Private ruling: Treatment of payments
Date of advice: 20 December 2017
Published: May 2018
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019 | Year ended 30 June 2020 | Year ended 30 June 2021 | Year ended 30 June 2022 | Year ended 30 June 2023
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the compensation payments received under the conduct and compensation agreement in relation to mining activities performed on your land form part of your assessable income? | A1: No. | Q2: Will the compensation payments received under the conduct and compensation agreement in relation to mining activities performed on your land reduce the cost base of the land for any future capital gain under section 110-40 or section 110-45 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: Yes. | Q3: Should the amounts received under the resumption compensation agreement that relate to the easement taken by Entity B be treated as capital proceeds for the part disposal of the relevant property? | A3: Yes. | Q4: Will the payments for the gravel extracted from your property reduce the cost base of the land for any future capital gain under section 110-40 or section 110-45 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A4: No. | Q5: Will the payments for the gravel and water taken from your land form part of your assessable income? | A5: Yes.

Relevant facts and circumstances: You and your spouse own a property (Lot X). You also previously owned a property (Lot Y). This property was sold on XX/XX/XXXX. The land is leased by a related entity which carries on a business on the land. Mining activities are being undertaken on the land. It is expected that the carrying capacity of the land will reduce due to the reduction in the actual amount of land available as a result of the placement of the mining infrastructure on the land and the impact on the productivity of all land due to the presence of all mining activities on the land. On XX/XX/XXXX you entered into a conduct and compensation agreement (CCA) under the Petroleum and Gas (Production and Safety) Act 2004 (PAGA) with Entity A for Lot X and Lot Y. The compensation amount set out in Schedule 1 to the CCA is $X per annum for Lot X and $X per annum for Lot Y, during the period from the date of the previous deferral agreement to the end of the term. The definitions to the CCA provide that the term of the agreement will cease upon the completion of the activities on the land. The activities will include exploration, development, decommissioning, monitoring, rehabilitation and other incidental activities. The CCA was entered into to compensate you for the construction of mining activities on your land. In addition to the CCA’s, you have also negotiated contracts with Entity B in relation to Entity B’s infrastructure on your land. On XX/XX/XXXX you entered into a Resumption Claim Agreement (RCA) for Lot X and Lot Y. The compensation amount received under this contract was $X for each Lot. Entity B have access to compulsory powers should they need to use them to compulsorily acquire an easement to construct pylons on the land. The actual powerline causes a permanent scar on the property but is a significant distance away from the homestead and it is not considered to have an immediate impact on the people residing on the property. However, there has been a loss of land area and some inconvenience caused by the placement of Entity B powerlines/pylons on the property. On XX/XX/XXXX you entered into a gravel take agreement with Entity A for Lot Y. The gravel take agreement provides that up to XXX,XXX tonnes of gravel may be extracted from Lot Y. A minimum amount of XX,XXX tonnes will be extracted. The price per tonne was set at $X.XX per tonne. As Lot Y has since been sold, Clause XX of the gravel take agreement provides that the landholders may assign their rights under the agreement provided that they get written consent from Entity A for such assignment (such consent not to be unreasonably withheld). Clause XX of the gravel take agreement provides that if there is a change in ownership of the land or petroleum authority that they will notify the other parties to the agreement in writing within 10 working days. Accordingly, it can be assumed that the new land owner has been assigned the rights under the agreement by you as the former owners. The gravel take agreement provides that you as the landowner must not damage or interfere with any equipment or infrastructure installed or used by Entity A. The gravel take agreement also states that you must not permit or enter into an agreement or arrangement to allow any other person to take or use gravel from the land unless you have the written consent of Entity A to do so. On XX/XX/XXXX you entered into water take agreement with Entity A for Lot Y. The amount to be paid for the water is XX cents per 100 litres and up to a maximum of XX mega-litres may be extracted from the property. The take point is a dam on Lot Y. The amount of water taken by Entity A from the dam is commensurate with available supplies which are governed by season conditions. The water sold is dependent on the available level of water in the dam. It is recognised that after the time that the water take agreement was entered into there was a change in ownership in the underlying land on XX/XX/XXXX. As Lot Y has since been sold, Clause XX of the water take agreement provides that if there is a change in ownership of the land the Entity A must be notified in writing within 10 working days and that the new owner must covenant to agree to be bound by the water take agreement. Accordingly, it can be assumed that the new land owner has been assigned the rights under the agreement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5, | Income Tax Assessment Act 1997 Section 6-10, | Income Tax Assessment Act 1997 Section 15-20, | Income Tax Assessment Act 1997 Section 110-40, and | Income Tax Assessment Act 1997 Section 110-45.

