Date of advice: 25 January 2022

Ruling

Subject: Lump sum - compensation

Question 1

Will the upfront and annual payment compensation received under the Conduct and Compensation Agreements (CCA's), excluding reimbursed costs, be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the upfront and annual payment compensation received under the CCA's 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 upfront and annual compensation received under the CCA's reduce the cost base of the relevant property for any future capital gain under section 110-40 of the ITAA 1997?

Answer

Yes.

Question 4

Does the inclusion of the occupier of the land as a party to the agreements mean that compensation needs to be apportioned between the landholder and the occupier?

Answer

No.

Question 5

Will the landholders incur a goods and services tax (GST) liability on the receipt of compensation amounts from under the CCA's?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

XXXX, XXXX and XXXX as trustee for XXXX have entered into three separate Conduct and Compensation Agreements with XXXX.

The three separate agreements cover three separate property titles which are all owned by XXXX & XXXX XXXX in joint names.

The three properties which are subject to the conduct and compensation agreements are:

1. Property 1
2. Property 2
3. Property 3

Conduct and Compensation Agreements

The Conduct and Compensation Agreements (CCA's) set-out the compensation to include reimbursement of accounting, legal, agronomy and valuation costs as well as compensation payments dissected between upfront and annual payments and provides that the Landholders agree that by entering into the agreement the compensation obligations have been met. The details of which are as follows:

Under the CCA agreements XXXX has the ability to construct a Right of Way including 3 x pipelines, cables, vents, pits and associated work areas on each of the properties.

XXXX carries on a business on the land. The CCA will have very minimal to no impact on the business activity, where the maximum impact will be XX square metres of property compared to the total area of XXXX hectares.

Assessable 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.

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).

The compensation payments made under the CCA's are not earned as it does not relate to services performed or from carrying on a business. The compensation payments paid under the terms of the CCA's 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. These payments are not assessable income under section 6-5 of the ITAA 1997.

Capital gains event

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.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts ('TR 95/35')provides the Commissioner's view as to the CGT consequences of receiving a compensation. 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).

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'.

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 the amount represents a recoupment of all or part of the total acquisition costs of the asset.

The compensation amounts received under the terms of the CCA's, do not constitute capital proceeds in respect of a CGT event happening.

Cost base

Pursuant to subsection 110-40(3) of the ITAA 1997, 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.

Apportionment

Where a portion of a lump sum payment is identifiable and quantifiable as "loss of income", that portion of the payment will be assessable.

There is no apportionment of the compensation outlined in the CCA's which is specifically in relation to the broad acre farming operation carried on by the occupier. It is accepted the occupiers' business will not suffer any detriment that would cause it to share in the compensation under the terms of the CCA's.

Goods and Services Tax

Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 ('GST Act') provides GST is payable on taxable supplies

Section 9-5 of the 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.

The Landholders giving up their 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 the Landholders.

The Landholders 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 their land by the company.

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

In applying the principles under Goods and Services Tax Ruling 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements to the present circumstances, the compensation amounts are paid to the Landholders to resolve a potential damage claim. A claim for damages (or payment that the Landholders receive as a consequence of such claim) due to activities conducted by the company on the Landholders' land, does not constitute a supply under section 9-10 of the GST Act.

The Landholder does not provide XXXX with any supply in return for the compensation amounts. Therefore, the receipt of the compensation amounts will not give rise to a GST liability pursuant to section 9-40 of the GST Act.

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
• 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
• A New Tax System (Goods and Services Tax) Act 1999 section 9-40