Private ruling: Compensation income
Date of advice: 8 March 2019
Published: June 2019
Ruling period: 1 July 2017 to 30 June 2027
Date scheme commenced: 1 December 2017

Ruling: Q1: Will the compensation received under the conduct and compensation agreement be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the compensation received under the conduct and compensation agreement be treated as capital proceeds from any capital gains tax event in Division 104 of the ITAA 1997? | A2: No | Q3: Will the compensation received under the conduct and compensation agreement reduce the cost base of the relevant asset in accordance with subsection 110-45(3) ITAA 1997? | A3: Yes

Relevant facts and circumstances: The Trust operates a business on a parcel of land (the land). On X January 20XX, the trust entered into a X year licence to occupy the land to run a business. During the 20XX-XX financial year the Trust entered into a conduct and compensation agreement (CCA) with XYZ. Under the CCA, XYZ and related parties will undertake petroleum activities on the land. The Trust will receive compensation for the impact of the CSG infrastructure and related activities on the land. ‘Compensatable Effects’ is defined in subclause 25.1 of the CCA as having the meaning given to that term in the Petroleum Act 1923 (Qld) and the Petroleum and Gas (Production and Safety) Act 2004 (Qld) which includes: (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; (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 incur to negotiate or prepare this agreement, other than costs of a person facilitating an alternative dispute resolution (ADR) process; and (g) consequential damages you incur because of a matter mentioned in (a) to (f). The Trust will receive the following compensation payments under the CCA: ○ Construction compensation to be paid as a once off payment within 25 days of the agreement date: - $X Alternative Arrangement (Outpost Receptor) - $X Additional Disturbance (all remaining Receptors) ○ Annual compensation to be paid with 25 days of the Annual Payment Date: - $X Alternative Arrangement (Outpost Receptor) - $X Additional Disturbance (all remaining Receptors) The compensation being paid under the CCA is primarily for excessive noise; the loss of the quiet enjoyment of the land due to the excessive and intrusive activity during the construction and gas production period; and the permanent damage to the land’s aesthetic beauty due to the placement of permanent and extensive CSG related infrastructure on the land; which cumulatively contribute to the permanent damage to the business activities of the business.

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 and | Income Tax Assessment Act 1997 Section 110-45.

Reasons for decision: Detailed Reasoning - Compensation payment as ordinary income: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Compensation paid due to loss and damage or a capital asset, or forgoing a right to sue, 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 applies in this 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. | 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 a taxpayer’s 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 and 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 post-CGT asset, or part of an underlying post-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 post-CGT underlying asset of the taxpayer or for a permanent reduction in the value of a post-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. In this case the Trust has received, and will continue to receive, compensation payments as a result of petroleum activities being carried out on the land. These activities have resulted in the permanent damage to, or permanent reduction in the value of, the land and the business. As the Trust did not dispose of all or part of the affected land and business, there are no CGT consequences at the time of entering the CCA. However, the lands acquisition cost will be reduced by the compensation payments received in relation to the land. That is, the cost base of the land will be reduced by the value of the payments and any gain or loss will crystallise at a later time when the land is sold.