Private ruling: Assessability of 'ex-gratia' payment
Published: June 2012
Ruling period: 1 July 2011- 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Is the 'ex-gratia' payment received by the corporation considered ordinary income and therefore assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: If the payment is not ordinary income, is the payment statutory income under section 6-10 of the ITAA 1997? | A2: Yes

Relevant facts and circumstances: The corporation holds title to the land on behalf of all the respective traditional owners of the area. The land was held by the Government by way of Deed of Grant in Trust. During the time the Government held the land it received royalties from mining operations conducted on the land. After a period of negotiations, it was determined that the land should be transferred to the corporation. The traditional owners and the community had no entitlement to receive royalties prior to the transfer of land. However, as a result of representations made by the corporation to the Government, the Government has agreed to pay an ex-gratia amount for the delays experienced in transferring the land. An ex-gratia payment was made by the Government to the corporation shortly after the transfer of land to the corporation. The ex-gratia payment had certain conditions attached to the payment which, the corporation fulfilled. An Overarching Deed, signed by the relevant parties provides the corporation's responsibility in distributing the ex-gratia payment. The Government accepted the Overarching Deed as fulfilling one of the conditions. The payment was made as a once-off lump sum. The payment was not based on royalties forgone but rather on a number of factors. The payment was not made in settlement of any legal action.

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 15-10 | Income Tax Assessment Act 1997 Section 15-20 | Income Tax Assessment Act 1997 Section 50-5 | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Section 104-25

