Private ruling: treatment of compensation payments
Published: September 2017
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022
Date scheme commenced: 1 July 2016

Ruling: Q1: Are the payments for compensation made in relation to the agreement assessable as income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Are the payments for compensation made in relation to the agreement assessable as capital gains under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997? | A2: No | Q3: Will payments made under the agreement reduce the cost base of the underlying asset? | A3: Yes

Relevant facts and circumstances: You are the owner of a property that is a post-CGT asset acquired after 7.30 pm on 13 May 1997. You entered into an agreement whereby a company will carry out petroleum activities on your land and you will be compensated for the effects of these activities. You will receive an upfront compensation payment and annual compensation payments thereafter. You have not disposed of the land.

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 110-45(3)

Reasons for decision: Summary: The compensation payments you have received and will continue to receive are considered to be compensation for the permanent damage to, or reduction in value of, your property. The total acquisition costs of the property are to be reduced by the value of the compensation received. | Detailed Reasoning - Detailed reasoning: Compensation payment as ordinary income Section 6-5 of the 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 Income tax: whether profits on isolated transactions are income ). Neither of the above elements apply in your situation. The compensation payments are 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 Income tax: capital gains: treatment of compensation receipts 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, pursuant to section 110-43(3) of the ITAA, 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 have received, and will continue to receive, compensation payments as a result of petroleum activities being carried out on your property. These activities have resulted in the permanent damage to, or permanent reduction in the value of, the property. As you did not dispose of all or part of the affected property there are no CGT consequences at the time of entering the CCA or receiving the compensation payments. However, the property's 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 the property is sold.