Private ruling: CGT - compensation - mining
Date of advice: 3 March 2020
Published: April 2020
Ruling period: Year ending 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: Will the termination compensation payment be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the termination compensation payment be assessable as a capital gain under the capital gains tax (CGT) provisions of the ITAA 1997? | A2: Yes, however the capital gain will be reduced by the amount assessable under section 6-5 of the ITAA 1997.

Relevant facts and circumstances: You and your spouse acquired a property (the property) as joint tenants before 20 September 1985. On XX March 19XX, you and your spouse entered into a compensation agreement (the agreement) with ABC Limited (ABC) for activity on the property. Under the agreement you and your spouse were to receive payment for anything removed from the property. The agreement also provided for additional compensation to be made to you and your spouse for any land rendered useless by the activity undertaken. On XX October 19XX ABC agreed to sell and assign to D Pty Ltd (D) all its right title and interest together with the benefits of the agreement. You and your spouse entered into a Compensation Agreement Novation Deed (the Deed) releasing and discharging ABC from its obligations in the terms of the agreement subject to D undertaking to perform those obligations. The Deed took effect on XX November 19XX. After execution of the Deed, D changed its name to SO Pty Ltd (SO). You and your spouse have received royalty payments under the agreement since its commencement. You and your spouse entered into a contract for the sale of the property on XX January 20XX to SO. Also on the XX January 20XX, you and your spouse entered into the Termination Deed -Compensation Agreement (termination deed) with SO. Under the Termination Deed, SO agrees to pay you and your spouse a termination compensation amount of $X on the basis that upon payment all obligations of SO to pay amounts under the agreement will cease.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 15-20 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 104-35 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 subsection 109-5(2) | Income Tax Assessment Act 1997 section 118-20

Reasons for decision: Detailed Reasoning - Ordinary income: Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Ordinary income has been held to include income from providing personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: · are earned · are expected or relied upon · have an element of periodicity, recurrence or regularity · replace income. Section 15-20 of the ITAA 1997 provides that an amount you receive as or by way of royalty is included in your assessable income if the amount is not assessable as ordinary income under section 6-5 of the ITAA 1997. An amount paid to compensate for loss generally acquires the character of that for which it is substituted ( FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641; Case Y47 (1991) 22 ATR 3422; 91 ATC 433). Taxation Determination TD 93/58 outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. The determination states that where the compensation payment is for loss of income, the amount is assessable as ordinary income. In your case, you and your spouse have been receiving royalty payments annually under the agreement since 19XX. The royalty payments have some of the characteristics of ordinary income as the payments have been regular, expected and relied on. As such the royalty payments would be considered ordinary income under section 6-5 of the ITAA 1997. Upon receipt of the termination compensation amount, SO's obligation to make future royalty payments to you and your spouse will cease. It is therefore considered that the termination compensation payment is to compensate you for the loss of your future claim to royalty payments. As such the termination compensation payment is also considered ordinary income and will be assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital Gains Tax: Section 104-35 of the ITAA 1997 provides the circumstances in which a CGT event D1 happens. CGT event D1 happens if you create a contractual or other legal or equitable right in another entity. The time of the event is when you enter into the contract or create the other right. Section 104-25 of the ITAA 1997 provides the circumstances in which a CGT event C2 happens. CGT event C2 happens if your ownership of an intangible asset ends by the asset being satisfied. You make a capital gain as a result of a CGT event C2 happening if the capital proceeds from the ending are more than the asset's cost base. At the time the Termination Deed was entered into on XX January 20XX, you acquired a right to receive the termination compensation amount, as a result of this right, CGT event D1 happened. Your right to receive the termination compensation amount as a result of the CGT event D1 happening is your CGT asset under section 108-5 of the ITAA 1997. You are taken to have acquired this right on XX January 20XX in accordance with subsection 109-5(2) of the ITAA 1997. Upon receipt of the termination payment, CGT event C2 is taken to have happened as you have received payment in full satisfaction of your right to receive payment (CGT event D1). | Detailed Reasoning - Anti-overlap provisions - preventing double taxation: Section 118-20 of the ITAA 1997 provides that where the disposal of an asset gives rise to both ordinary income and a capital gain, the capital gain is reduced by the amount assessable as ordinary income. In your case, the capital gain made from CGT event C2 happening would be reduced by the termination payment amount assessable under section 6-5 of the ITAA 1997.