Private ruling: Tax Treatment of Landholder Compensation
Published: July 2013
Ruling period: Year ended 30 June 2007 | Year ended 30 June 2008 | Year ended 30 June 2009 | Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2006

Ruling: Q1: Are the payments received under the compensation arrangements with the companies assessable as ordinary income? | A1: No | Q2: Are the payments received under the compensation arrangements with the companies assessable under capital gains tax provisions as capital payments? | A2: No | Q3: Are the payments received under the compensation arrangements with the companies to be treated as an adjustment to the cost base of the underlying asset? | A3: Yes | Q4: Are the payments received under the compensation arrangements with the companies assessable as primary production income? | A4: N/A

Relevant facts and circumstances: The taxpayers own a property in an Australian state. The taxpayer entered into several landholder compensation agreements with the companies between 200X and 20XX. The initial agreement was with Company A; which was subsequently acquired by Company B. The agreements include details for payments for a number of matters including restored well sites, unrestored well sites, road access, gas plant compensation, and other gas plant services. The final agreement entered into was unsigned, and agreed to verbally between the parties being the taxpayer and Company B. The landholder compensation deeds explain that Company B must pay the compensation to the landholder in respect of operations, in accordance with the Petroleum Act 1923. As per the landholder compensation agreements, the landholder will receive compensation when the following activities occur: · Seismic surveys · Well drilling and other related activities. · Annual payments · Access to and use of land for roads · Compensation for controlling weeds · Future loss or damage of any other nature. 50% of the property was acquired before 20 September 1985 and 50% on or after 20 September 1985.

Relevant legislative provisions: Income Tax Assessment Act 1997 6-5, | Income Tax Assessment Act 1997 6-10 and | Income Tax Assessment Act 1997 15-15.

Reasons for decision: Summary: The compensation deeds entered into between two companies and the landowner were made pursuant to the Petroleum Act 1923 (QLD) which has now been repealed. The current legislation is the Petroleum and Gas (Production and safety) Act 2004. As the agreement was made under the old Act, the legislative references in the following reasons for decision are in relation to that Act, however, all the relevant provisions have been included in the current legislation in force in the Australia state today. Part 6K of the Petroleum Act 1923 (repealed) (the Act) set out the general compensation provisions. Section 79Q of the Act makes each tenure holder liable to compensate for the effect the 'eligible claimant' suffers caused by the authorised activities of a tenure holder or the carrying out of an activity by a person authorised by the holder. The eligible claimant owns private land in the area of the authority; or access land for the tenure holder. What constitutes a 'compensatable effect' was defined under subsection 79Q(4) of the Act, as 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 costs or loss arising from the carrying out of activities under the authority on the land'. As such, the types of compensatable events are not exhaustive and the list is a reflection of the nature of the event that compensation is generally warranted. Under section 79R of the Act, the eligible claimant and tenure 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 subsection 79S of the 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 the Act this gives rise to a right to compensation. | Detailed Reasoning - 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 (whatever 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 holder exercises its powers accesses and uses a claimant's 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. Receipts received in this way does dot 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. | Detailed Reasoning - 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. | Detailed Reasoning - 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 or part or all of any underlying asset it is 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 (including a deemed cost base) of the underlying asset, there are no CGT consequences in respect of the excess compensation amount (paragraph 7TR 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 damager 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 partnership acquired 50% of the land prior to 20 September 1985, there will be no CGT consequences for that 50% when land is disposed. However the cost base of the other 50% of land purchased in 200X will be reduced. Furthermore, as the compensation is not assessable as income, it is not necessary to determine if the compensation should be assessed as primary or non primary production income.

Subject: Tax Treatment of Landholder Compensation: The compensation payments for damage and loss of assets; for example, deprivation of possession of its surface and diminution in its value do not give rise to income according to ordinary concepts. | 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 the statutory income arising from a CGT event will generally be deferred until the asset is disposed.