Edited version of private advice

Authorisation Number: 1052072326508

Date of advice: 19 December 2022

Ruling

Subject: Compensation payment

Question 1

Will the compensation payments outlined under the Schedule to the CCA be treated as assessable income under sections 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. However, the total acquisition costs of the Land, if the Land is a post-CGT asset, should be reduced by the amount of the compensation received for capital gains tax purposes.

This ruling applies for the following period:

Income year ending 30 June XXXX

Relevant facts and circumstances

Background

Individual A (the Taxpayer) is the owner (the Landowner) of the Land.

The trustee for the Family Trust (the Trustee) operates a primary production business on the Land (the Occupier).

Compensation agreement

The Taxpayer entered into an agreement that is a conduct and compensation agreement (CCA) with unrelated parties, (the Tenement Holders), with respect to activities conducted by the Tenement Holders on the Land.

The parties to the CCA have treated the Taxpayer as the Landowner and Occupier of the Land (collectively, the Claimants).

The CCA is a compensation agreement under the Petroleum Legislation. The term Petroleum Legislation means the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) and relevantly, where the context requires, the Petroleum and Gas (Production and Safety) Act 2004 (Qld) and the Petroleum Act 1923 (Qld) (as amended and replaced).

Under the Petroleum Legislation, entities are granted petroleum authorities that enable them to conduct authorised petroleum activities in an authorised area on private or public land.

Section 81 of the Mineral and Energy Resources (Common Provisions) Act 2014 (Common Provisions Act) defines the general liability of the resource authority holder (in this case, the Tenement Holders) to compensate each owner/occupier of private and public land that is in an authorised area for any compensatable effect the eligible claimant suffers caused by authorised activities carried out by the holder or a person authorised by the holder.

Subsection 4 of section 81 defines compensatable effect as follows:

"compensatable effect", suffered by an eligible claimant because of a resource authority holder, means-

(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 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).

Generally, before a resource authority holder can enter private land to carry out advanced activities (authorised activities other than preliminary activities), they must have a legally binding agreement with the landholder. This can be either: a conduct and compensation agreement; a deferral agreement or an opt-out agreement. Conduct and compensation agreements set out the activities or conduct proposed to be undertaken as well as the compensation arrangements for any impacts.

The Recital to the CCA sets out that the Tenement Holders will carry out activities that are authorised under the relevant petroleum authority described in the Schedule to the CCA as it relates to the Tenements.

Clause X of the CCA provides that the Landowner is to be compensated as required by the Petroleum Legislation.

Clause X provides that the CCA will continue in force until Tenement Land no longer exists.

Clause X of the CCA provides that the Tenement Holders must pay compensation to the Claimants (the Landowner and Occupier) in the amount and time set out in the Schedule to the CCA in respect of the authorised activities under each Tenement on or in respect of the Tenement Land. Clause X provides that the compensation is, amongst other things, to compensate the Landowner and Occupier for:

•                     deprivation of the possession of the surface or of any part of the surface of the Land;

•                     damage to the surface of the Land or any part thereof, and to any improvements thereon, which may arise from the carrying on of operations by the Minister or the Holders thereon or there under; and

•                     severance of the Land from other land of the Claimants; and

•                     surface rights of way; and

•                     all consequential damages;

•                     deprivation of possession of its surface;

•                     diminution of its value;

•                     diminution of the use made, or that may be made, of the land or any improvement on it;

•                     severance of any part of the land from other parts of the land or from other land that the Claimants own; and

•                     any cost or loss arising from the carrying out of activities under the tenure on the land.

The CCA sets out the authorised activities and works carried out by the Tenement Holders - the main activities are:

•                     drilling and operating wells;

•                     constructing a shed and a hardstand area at the location to store material and equipment (Storage Area);

•                     using the water bore;

•                     taking water; and

•                     taking gravel for infrastructure construction.

Pursuant to section 26 of the Water Act 2000 (QLD), all rights to the use of water in Queensland are vested in the State.

