Private ruling: Assessable income - mining compensation - cgt - permanent damage/reduction in value
Date of advice: 20 April 2020
Published: June 2020
Ruling period: Years ending 30 June 2020 to 30 June 2029
Date scheme commenced: 1 July 2019

Ruling: Q1: Will the one off agreement completion payment of $X to be received from ABC be characterised as compensation under the conduct and compensation agreement (CCA)? | A1: Yes. | Q2: Will the compensation to be received from ABC under the CCA (agreement completion payment, pre-construction, construction and annual compensation) for permanent damage to the land be treated as assessable income under 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No. | Q3: Will the compensation to be received from ABC under the CCA (agreement completion payment, pre-construction, construction and annual compensation) for permanent damage to the land 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?? | A3: No. | Q4: Will the compensation to be received from ABC under the CCA (agreement completion payment, pre-construction, construction and annual compensation) for permanent damage to the land reduce the cost base of the relevant property for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997? | A4: Yes. | Q5: Will the proceeds received for the water taken from the land be ordinary income and assessable under section 6-5 of the ITAA 1997? | A5: Yes. | Q6: Will the landholder incur a GST liability on the receipt of compensation amounts from ABC? | A6: No.

Relevant facts and circumstances: Person A and Person B (you) (landholders) of Property A (the land) have entered into a Conduct and Compensation Agreement (CCA) with ABC for the construction of X coal seam gas (CSG) wells on your land. The property is used primarily as a primary production property. There is around X acres of land of varying quality from very good to lesser quality land. A feature of the land is the presence of a creek which supplies a lagoon close to the homestead on the property. Some of the land was originally acquired prior to 20 September 1985 by Person A and their sibling but soon thereafter Person A's sibling ceased having any involvement with the farming activity on the land. Some of the land was purchased in the early 1990s and this land is held in the joint names of Person A and Person B. The water supply for the livestock and related enterprise activities comes from ground/earth tanks/dams on the property. The water level in those water storage facilities is substantially diminished due to the ongoing drought. The CCA provides that should ABC take water from the dams that they will compensate the landholder at the rate of $X per litre. The water from the dams has been captured through overland flow and flows related to a creek. To provide water security to the land there is a water bore on the property and this can be used to supplement livestock drinking needs if the water level in the dams falls too low. The CCA provides the following: Water is available under the following arrangements: · Water required to carry out the Petroleum Activities may be sourced from the Land, subject to the availability, suitability and location of the water for its intended purposes which will be determined by us, acting reasonably. We must preference taking water from the Land, if it is in a suitable location, the quality is suitable and the water is available. We acknowledge that there is a dam in close proximity to the Activities that is a suitable location. · All water used will be compensated at a rate of $X per litre. - Water can be sourced at a location to be advised by the Landholder. · Landholder is to be contacted prior to accessing water. Water availability is dependent on weather conditions at the time. The level of proposed infrastructure on the land is set out in the CCA and the infrastructure will include 12 individual gas wells. You will be paid pre-construction compensation, construction compensation and annual compensation. Additionally, a letter of offer was provided to you on X October 20XX and that letter provided that ABC will pay an additional amount of $X being a one-off agreement completion payment if the CCA is signed on or before X December 20XX. The payments are set out as follows: Type Amount (ex GST) Payment conditions One off agreement completion payment $X Payable within 25 business days of agreement execution date, where you choose to sign the CCA by 11 December 2019 (being 40 business days from the date of this letter of offer). This permits you twice the statutory timeframe to obtain legal advice to negotiate the CCA. One off pre-construction compensation $X Payable within 25 business days of agreement execution date. One off construction compensation (Including Alternative Arrangement) $X Construction Compensation (ex GST) - one off payment, payable within 25 business days of issuing a construction notice. First full annual payment $X Payable each year after the construction period until the Petroleum Activities have ceased and the land has been rehabilitated. Payment will be made by 30 June each year. The compensation under the CCAs is paid in accordance with the Petroleum Legislation. Petroleum Legislation means the Petroleum Act 1923 (Qld) ,the Petroleum and Gas (Production and Safety) Act 2004 (Qld) ,the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) and applicable Regulations. Section 81 of the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) provides as follows in relation to the general liability to compensate and defines compensable effect as being: a) deprivation of possession of the surface of the Land; b) diminution in the value of the Land; c) diminution of the use made, or that may be made, of the Land or any improvement on