Reasons for decision: Summary: Section 6-5 of the ITAA 1997 provides that assessable income includes income according to ordinary concepts, which is called ordinary income. The term 'ordinary income' is not defined in the ITAA 1997. Its meaning has evolved from case law, which has laid down certain established tests to determine whether receipts can be deemed as ordinary income. In Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 Windeyer J stated: Whether or not a particular receipt is income depends upon its quality in the hands of the recipient. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court stated at CLR 138, ATR 7; ATC 4420: To determine whether a recipient 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. 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. Characteristics of 'income' that have evolved from case law include receipts that: · are earned · are expected · are relied upon, and · have an element of periodicity, recurrence or regularity. The assessability of an 'ex-gratia' payment was considered in First Provincial Building Society v FC of T 95 ATC 4145 ( First Provincial ). In that case an amount was paid to the taxpayer by the Government out of the Consolidated Fund of the State, It was an ex-gratia payment that arose out of the establishment of a national regulatory scheme for building societies and the winding up of a contingency fund established under a previous scheme. The Court looked at the relationship between the payment and the business activities of the taxpayer in order to determine whether the payment was to be characterised as a profit or gain made in the course of the applicant's business as a building society. The taxpayer was eligible to receive payment because it was a continuing building society and at the time of its receipt, was engaged in the conduct of a business as a building society. The Court said that the fact that the taxpayer was a continuing building society merely explained how the taxpayer was eligible to receive the payment. It was not determinative of the character of the payment. The Court also said the payment was not compensation for or a recoupment of subscriptions which the taxpayer had made to the former contingency fund. The Court held that the payment lacked the necessary connection with the taxpayer's business. It was not a case where the payment could be said to relate to some particular trading activity as was the case in Federal Commissioner of Taxation v. Squatting Investment Co Ltd (1954) 88 CLR 413 . It was an ex-gratia payment made by the Government not being consideration for some trading activities of the applicant but made consequent upon the establishment of a national regulatory scheme for building societies and the winding up of an earlier contingency fund. The payment was not ordinary income. It was a capital payment. The Court went on to hold that the payment constituted a subsidy paid by the Crown in relation to the carrying on of the applicant business and was assessable as statutory income. In this case, there was a delay in transferring land to the corporation. This delay prevented the traditional owners and the community from receiving royalty payments. As the Government held the land it received royalties from the mining operations conducted on the land. In recognition of the traditional owners and the community being unable to access royalty payments, the Government offered the corporation an 'ex-gratia' payment. Following the transfer of the land, the Government made the payment to the corporation. The payment was made as a once-off lump sum in recognition of the traditional owners and the community being unable to access royalty payments. This amount was not calculated based on royalties forgone or in settlement of any legal action. It is considered that the payment was not earned, expected or regular or in respect of a trading receipt. Although the payment can be said to be relied upon, the Government maintains its position that the corporation was not entitled to royalty payments before the land was transferred. In summary, the payment was not solely made as compensation for lost of royalty income as the payment was not strictly calculated on the royalty payments the Government received, but rather on a number of factors. It is considered that the amount paid is most certainly made up of a number of components; royalties forgone and compensation due to the delays in transferring the land. Where a payment is made in a lump sum form and cannot be undissected between income and capital, the whole amount will be capital. This view is confirmed in ATO Interpretive Decision ATO ID 2003/707 Assessability of an undissected lump sum workers compensation payment , where an undissected lump sum was considered to be capital and not income according to ordinary concepts. In consideration of the above, the payment does not fall within the ordinary meaning of income and is not assessable income under section 6-5 ITAA 1997. | Detailed Reasoning - Statutory Income: Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income also includes statutory income amounts that are not ordinary income but are included in assessable income by another provision. The following categories of statutory income will be assessed in turn: Section 15-10 of the ITAA 1997 - Bounties and Subsidies Section 15-20 of the ITAA 1997 - Royalties Parts 3-1 and 3-3 of the ITAA 1997 - Capital gains | Detailed Reasoning - Bounties and Subsidies: The Macquarie Dictionary defines 'bounty' as 'a premium or reward, especially one offered by a government.' A 'subsidy' is defined as 'a direct pecuniary aid furnished by a government to a private industrial undertaking, a cultural organisation, or the like.' In Placer Development Ltd v. Commonwealth of Australia (1969) 121 CLR 353, Windeyer J stated, in relation to the meaning of 'subsidy' that: "It ordinarily means today not aid given to the Crown but aid provided by the Crown to foster or further some undertaking or industry." The meaning of the expression "in relation to carrying on a business" was considered in First Provincial by Hill J who noted that a bounty or subsidy received "in relation to" has a less direct relationship with the carrying on of the business than if it had been received "in carrying on a business". However, the relationship must still be a real one and a merely remote connection between the payment and the carrying on of the business is not sufficient. In First Provincial the taxpayer, a building society, received an ex-gratia payment by the Government which assisted it to meet the capital adequacy requirements without the need for capital restructure and therefore was of a capital nature. The Court held that as the payment assisted the taxpayer to continue to carry on its building society activities; it was made in relation to the carrying on of its business and was therefore assessable under section 26(g) (the former provision). In this case, the payment was made in recognition of the delay of transferring land to the corporation, this delay prevented the traditional owners and the community from receiving royalty payments. It is considered that the payment was not in relation to carrying-on a business and does not assist the corporation to carry on a business. | Detailed Reasoning - Royalties: Subsection 15-20(1) of the ITAA 1997 states: Your assessable income includes an amount you receive as or by way of royalty within the ordinary meaning of 'royalty' (disregarding the definition of royalty in subsection 995-1(1)) if the amount is not assessable income as ordinary income under section 6-5 of the ITAA 1997. Subsection 995-1 of the ITAA 1997 provides that the term 'royalty' has the meaning given by subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936). Subsection 6(1) of the ITAA 1936 defines royalty to include payments and credits for the use of, or the right to use, materials supplied by or rights held by another person, including copyright, patents, trademarks, knowledge, visual images or sounds transmitted by satellite or cable or similar technology. The definition of 'royalty' also includes a payment or credit that is consideration for an agreement not to make available to third parties the use of, or right to use, any such property or right. As stated above, the definition of royalty includes payments for the use of, or the right to use, materials supplied by another person. In this case, the amount received by the corporation does not come within the meaning of a royalty under subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Capital Gains: The relevant provisions on the ITAA 1997 that covers capital gains tax (CGT) is Parts 3-1 and 3-3. Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes the amount of any capital gains. Section 102-20 of the ITAA 1997 provides that a capital gain is made only if a CGT event happens. A CGT event is generally something that happens in relation to a 'CGT asset'. The most common CGT event occurs when a CGT asset is disposed off. Section 108-5 of the ITAA 1997 provides that a 'CGT asset' is any kind of property or a legal or equitable right that is not property. The wide definition of 'asset' in section 108-5 of the ITAA 1997 would include the 'right to seek compensation'. Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation. In this case, the payment made by the Government is not a right which was legally enforceable, as the Government maintains its position that the corporation was not entitled to royalty payments until the transfer of land occurs. Further, the payment by the Government was not in settlement of any legal action and the corporation still retains the right to seek damages from the Government. However, the corporation's entitlement to receive the ex-gratia payment is a CGT asset under subsection 108-5(1) of the ITAA 1997 being the right that was acquired by the corporation under subsection 109-5(1) of the ITAA 1997 when the payment was approved by the Government. CGT event C2 under section 104-25 of the ITAA 1997 happens when the entitlement to receive the payment is satisfied. For CGT event C2 to happen there needs to be: · Submission of an application; · Satisfaction of eligibility criteria; and · Execution of an agreement either active (acts to be performed by the applicant) passive (things which the applicant aggress not to do). If the receipt of the payment does not depend upon the above listed criteria, CGT event C2 does not happen and the payment is a gift. In this case, the amount agreed by the Government took into account a sum requested as part of the representations made by the corporation on behalf of the traditional owners and the community (submission of an application). There were conditions associated with the payment and the conditions took a number of years to be fulfilled (satisfaction of eligibility criteria). The corporation agreed that the ex-gratia payment will be dealt with in accordance with the Overarching Deed (execution of an agreement). Accordingly, CGT event C2 under section 104-25 of the ITAA 1997 happened when the ex-gratia payment was made. The cost base and reduced cost base of the corporation's entitlement to receive the ex-gratia payment is calculated under Division 110 of the ITAA 1997 as modified by Division 112 of the ITAA 1997. It includes the money paid or required to be paid by the corporation to acquire entitlement. The cost base is reduced by any amount that is a deductible expense. If the corporation did not incur any expenditure to acquire the entitlement to receive the ex-gratia payment, there is no market value substitution rule for the first element of the cost base under subsection 112-20 of the ITAA 1997. This is because the entitlement was created in the corporation by the Government. Therefore, the corporation acquired the entitlement as a result of CGT event D1 happening, and the exclusion in subparagraph 112-20(1)(a)(i) of the ITAA 1997 applies. The second element of the cost base of the entitlement includes any costs of acquiring this entitlement (subsection 110-25(3) of the ITAA 1997). The ex-gratia payment received by the corporation is the capital proceeds from CGT event C2 (section 116-20 of the ITAA 1997) happening. The corporation will make a capital gain if the capital proceeds is more than the cost base of the entitlement to receive the payment and a capital loss if the capital proceeds is less than the reduced cost base of the entitlement. A capital gain from a CGT event C2 is not a discount capital gain because a discount is not available to companies (section 115-10 of the ITAA 1997). Therefore, the payment made to the corporation is caught under the CGT provisions (CGT event C2) and is included in its assessable income under section 102-5(1) of the ITAA 1997. Consequently, the payment is statutory income under section 6-10 of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.