Private ruling: Compensation payments
Published: March 2014
Ruling period: Year ended 30 June 2012 Year ended 30 June 2013 Year ending 30 June 2014 Year ending 30 June 2015 Year ending 30 June 2016 Year ending 30 June 2017 Year ending 30 June 2018
Date scheme commenced: 1 July 2011

Ruling: Q1: Will the compensation payments received under the terms of the conduct and compensation agreements (CCAs) be assessable as ordinary income? | A1: No. | Q2: Will the compensation payments received under the terms of the CCAs be assessable under the capital gains tax (CGT) provisions as capital payments? | A2: No. | Q3: Will the compensation payments received under the terms of the CCAs be treated as a reduction to the cost base of the relevant properties? | A3: Yes.

Relevant facts and circumstances: The landholders individually and jointly own various properties. The properties are post 1985 CGT assets. The landholders lease the land to Entity X which carries on primary production activities on the land. The landholders have individually and jointly entered into a number of CCAs with Entity Y for the purpose of compensating the landholders for the impact of authorised activities on the land owned by the landholders. Upfront and annual compensation payments are provided for under the CCAs. Under the CCAs terms of agreement: · the agreements commence on the agreement date and will continue until the authorised activities have ceased and the land has been rehabilitated in accordance with the relevant legislation · the agreements constitute a 'compensation agreement' in respect of the authorised activities for the purpose of the relevant legislation · the upfront compensation payment compensates the landholder for the first 12 months after commencement of the authorised activities on the land and the annual compensation will compensate the landholder for the remainder of the term · the compensation is in full and final satisfaction of all current and future liability of the authority holder to compensate the landholder for: o the compensatable effects of the authorised activities; and o any consequential damages the landholder incurs due to the compensatable effects of the authorised activities · compensatable effects is defined as having the meaning provided in the relevant legislation and includes: o deprivation of possession of the surface of the land o diminution in the value of the land o diminution of the use made, or that may be made, of the land or any improvement on it o severance of any part of the land from other parts of the land or from other land that the landholder owns o any cost or loss arising from the carrying out of the authorised activities under the relevant authority on the land o accounting, legal or valuation costs, and o consequential damages the landholder incurs because of a matter mentioned above. The landholders will continue to receive annual compensation payments for the term of the CCAs, that is, whilst Entity Y carries out authorised activities on their properties.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 Income Tax Assessment Act 1997 Section 6-10 Income Tax Assessment Act 1997 Part 3-1 Income Tax Assessment Act 1997 Subsection 110-55(6)

Reasons for decision: Summary: Compensation payments for damage and loss of assets, for example, deprivation of possession of a property's surface and diminution of its value, are not assessable as ordinary income. Where a compensation payment directly relates to diminution of the underlying asset's value, the payment is treated as a reduction of the assets cost base and any statutory income arising from a CGT event will generally be deferred until the disposal of the asset. | Detailed Reasoning - Detailed reasoning: The relevant legislation sets out the general compensation provisions under each act. The holder of each authority is liable to compensate each owner or occupier of private land or public land, known as the 'eligible claimant'. The eligible claimant owns private or public land included in the tenement's area. The Acts make each authority holder compensate for any compensatable effect the eligible claimant suffers as a result of the relevant authorised activities. 'Compensatable effect' is defined in the Acts to mean all or any of the following: (a) all or any of the following relating to the eligible claimant's land - (i) deprivation of possession of its surface; (ii) diminution of its 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 petroleum authority on the land; (b) accounting, legal or valuation costs the claimant necessarily and reasonably incurs to negotiate or prepare a conduct and compensation agreement, other than the costs of a person facilitating an ADR [alternative dispute resolution process]; Examples of negotiation - an ADR or conference (c) consequential damages the eligible claimant incurs because of a matter mentioned in paragraph (a) or (b). As such, the types of compensatable events are not exhaustive and this list is a reflection of the nature of event that compensation is generally warranted. The eligible claimant and the authority holder may enter into CCA about the holder's compensation liability to the claimant or any future compensation that the holder may have to the claimant that relates to all or part of liability or future liability. The CCA must be in writing and signed by, or for, the authority holder and the eligible claimant and state whether it is for all or part of the liability. Where the CCA is for only part of the liability the CCA must state the details of each activity or effect of the activity and the period for which the CCA has effect. It follows that where a landowner is an eligible claimant under either of the Acts this gives rise to a right to compensation. | Detailed Reasoning - Payments as ordinary income: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that, if a taxpayer is an Australian resident, their assessable income includes ordinary income they derive directly or indirectly from all sources, whether in or out of Australia, during the income year. Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business. Taxation Ruling TR 95/35 considers the tax treatment of compensation receipts. 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 (paragraph 3). Upfront compensation paid due to loss and damage of a capital asset, or forgoing a right to sue, in the process of an authority holder entering and accessing resources can be viewed as an isolated transaction. A profit from an isolated transaction is assessable under section 6-5 of the ITAA 1997 when both of the following elements are present: (a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income, and (b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character ( Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355, 82 ATC 4031, 12 ATR 692). Whether a particular transaction has a business or commercial character depends on the circumstances of the transaction. Neither elements (a) or (b), as noted above, apply in the circumstances of receiving compensation where an authority holder exercises its' powers to access and use a claimant's land for authorised activities under the Acts. Therefore the compensation would not be profit from an isolated transaction and included in ordinary income on this basis. The compensation payments the landholders receive are made in accordance with the legislative criteria outlined in the relevant Acts. Some CCAs state that payments are to be received over a number of years due to ongoing monitoring and other activities. The fact that ongoing payments are received does not disturb the nature of the compensation payment in the hands of the claimant. Accordingly, the compensation payments 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 - Payments as statutory income: 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 landholders have received, and will continue to receive, compensation payments as a result of authorised activities being carried out on their properties. These activities have resulted in the permanent damage to, or permanent reduction in the value of, the affected properties. As the landholders did not dispose of all or part of each affected property there are no CGT consequences at the time of entering the CCAs or receiving the compensation payments. However, the individual properties acquisition cost will be reduced by the compensation payments received in relation to that property. That is, the cost base of the property will be reduced by the value of the payments and any gain or loss will crystallise at a later time when each property is sold.