it; d) severance of any part of the Land from other parts of the Land or from other land that you own; and e) any cost or loss arising from the carrying out of the Petroleum Activities under the Petroleum Authority on the Land; f) accounting, legal or valuation costs you necessarily and reasonably incur to negotiate or prepare this agreement, other than costs of a person facilitating an ADR as that term is defined under the Petroleum Legislation; and g) consequential damages you incur because of a matter mentioned in (a) to (f). It is expected that there will be a negative impact on the quiet enjoyment of the property due to the CSG construction activities and the ongoing activities to be carried out by ABC on the property. The CCA specifically acknowledges the impact of the activities on the lifestyle that may be enjoyed on the property and additional compensation of $X is paid to the landholder for such permanent negative impacts on the lifestyle associated with the property. This amount is included in the Construction compensation amount. Additionally, you are significantly concerned by the potential biosecurity risk associated with weeds. The following table provides a summary of the different categories of land that may be identified as resulting from the proposed CSG activity on the improved farmland/pasturage. Category Number Category of Land 1 No access in the short or long-term. 2 No access in the short term with limited access restored in the long term but productive capacity permanently compromised. 3 Limited access in the short and long term with no productive capacity in the short-term and long-term production permanently compromised. 4 Full access once construction is completed but long-term production is permanently compromised. Category 1 land includes land to which no access can be made in the short or long term and will include land under the access roads, vents and drains, land under a facility (including the land on which a well is placed) and other land that cannot be accessed or used as a result of the CSG activity on the land. This will represent land that the landholders are deprived of the possession of the land's surface and of course the productive capacity of that land will have been reduced to nil and accordingly the market value of this land for agricultural uses is reduced to nil. Category 2 land is land to which no access can be made in a short-term (up to five years) but for which access is expected to be restored at some time in the future or after the construction phase of the CSG activity has concluded but the productive capacity is likely to be permanently compromised due to the activities carried on in the short term. This land includes lay down yards (storage of material and equipment) and temporary work areas. If the degradation caused by the CSG activity is severe then permanent damage will have occurred to this area of land. To develop lay down yards and temporary work areas the surface of the land may be graded in a manner to assist in creating a weather proof surface suitable for vehicle use. Occasionally gravel may be used to create a more durable and weather proof surface to these areas. Crops or pasture may not grow well in the gravel if and when the land is returned to agricultural usage and if the gravel is mixed with the topsoil then the underlying soil will be permanently degraded. In other words, the presence of the lay down area or similar area such as a temporary work area is likely to cause permanent damage to the land. Category 3 lands includes land around the well pads to which limited access can be made in the medium and long term and it will be significantly impacted by the CSG activity on the land. The construction of well sites, drilling, testing, operation and ongoing access to the well sites each within a fenced area of up to two hectares, together with any other necessary petroleum engineering operations carried out within the confines of the fenced well sites, including remedial work-overs and fracture stimulation/cavitation. These activities will result in limited assess being available to this land at least in the short-term and also access to this land will be denied intermittently in the long term due to regular work-overs and fracture stimulation. While it is expected that each well site will in the long term be resized to a smaller area in the short term there is denial of access to the land can be up to two hectares for multiple well sites. Therefore, while access to the land around each well is restricted a crop cannot be grown on this land and the land's productive agricultural capacity is diminished during the period of exclusion and in the long term due to the activities that are carried on during the construction phase. Land which access and use can be made once construction is completed include the land associated with water and gas gathering system (seismic or flow lines (water and gas as well as buried power lines and other communication infrastructure) but for which the productive capacity is permanently compromised due to the soil damage during the pipe laying process and the inability to maintain soil structure on a long term basis due to the restriction on deep-ripping of soils and other soil management techniques that could otherwise be employed to aerate the soils and break up impermeable soil pans. In addition, there are likely to be restrictions on how fencing can be erected on the farmland where the gathering system is situated. The placement of posts with warning signage on the gathering system creates a permanent obstruction on the land and inhibits agricultural/pastoral use of the surface of the land. Category 4 land is described as restricted due to the fact that the landholders can undertake only a