Reasons for decision: Summary: The compensation payments you 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. The payments you received from Entity B in relation to granting the easement is considered to be capital proceeds from the part disposal of the Land. If they result in a gain, it is assessable as a capital gain. Any payments you received for the extraction of water and gravel are considered to form part of your assessable income. | Detailed Reasoning - Conduct and Compensation Agreement payments: 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 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 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. 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 you will receive compensation for the compensable effects of mining activities undertaken on your land. The term ‘compensable effects’ is defined in section 532 of the petroleum legislation as meaning: ● all or any of the following relating to the eligible claimant’s land ● 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 eligible claimant owns ● any cost, damage or loss arising from the carrying out of activities under the petroleum authority on the land ● accounting, legal or valuation costs the claimant necessarily and reasonably incurs to negotiate or prepare a conduct and compensation agreement, and ● consequential damages the eligible claimant incurs because of a matter mentioned above. The mining activities have resulted in the permanent damage to, or 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 the Agreements or receiving the compensation payments. However, the land’s 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 value of the payments and any gain or loss will crystallise at a later time when each parcel of land is sold. | Detailed Reasoning - Resumption Compensation Agreement payments: Payments relating to the easements An easement is a right over someone else’s land or property. It is an asset which is created at the time it is granted. The taxation treatment of a payment for the granting of an easement depends on whether the easement has been created by compulsory acquisition or as a voluntary action. Taxation Ruling TR 97/3 at paragraph 4 states: Compensation in respect of an easement created by statute in favour of a public authority cannot be said to have been received for the grant of the easement. The Land Acquisition (Just Terms Compensation) Act 1991 (NSW) and similar Acts in other jurisdictions enable public authorities to take land or an interest in land (including an easement) for specified purposes and confer on the affected landowner a right to compensation. In these circumstances, the landowner cannot be said to have created an asset as required for subsection 160M(6) of the Act to apply. The easement is created by operation of the relevant statute and is vested in the public authority. This constitutes a compulsory acquisition of the easement. Note: subsection 160M(6) of the Income Tax Assessment Act 1936 referred to in the above paragraph has been replaced with section 104-35 of the Income Tax Assessment Act 1997 (ITAA 1997). The effect of both provisions is the same. As stated above, TR 95/35 examines the treatment of any amount received in respect of a right to seek compensation in relation to an underlying asset. Where easements are acquired under statute, the underlying asset is the landowner’s pre-existing land with its rights of ownership, including the right to exclude all others. This right to exclude all others is forfeited when the easement comes into existence. Compensation received by a landowner for the loss of part of the rights of ownership is accepted as being consideration received in respect of the part disposal of the underlying asset (the land) (paragraph 8 of TR 97/3). It is possible that a public authority that has the power to compulsorily acquire an easement by exercising a statutory power may enter into an agreement with the landowner to acquire the easement. The Commissioner’s view, in these situations, is the amount received takes on the same character as compensation for a compulsorily acquired easement. Thus, the consideration (compensation) for granting the easement is treated as being paid in respect of the part disposal of the land and not in respect of the grant of the easement (paragraphs 9 and 10 of TR 97/3). It is accepted that Entity B has the legislative power to compulsorily acquire the easement. Thus, the payment you received from Entity B is considered to be capital proceeds for the part disposal of the Land. Any gain you made from the granting of the Easements is assessable as a capital gain. | Detailed Reasoning - Payments for gravel extraction: Section 15-20 of the ITAA 1997 states your assessable income includes an amount that you receive as or by way of royalty if the amount is not assessable as ordinary income under section 6- 5 of the ITAA 1997. Royalties are statutory income. The Commissioner’s view on the definition of a royalty is provided by Taxation Ruling IT 2660. The ordinary meaning of the term ‘royalty’ has been considered by the Courts on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that: … the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken. Paragraph 10 of IT 2660 provides that in the Commissioner’s view there are four key characteristics of a common law royalty: ● it is a payment made in return for the right to exercise a beneficial privilege or right, for example to remove minerals or natural resources such as timber (McCauley v. FC of T (1944) 69 CLR 235) ● the payment is made to the person who owns the right to confer that beneficial privilege or right ( Barrett v. FC of T (1968) 11 CLR 666) ● the consideration payable is determined on the basis of the amount of use made of the right required ( McCauley, Stanton) , and ● the consideration will usually be paid as and when the right acquired is exercised. However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired ( IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272). In your case, you entered into an agreement with Entity A whereby you were to receive payments for the volume of gravel extracted from your property. Gravel is a natural resource. It is considered that the payment for each cubic metre of gravel extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997. | Detailed Reasoning - Payments for water taken: You also entered into an agreement with Entity A whereby you were to receive payments for the volume of water taken from a dam on your property. The amount of water taken is dependent on the available level of water in the dam which is governed by seasonal conditions. It is considered that any proceeds you received from the sale of the water is ordinary income. Even if the proceeds were not ordinary income, they would be assessable as a royalty given that the water is a natural resource that was removed from your land.