Private ruling: Compensation
Published: April 2013
Ruling period: Year ending 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are the payments received under the agreement with XYZ assessable as ordinary income? | A1: No | Q2: Are the payments received under the agreement with XYZ assessable under the capital gains tax provisions as capital payments? | A2: No | Q3: Are the payments received under the agreement with XYZ considered to be a recoupment of the cost base of the property? | A3: Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. The property was acquired prior to 19 September 1985. Due to an activity undertaken by XYZ on your property, there has been substantial permanent damage and reduction to the value of the property. You have also suffered a loss of exclusive possession and quiet enjoyment of the property including the substantial negative impacts of excessive noise, light, dust, odour, vibration, vehicular movements and loss of amenity generally. The noise and vibration can occur on a 24 hour continuous basis from noise emitting equipment used. The activities on the property are seen as ongoing. You have received payments including upfront and annual compensation payments for various specified and authorised purposes as set out in the landholder compensation agreement and conduct and compensation 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 15-15. | Petroleum and Gas (Production and Safety) Act 2004 Section 532. Reasons for decision | Summary | 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. | As the compensation payment relates to permanent damage to, or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (the cost base). | As the land was acquired prior to 20 September 1985, there will be no CGT consequences when you dispose of the land. | Detailed reasoning | Part 5 of the Petroleum and Gas (Production and Safety) Act 2004 (P & G Act) sets out the general compensation provisions. The holder of each petroleum authority 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; or access land for the petroleum authority. Subsection 532(1) of the P & G Act makes each petroleum authority liable to compensate for the effect the eligible claimant suffers caused by the authorised activities of a petroleum authority or the carrying out of an activity by a person authorised by the holder. | Compensatable effect, defined under subsection 532(4) of the P & G Act, means 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, and 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 events for which compensation is generally warranted. The eligible claimant and petroleum authority 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 the liability or future liability. | Pursuant to section 534 of the P & G 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 subsection 532(1) of the P & G 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 petroleum holder exercises it's powers to accesses and uses a claimants land for prosecting and mining under the Act. | The compensation payments are made in accordance with the legislative criteria outlined in the 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 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 pursuant to section 6-5(1) of the ITAA 1997 or to a profit arising from a profit-making undertaking or plan within the meaning of section 15-15 of the 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. | Compensation for loss and destruction of underlying assets | 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. | If the payment relates to permanent damage to, or permanent reduction in the value of, an underlying asset, the compensation is treated as a recoupment of all or part of the acquisition cost of the asset (that is, you reduce the cost base and reduced cost base by the amount of the compensation). 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, in the case of a post-CGT underlying asset, unless 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 (paragraph 7 TR 95/35). | For example, where there is an upfront lump sum payment paid by the statutory authority party to the claimant in relation to clearing land and the constructing of a dam. The consideration received is treated in respect of the underlying asset, the land. 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. | Compensation received by a taxpayer has no CGT consequences, if the underlying asset that has suffered permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985 or is any other exempt CGT asset (paragraph 9 TR 95/35). | As the land was acquired prior to 20 September 1985, there will be no CGT consequences when you dispose of the land.