restricted number of activities on this land. This category of land may include grazing land near roadways as this land's productive capacity is also significantly compromised due to the increased compaction of soils as a result of the road construction in addition to the impact of frequent traffic causing dust and other disruption to people, crops and livestock. The presence of dust on pasture will suppress photosynthesis and crop growth and also diminish the effectiveness of herbicides that may be used to control weeds. Clause 19 of the terms and conditions to the Property A CCA provides as follows in relation to Goods and Services Tax: 19. GST 19.1 Amounts shown in this agreement do not include GST. 19.2 If a supplier is or becomes liable to pay GST in connection with a taxable supply made under this agreement, then the consideration to be provided under this agreement for that taxable supply or part thereof (unless it is expressly stated to include GST) is increased by an additional amount on account of GST equal to the consideration in respect of the taxable supply multiplied by the rate of goods and services tax. The recipient must pay the additional amount on account of GST to the supplier within 14 days of the recipient receiving a tax invoice from the supplier for that supply. 19.3 If the GST payable in relation to the supply made under or in connection with this agreement varies from the additional amount paid or payable by the recipient under clause 19.2 or as part of GST inclusive consideration, whether as a result of an adjustment event or otherwise, the supplier must provide a corresponding refund or credit to, or will be entitled to receive the amount of that variation from, the recipient. 19.4 If an adjustment event occurs in relation to a supply, the supplier must issue an adjustment note to the recipient in relation to that supply within 14 days after becoming aware of the adjustment. 19.5 Where a party reimburses the other party for an expense or other amount incurred in connection with any wholly or partly creditable acquisition or any wholly or partly creditable importation made by the other party, the amount reimbursed shall be net of any input tax credit claimable in respect of that acquisition or importation (as the case may be).

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 | 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: Summary: Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (TR 95/35) contains a broad definition of compensation receipt: A compensation receipt, or compensation, includes any amount (whether money or other property) received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not: in relation to any underlying asset; arising out of Court proceedings; or made up of dissected amounts. Notwithstanding the agreement completion payment is paid separately from the CCA and is not described by ABC as compensation, it can still meet this definition of a compensation receipt. Looked at from the totality of the relationship between the parties, the Agreement completion payment is part of the overall deal that the landowner agrees to. The Agreement completion payment along with the amounts payable under the CCA all form part of the compensation received by the landowner. The Agreement completion payment is part of what results or "moves" the landowner to agree to the CCA. There will be circumstances when an inducement payment is paid because something is provided by the recipient that is additional to agreeing to the offer of compensation. For instance, Example 21 in TR 95/35 involves a situation where an inducement payment is made to expedite the process following the conclusion of an agreement relating to the amount of compensation payable. The inducement payment is treated separately to the compensation. The compensation is treated as relating to the underlying land, while the inducement payment is treated as the right to enter on the land at an earlier time than previously agreed. This case is however distinguishable. There is only one agreement between the parties, that being the agreed compensation. The situation would be different if the compensation amount was determined and then during subsequent dealings the parties agreed to expedite the timing of the original agreement (as is the case with Example 21). Consequently the agreement completion payments will represent compensation received. | Detailed Reasoning - Questions 2, 3 & 4: The compensation payments you will receive under the conduct and compensation agreement do not form part of your assessable income. They are considered to be compensation received for the permanent reduction in value and damage relating to the land and will be treated as a reduction in the land's cost base. | Detailed Reasoning - 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 TR 92/3). Neither of the above elements apply in your situation. The compensation payments were made in accordance to the legislative provisions of the petroleum legislation. Accordingly, 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. Neither of the above elements apply in your 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. It is accepted that the compensation amounts are not income according to ordinary concepts pursuant to section 6-5 of the ITAA 1997. | Detailed Reasoning - 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 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, 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. Compensation received by a taxpayer for permanent damage or a permanent reduction in value of a pre-CGT asset has no CGT consequences for the taxpayer. The coal seam gas activities 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. The compensation in relation to the