The holders of petroleum leases and authorities to prospect (petroleum authorities) obtain water rights, including the right to take underground water within the area covered by the petroleum authorities in the course of carrying out their authorised activities, under the Petroleum Legislation (section 86 of the Petroleum Act 1923 and section 185 of the Petroleum and Gas (Production and Safety) Act 2004) or otherwise under the Water Act 2000.

These activities cause damage and loss of assets.

The compensation set out in the Schedule to the CCA is as follows:

Relevantly:

•                     The ongoing taking of the water is to be paid at the rate of $X per tanker load, with monthly invoicing.

•                     Taking of gravel for infrastructure construction is to be paid at $X per meter with monthly invoicing.

Clauses X and X provide for the review and adjustment of the rates.

The CCA also indicates that compensation may include compensation for losses where a claimant's livestock is injured or killed. No compensation has been paid in relation to loss of or damage to livestock.

No lease or share farm agreements have been in place between the Taxpayer and the Trustee.

The Trustee has not owned and does not own any improvements or equipment on the property which could be permanently damaged by the authorised activities carried out on the Land.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 110-40

Income Tax Assessment Act 1997 section 110-45

Reasons for decision

Question 1

Summary

The compensation payments under the CCA do not give rise to income according to ordinary concepts pursuant to section 6-5 of the ITAA 1997.

However, the compensation relates to the permanent damage or reduction in the value of the land. Whilst there is no disposal of the Land, and therefore, the compensation under the CCA does not constitute capital proceeds in respect of a CGT event, the compensation relates to permanent damage or a reduction in value of the Land for the purposes of subsection 110-45(3) of the ITAA 1997. If the Land is a post CGT asset, the compensation payments outlined under the Schedule will reduce the cost base of the Land, for the purposes of any future capital gain, under section 110-40 or section 110-45 of the ITAA 1997. No capital gain or loss arises in respect of the Land until the Taxpayer actually disposes of the Land.

Detailed reasoning

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.

In order to determine whether the payments received under the CCA constitute ordinary income it is necessary to consider how the courts have determined when a receipt is ordinary income.

In G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 (GP International) the High Court stated that:

'...To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.'

The character of the receipt is also assessed by reference to its character in the hands of the recipient. It is in this context that the character of the payments is determined (GP International citing Scott v. F.C. of T. (1966) 117 C.L.R. 514 (Scott), per Windeyer J. at p. 526).

The motive of the payer may also be relevant to this consideration i.e. it is necessary to inquire how and why it came about that the payment was made (Scott at 527-528 citing Kitto J. in The Squatting Investment Co. Ltd. v. Federal Commissioner of Taxation [1953] HCA 13; (1953) 86 CLR 570, at pp 627, 628).

In addition to the above, two fundamental principles used to determine the appropriate taxation treatment of payments in the nature of compensation are:

a)            the general principle relating to the taxation of a compensation receipt is that the receipt takes on the character of the item it replaces: Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82; and

b)            the fundamental question is what is the 'compensation' being paid for: The Glenboig Union Fireclay Co Ltd v Inland Revenue Commissioners [1922] SC (HL) 112; (1922) 12 TC 427: FC of T v. Northumberland Development 95 ATC 4483 per Beaumont J at 4492.

Barrett v. Federal Commissioner of Taxation (1968) 118 CLR 666; (1968) 15 ATD 149; (1968) 10 AITR 685 (Barrett's Case) and Nullaga Pastoral Co Pty Ltd v. Federal Commissioner of Taxation 78 ATC 4329 (Nullaga) dealt with periodic on-going payments made to landowners in relation to mining operations where the quantum was determined with reference to the volume of minerals that were extracted. The Courts considered whether the payments were royalties, licence fees, rent or in the nature of rent or receipts of a general nature and therefore included in assessable income before holding (in both cases) that the payments were capital in nature because they were intended to make good the estimated diminution of the value of the land as a result of the mining operations.

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? (TD 93/58), states that a lump sum compensation payment is assessable 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 lump sum 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 method of calculation and payment does not alter the character of the payment.

