Private ruling: Assessable income - compensation
Published: June 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Are the payments received under the compensation agreement (agreement) assessable as ordinary income under section 6-5 or section 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1:  | Q2: Are the payments received under the agreement assessable as statutory income under section 6-10 of the ITAA 1997? | A2:  | Q3: Are the payments received under the agreement considered a recoupment of the cost base of the asset and therefore will have no capital gains tax (CGT) implications until the subsequent disposal of the asset? | A3: 

Relevant facts and circumstances: The land is owned jointly. All trading is conducted by a separate partnership. An agreement has been entered into between the landowners and a mining company for the provision of water from the dams and a water storage facility on the land. There is a compensatable amount detailed on the contract for the disruption to normal conditions of the land and a rehabilitation plan. A separate agreement exists for the supply of water by the landholders to the mining company. The provision of water is not a supply for GST purposes as water is not 'owned' by the landholder. A one-off compensation payment has been made for both the disruption and the use of the land and water. Until the rehabilitation of the land is complete, the mining company will pay the landholders an amount per annum in full and final satisfaction of its compensation liability in relation to all compensatable effects, if any, arising from its or its associates activities on the land. The agreement in this case constitutes a conduct and compensation agreement pursuant to the Petroleum and Gas (Production and Safety) Act 2004 (PAG Act). 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 15-15 Petroleum and Gas (Production and Safety) Act 2004


Reasons for decision: Summary: Compensation payments for damage and loss of assets; for example, deprivation of possession of its surface and diminution of its value, is not assessable as ordinary income. Where the compensation payment directly relates to the damage and loss of the underlying asset, 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 asset is disposed. | Detailed Reasoning - Detailed reasoning: Part 5 of the PAG Act sets out the general compensation provisions under the act. The holder of each exploration tenement is liable to compensate each relevant owner or occupier of private or public land, known as the 'eligible claimant'. The eligible claimant owns private or public land included in the area of the petroleum authority. Part 5 of the PAG Act makes each exploration tenement holder liable to compensate for the effect the eligible claimant suffers caused by relevant authorised activities of an exploration tenement holder. 'Compensatable effect' is defined in the PAG Act to mean all or any of the following occurring to the claimants 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 improvement on it, severance of any part of the land from other parts, any cost or loss arising from the carrying out of activities under the petroleum authority on the land'. 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 exploration tenement holder may enter into an agreement (a 'compensation agreement') 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. Pursuant to the provisions of the PAG Act a compensation agreement must be in writing and signed by, or for, the holder and the eligible claimant and state whether it is for all or part of the liability. Where the agreement is for only part of the liability the agreement must state, the details of each activity, or effects of it and the period for which the agreement has effect. It follows that where a landowner is an eligible claimant under Part 5 of the PAG Act this gives rise to a right to compensation. Ordinary income section 6-5 of the ITAA 1997 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). Compensation paid due to loss and damage of a capital asset, or forgoing a right to sue, in the process of a mining authority entering and accessing minerals and resources, is an isolated transaction. Whether a profit from an isolated transaction is ordinary assessable income according to the ordinary concepts depends very much 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 the transaction was entered into, 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 Taxation Ruling TR 92/3). Neither elements (a) or (b) as noted above, apply in the circumstances of receiving compensation where a exploration tenement holder exercises it's powers to accesses and uses a claimants land for prosecting and mining under the PAG Act . The compensation payments are made in accordance with the legislative criteria outlined in the PAG Act. Standard compensation agreements state that payments may be dissected into events, for example, damages from drilling and clearing land where payments are received by the claimant over a number of years. A receipt received in this way this 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 Income Tax Assessment Act 1997 (ITAA 1997). Statutory income under section 6-10 of the ITAA 1997 Statutory income may arise from CGT events as a consequence of an eligible claimant being entitled to receive compensation, and the loss and destruction of a CGT asset. The CGT consequences of an award of damages depends on whether there is an underlying asset that damages have a direct and substantial link 'by looking through the transaction that gave rise to the compensation receipt to the most relevant asset relating to the receipt' (paragraph 76 of TR 95/35). In Carborundum Realty Pty Ltd v. RAIA Archicentre Pty Ltd and Graeme McDonald 93 ATC 4418; (1993) 25 ATR 192, Harper J suggested that the compensation receipt should be linked to the underlying asset in determining whether the plaintiff had received any capital gain. The ATO view is that where there is loss or destruction of the underlying asset that is why the compensation is received, rather than for the disposal of any rights arising from that loss or destruction. Only if the insurance or settlement proceeds do not relate to the disposal of part or all of any underlying asset is it necessary to consider the policy rights or the right to seek compensation as the relevant asset (paragraph 77 TR 95/35). The standard compensation agreements consist of an upfront payment and future ongoing payments reflective of the damages to underlying assets. Compensation payments paid to an eligible claimant under the PAG Act in the forgoing circumstances are not assessable income under section 6-5 of the ITAA 1997. Compensation received by the eligible claimant in relation to the damage and loss of value of an underlying asset will be treated as a reduction of the cost base. If the compensation amount exceeds the total acquisition costs of the property, there are no CGT consequences in respect of the excess compensation amount (paragraph 7 TR 95/35). The cost base of the land is reduced to the extent of the consideration and any gain or loss will crystallise at the later time when the land is sold.