pre-CGT land has no CGT consequences for you. The post-CGT land's acquisition cost will be reduced by the compensation payments received in relation to that land. That is, the cost base of the post-CGT land will be reduced by the compensation payments and any gain or loss will crystallise at a later time when the post-CGT land is disposed of. | Detailed Reasoning - Question 5: You may receive payments for the volume of water taken from your property. The amount of water taken is dependent on the available level of water on the property which is governed by seasonal conditions. It is considered that any proceeds you receive from the sale of water is ordinary income under section 6-5 of the ITAA 1997. If the proceeds are not ordinary income, they are assessable as a royalty under section 15-20 of the ITAA 1997 as the water is a natural resource that was removed from your land. | Detailed Reasoning - Question 6: GST is payable on taxable supplies and the supplier must pay the GST payable on any taxable supplies that it makes. For the receipt of compensation amounts to give rise to a GST liability there has to be a taxable supply made. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (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. | Detailed Reasoning - Supply: 'Supply' is defined in subsection 9-10(1) of the GST Act as 'any form of supply whatsoever'. 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. | Detailed Reasoning - 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. | Detailed Reasoning - 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 the landholders have provided something to ABC in return for the compensation amounts that are paid to them. The landholders giving up their rights for further compensation upon commencing the agreement, clause 5 of the Conduct and Compensation Agreement (CCA), raises the issue of whether giving up of a landholder's rights would be a separate supply or as termed in Goods and Services Tax Ruling 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) a 'discontinuance supply'. 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. In the process of ABC carrying out its Authorised Activities on the Land, significant damage and adverse effects will impact the landholders, for which ABC must compensate the landholders under the law. Upon receipt of the compensation amounts under the CCA, the landholders accept that they give up their right to pursue further compensation in relation to the Authorised Activities. The landholders giving up their 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 the landholders. We do not consider that the giving up of the landholders' rights for further compensation is a separate supply from the landholders to the company since it is not the reason for which the compensation amount is paid to the landholders. Damages GSTR 2001/4 states the following in relation to damages, at paragraph 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. 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. The landholders received the amounts as a landholder under state mining legislation, as compensation for any economic loss, hardship and inconvenience as a result of Coal Seam Gas mining activities carried out on their Land by ABC. The payment by ABC 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 ABC Authorised Activities carried out on the Land. In applying the above principles in GSTR 2001/4 to the present circumstances, we consider that, the compensation amounts are paid to the landholders to resolve a damages claim. A claim for damages (or payment that the landholders receive as a consequence of such claim) due to activities conducted by ABC on the landholders' Land, does not constitute a supply under section 9-10 of the GST Act. The landholders do not provide ABC with any supply in return for the compensation amounts. As such, the compensation payments made by ABC is not consideration for a supply from the landholders to ABC, and accordingly no taxable supply will be made by the landholders. Therefore, the receipt of the compensation amounts by the landholders from ABC will not give rise to a GST liability. | Detailed Reasoning - Supply of water: Subsection 9-30(1) of the GST Act states that a supply is GST-free if: a) it is GST-free under Division 38 or under a provision of another Act, or b) it is a supply of a right to receive a supply that would be GST-free under paragraph (a). A supply of water in section 38-285 of the GST Act refers to the delivery or the making available of water, as goods. A supply of water is GST-free under subsection 38-285(1) of the GST Act. However a supply of water is not GST-free under subsection 38-285(2) of the GST Act where it is 'supplied in a container', or 'transferred into a container, that has a capacity of less than 100 litres'. Goods and Services Tax Ruling GSTR 2000/25 Goods and service tax: GST-free supplies of water, sewerage and sewerage-like services, storm water draining services and emptying of a septic tank (GSTR 2000/25) explains the Commissioner's view of what activities are covered by Subdivision 38-I of the GST Act. Paragraphs 25 and 26 of GSTR 2000/25 deal with the application of paragraph 9-30(1)(b) of the GST Act to the supply of water rights, and discuss trading 'water rights. Paragraph 25 provides that a supply of a right to receive a supply of water includes: · a right to receive a supply of a quantity of water; or · a right to receive a supply of water for a specified period; or · a tradeable right to receive a supply of water. As stated above the supply of water is GST-free under subsection 38-285(1) and section 9-30 of the GST Act. Accordingly, the supply of water is GST-free and the consideration for this supply will not be subject to GST.