Edited version of private advice

Authorisation Number: 1052056403751

Date of advice: 22 November 2022

Ruling

Subject: Conduct and compensation agreement payments

Question 1

Will the compensation amounts received under the 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 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 receipts under the CCA which are being entered into 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, does any compensation received under the CCA reduce the cost base of the property under Section 110-45(3) of the ITAA 1997?

Answer

Yes.

Question 4

To the extent that the compensation receipts under the CCA do not constitute capital proceeds under Division 116 of the ITAA 1997 and the amounts of compensation received reduce the cost base of the property under Section 110-45(3) of the ITAA 1997 to Nil, are the excess compensation receipts assessable?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

XX XX 20XX

Relevant facts and circumstances

Person A and Person B purchased the Land after 20 September 1985.

Partnership C, as the Occupier, in which Person A and Person B are the two partners with equal interest. Partnership C carry on a primary production livestock business on the land. Partnership C is registered for GST effective from 1 July 20XX.

In the relevant year, Person A and Person B as the Landholder and the Partnership C as the Occupier (collectively referred to as 'you') entered into a Petroleum Conduct and Compensation Agreement (the CCA) with the Company and other authority holders, for the damage caused by the Authority Holders' mining activities with construction of multiple coal seam gas (CSG) wells on the Land.

The CCA stipulates compensation amounts to you for the impact of all continuing activities and proposed impacts due to the Petroleum Activities. The compensation under the CCA is paid in accordance with the Petroleum Legislation. Amounts shown in this CCA do not include GST.

Conduct and Compensation Agreement:

The CCA is a conduct and compensation agreement under the petroleum legislation, the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) and, where context requires, the Petroleum and Gas (Production and Safety) Act 2004 (Qld) and the Petroleum Act 1923 (Qld) (as amended and replaced) and the applicable Regulations.

The Activities relating to the multiple coal seam gas (CSG) wells are described in the CCA.

The Authority Holders must indemnify the Landholder and keep the Landholder indemnified from any claims or liabilities outlined in the CCA.

The compensation in the CCA is to compensate you for the impact of the Activities on the land.

The Activities proposed under the CCA will not impact the continuing operation of the primary production business activities.

The CCA set out the compensation as follows:

The compensation amount to be paid are set out in the CCA, the compensation will be paid throughout the whole term of the Agreement. The CCA will only be terminated by agreement between the parties, subject to the expiration of the Term.

The CCA provides that the Landholder and the Occupier have had the opportunity to seek advice before signing the agreement and the Authority Holders will compensate the Landholder/the Occupier under the Petroleum Legislation for the Professional Costs.

The compensation amounts in the Agreement relate to the Compensatable Effects of carrying out the Activity (listed in the CCA) on the Land.

The CCA states that the Compensatable Effect means compensatable effect as defined in either or both of the Petroleum Legislation - the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) and the Environmental Protection Act 1994 (Qld). The definition of compensatable effect under subsection 81(4) of the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld)) is as below:

(a)         any of the following caused by the holder, or a person authorised by the holder, carrying out authorised activities on 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 the 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 CCA also sets out the scope of compensation and lists out the effects that the compensation does not cover.

The CCA states that the parties will enter into a separate agreement for the purchase of the gravel if the Authorised Holders intend to extract gravel from the Borrow Pit on the Land. This means the compensation amounts do not include the income from selling gravel.

An Alternative Arrangement was mentioned in the CCA regarding the noise impact, but without further information.

The CCA provides that you may seek further compensation for any loss caused by activities that are not covered by the CCA.

You stated that the Activities carried out by the Authority Holders under the CCA will not impact the continuing operation of the primary production business carried by the Occupier on the Land.

Assumption

The compensation is wholly in respect of permanent damage to the 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 Division 104

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

It is accepted that the compensation payments you will receive under the Conduct and Compensation Agreement (the CCA) are for permanent damage to the land and do not form part of your assessable income. The compensation amount will be treated as a reduction in the land's cost base. If the compensation amount exceeds the total unindexed acquisition costs (including a deemed cost base) of the land, there are no CGT consequences in respect of the excess compensation amount. Any gain or loss will crystallise at a later time when the post-CGT land is disposed of.

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 ordinary assessable income according to ordinary concepts depends 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 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 Income tax: whether profits on isolated transactions are income (TR 92/3)).

Neither of the above elements apply in your situation. You did not enter into the arrangement to make a profit. Rather, you as the Landholder and the Occupier, entered into the arrangement in order to receive compensation for damage that will be caused by the mining activities. These compensation payments are made in accordance with the legislative provisions of the petroleum legislation.

It is accepted that the compensation is wholly for the permanent damage to the Land, as your primary production business will not suffer by the activities outlined in the CCA.

Accordingly, to the extent the payments are for the reduction in value in land the compensation payments paid under 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.

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 (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. 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 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 Commissioner considers 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.

In your case, the activities relating to the multiple coal seam gas (CSG) wells conducted by the Authority Holders on your Land will result in permanent damage to, or a permanent reduction in the value of the Land.

As you did not dispose of all or part of the affected land there are no CGT consequences at the time of entering into the CCA or receiving the compensation payments. As your land is considered as post-CGT asset, its acquisition cost will be reduced by the compensation payments received in relation to that land. That is, the cost base of the Land will be reduced by the compensation payments. If the compensation amount exceeds the total unindexed acquisition costs (including a deemed cost base) of the land, there are no CGT consequences in respect of the excess compensation amount. Any gain or loss will crystallise at a later time when the Land is disposed of.