In Van den Berghs Ltd v. Clark (Inspector of Taxes) [1935] A.C. 431 the court observed that the manner in which the quantum of the compensation amount is calculated will not alter the purpose for which the payment is made:

But even if a payment is measured by annual receipts, it is not necessarily itself an item of income. As Lord Buckmaster pointed out in the case of the Glenboig Union Fireclay Co. v. Commissioners of Inland Revenue:

"There is no relation between the measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of the test."

In Commissioner of Taxation v Sydney Refractive Surgery Centre Pty Ltd 2008 ATC 20-081, the court confirmed that the method of calculation does not determine the character of a payment, in finding that a compensation calculated solely by reference to lost profits did not render the amount ordinary income:

1. The question on appeal may be simply stated: are compensatory damages for defamation received by a corporation "income according to ordinary concepts" and assessable under s 6-5 of the Income Tax Assessment Act 1997 (Cth) ("the ITAA97") if calculated solely by reference to lost profits attributable to the defamatory publications? The learned primary judge answered that question in the negative, allowing the appeal of the respondent taxpayer, Sydney Refractive Surgery Centre Pty Ltd ("SRSC"), against the disallowance of its objection to the decision of the appellant, the Commissioner of Taxation ("the Commissioner"), that the sum of $812,726.00 received by SRSC in compensatory damages for defamation was assessable: Sydney Refractive Surgery Centre Pty Ltd v Commissioner of Taxation (2008) 247 ALR 313. We agree the answer to the question presented is no. Whether a payment of compensatory damages is assessable must be determined by looking to the nature of the cause of action in respect of which the payment is made, rather than the way in which damages are calculated. Accordingly, the appeal must be dismissed with costs.

...

16. For those reasons, we find no error in the primary judge's conclusion that the award of damages for defamation did not constitute income within the meaning of s 6-5 of the ITAA97 notwithstanding that the amount was calculated solely by reference to lost profits.

Notwithstanding that a recurrent payment is more likely to be of an income nature and a one-off payment is more likely to be capital in nature, the manner of payment will not negate the character of the payment with reference to the purpose for which the payment is made: that is, the method of payment will not overcome whether the payment relates to the profit-yielding structure or an enduring benefit - see e.g. ESSO Australia Resources Ltd (formerly ESSO Exploration and Production Australia Incorporated) v FC of T 98 ATC 4768,where the court observed:

The so called "one-off" nature of the payment did not alter the revenue character of the receipt as stamped by the circumstances described. (See GP International Pipecoaters (1990) 170 CLR 124 at 137; Allied Mills Industries Pty Ltd v Federal Commissioner of Taxation (1989) 20 FCR 288, 300-301).

Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme is ordinary assessable income according to the ordinary concepts: FC of T v. Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693.

Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions explains that 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.

Application to your circumstances

The Common Provisions Act establishes the framework for land access and compensation for conducting authorised activities under resource authorities. There is a general requirement for resource authority holders to enter into conduct and compensation agreements with the owners and occupiers of private land before certain authorised activities can be undertaken on their land.

The amounts to be paid under the CCA are to compensate the Landowner as required under section 81 of the Common Provisions Act. Clause 5 of the CCA states that the amounts compensate for the impacts of the authorised activities, including loss and deprivation of land.

In this case, the Tenement Holders hold a resource authority in respect of the Land, which confers the right to enter the Land to conduct authorised activities. It is considered the payments under the CCA are made by way of compensation for loss of land surface, deprivation of use of the land, permanent damage to the land, for disturbance and other potential adverse impacts to the property which will cause a reduction to the land value as a result of the authorised activities.

Royalties, licence fee or rent

The payments made to the Landowner under the CCA are not made in return for the right to extract resources or the right to occupy or use the Land.

The authorised activities of the Tenement Holders under the Tenements include rights to access and take water and to use the water bore located on the Land. The payment for the water bore and for the taking of water (collectively described as water payments) are part of the overall payments to compensate the Landowner for the 'compensatable effects' of the authorised activities including this authorised taking of water under the petroleum authorities. These water payments to the Landowner are not for the right to use the water bore or for the right to take the water as these rights were granted to the Tenement Holders by the State: a landholder does not own the water, have a right to sell the water or permit the taking of the water. The water payments, as with the other payments under the CCA, are compensation to the Landowner for the impact of the authorised activities on the land including disturbance and potential adverse impacts (e.g. reduction of water levels).

Generally, where an entity is not in the business of selling gravel, the sale of gravel falls within the ambit of royalties for the purposes of section 15-20 of the ITAA 1997. In this case, the Landowner is not carrying on business of selling gravel. Nor is the payment in relation to the taking of gravel a payment of royalties as contemplated. Rather, as with the payments that relate to the water bore and the taking of water, it relates to compensation for the impact of the Tenement Holders' activities under the terms of the Tenements in relation to their authorised activities. The Tenement Holders hold a resource authority in respect of the Land, which confers upon them the right to enter the property to conduct authorised activities - including the taking of gravel for construction purposes. The Landowner's participation in the process does not negate the fact that the conduct of the authorised activities is not subject to their acceptance. The payments for taking gravel, as with the other payments under the CCA, are compensation to the Landowner for the impact of the authorised activities on the land including disturbance and potential adverse impacts.

No amount received under the CCA is in the nature of royalty, licence fee or rent.

Replacement of income

It is accepted that in these circumstances that no part of the payments relates to a compensation for loss of income. In the absence of any portion being identifiable and quantifiable as being paid for a claim of an income nature, the whole of the payments is accepted to be capital.

Profit

Further, the payments are not profit from an isolated transaction as a result of entering into a profit-making undertaking or scheme. The CCA was not entered into with the purpose of making a profit or gain. The compensation is payable in accordance with the Petroleum Legislation. The Landowner receives compensation as a result of the Tenement Holders exercising their powers to access and use the Land and to carry out authorised activities.

Does the inclusion of the Occupier of the Land as a party to the agreement mean that compensation needs to be apportioned between the Landowner and the Occupier?

The CCA include both the Landowner and the Occupier as parties to the agreement. They do not, however, contain an apportionment between the Landowner and Occupier as claimants.

The parties to the CCA have treated the Taxpayer as the Landowner and Occupier, notwithstanding the Trustee carries on a primary production business on the Land. In these circumstances, it would be reasonable to accept that the Landowner is also acting on behalf of the Occupier.

In reviewing the consequences of this, it is important to consider who suffers a detriment when the listed activities in the CCA are undertaken by the Tenement Holders. We note the following:

a)            There is currently no lease or share farm agreement in place between the Landowner and the Occupier.

b)            No amount of the compensation payments relates to loss of or damage to livestock.

c)            The Trustee does not own any improvements or equipment on the property which could be permanently damaged by the authorised activities carried out on the Land.

The inclusion of the Occupier as a claimant under the CCA does not mean that compensation needs to be apportioned between the Landowner and the Occupier.

Conclusion

In this case, the Tenement Holders hold a resource authority in respect of the Land, which confers the right to enter the Land to conduct authorised activities. It is considered the payments under the CCA are made by way of compensation for loss of land surface, deprivation of use of the land, permanent damage to the land, for disturbance and other potential adverse impacts to the property which will cause a reduction to the land value as a result of the authorised activities.

The CCA reflects the Tenement Holders' obligations under the Common Provisions Act to compensate landowners/occupiers for compensatable effects as a result of the conduct of authorised activities. The payments are made with reference to that compensatory framework. The method of calculating the compensation for the impact of authorised activities under the CCA does not alter the character of the payments.

Accordingly, the compensation payments paid under the CCA do not give rise to income according to ordinary concepts under section 6-5 of the ITAA 1997.

In these circumstances, it is accepted that no amount of the compensation payments addressed in this Ruling need be apportioned, to ascribe an amount to the Occupier, even though it is a claimant under the CCA.