Private ruling: compensation payments
Published: December 2011
Ruling period: 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
Date scheme commenced: 1 July 2008

Ruling: Q1: Are the compensation payments assessable as ordinary income? | A1: Yes.

Relevant facts and circumstances: The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: § the application for private ruling, including § mining lease, and § licence agreement. You have been a farmer on land for many years. You are the owner of various parcels of agricultural land. You acquired the land before 1985. The District Council opened quarries for Council purposes to provide access to materials for construction of local roads. Subsequently the Council allowed private contractors to take material from quarries without the need for a mining lease. In 1985 you were informed that this practice was to cease. The Department of Mines instigated a 'mining lease' structure in relation to material to be quarried. A Mines Department inspector advised, urged and preferred you to apply for the mining lease. You followed this advice and applied for and were granted a mining lease over a portion of the land by the Minister of Mines and Energy, initially for a term of X years. This lease has been renewed from time to time. The latest renewal was approved for a term of X years. Several years ago you were issued with a 21 day notice of entry by a mining entity which was looking to establish a mining lease over a further portion of the land. You did not want any further mining on your land. You contacted the mining inspector and you were advised that the notice of entry gave you time to establish a mineral claim over the area that would most likely be required. The mineral claim became a Mining Lease. This mining lease, was granted over the further portion of the land adjacent to land in the original mining lease. You obtained this mining lease in order to prevent the mining entity from having any mining rights, thereby preventing another mine being established on the land. You did not obtain this new mining lease for a business purpose nor for profitable purposes. No mining has ever occurred on this new mining lease. This lease has been renewed from time to time and was recently renewed for a term of X years. The original mining lease land has never been used for farming. You are ultimately responsible for rehabilitation of the land under the mining lease to the satisfaction of an Inspector of Mines. You have entered into a licence agreement with various entities from time to time to allow the licensee mining entity to undertake mining activities on the land under the mining lease. The agreement has not substantively changed over the years and in substance provides: § full licence and authority to the mining entity to search, extract, screen, wash and remove minerals from the land under the mining lease, § the right to compensation from the mining entity, and § covenants by the mining entity to progressively rehabilitate the area of the land which has been mined. At the time of the agreement was entered into, in agreeing on the compensation amount, the amount of possible loss or damage could not be calculated with any degree of accuracy and the amounts agreed to be paid represented a genuine pre-estimate. The compensation amount took into account the fact that you were required to pay royalties to the Crown and the relevant damage caused to the land. The royalties applied to every tonne of materials removed from the land. The compensation payments are made monthly predominantly for the diminution in the value of the land.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5

Reasons for decision: Summary: Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Ordinary income has generally been held to include three categories, namely, income form rendering 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, § are relied upon, and § have an element of periodicity, recurrence or regularity. It was noted in FC of T v McNeil (2007 ATC 4223) at page 4228, that … as a general proposition, a gain derived from property has the character of income and this includes a gain to an owner who has waited passively for that return from property. Income Tax Ruling IT 2660 discusses the definition of royalties. Paragraph 10 of IT 2660 outlines the key characteristics of a common law royalty, that is, a royalty within the ordinary meaning of the term. A common law royalty will normally have all of the following features: (a) It is a payment made in return for the right to exercise a beneficial privilege or right (for example, to remove minerals or natural resources such as timber, to use a copyright, or to produce a play) - McCauley v. F.C. of T. (1944) 69 CLR 235; 7 ATD 427; F.C. of T. v. Sherritt Gordon Mines Ltd (1977) 137 CLR 612; 77 ATC 4365; 7 ATR 726. Amongst other things, copyright can cover music, literary and artistic works, various forms of mechanical, electronic and biological knowledge, equipment and processes. Where, for example, the copyright is licensed to someone to manufacture and sell records, compact discs, books, prints of art works, motor vehicle engines, packaged computer software etc., for an amount based on the number of units produced or sold, the amount paid would be a royalty. (b) The payment is made to the person who owns the right to confer that beneficial privilege or right - Barrett v. F.C. of T. (1968) 118 CLR 666; Sherritt Gordon Mines Ltd; Case H9 76 ATC 39; 20 CTBR(NS) Case 64. However, the payment would still be a royalty if paid to another person or otherwise applied or dealt with at the direction of the owner. Moreover, payments for the use of the right that are made to a person who has been licensed or sub-licensed to deal with the right will also be regarded as royalty payments. (c) The consideration payable is determined on the basis of the amount of use made of the right acquired - McCauley; Stanton; Sherritt Gordon Mines; Case H9. (d) The consideration payable will usually be paid as and when the right acquired is exercised - McCauley; Stanton; Case H9 . However, a lump sum payment will be a royalty where it is a pre-estimate or an after the event recognition of the amount of use made of the right acquired - I.R. Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272; Mills v. Jones (1929) 14 TC 769; Constantinesco v. R (1927) 11 TC 730. In your case it is considered that your receipts constitute income from property in the form of royalty payments. Your mining leases constitute property from which you derive common law royalty income as the owner. It is noted that payments are mandated in respect of landholders affected by mining activities on land that they own. In Nullaga Pastoral Company Pty Ltd v FC of T (78 ATC 4329; (1978) 35 FLR 8; 8 ATR 757) ( Nullaga's case ), Wickham J considered that periodic payments for compensation were of a capital nature and not assessable income. The company conducted a pastoral business and entered into the agreement with the consortium of mining companies whereby it granted to them the right to explore for bauxite on approximately 1/3 of its farmlands. The exploration rights were to subsist for five years in consideration of an annual payment of $10,000. Payments were received as compensation for damage to and interference with the company's use of the land. The agreement had very few characteristics of a lease. In Barrett v FC of T ((1968) 10 AITR 685; 118 CLR 666; (1968) 15 ATD 149; 42 ALJR 235) ( Barrett's case) , a licence to win minerals was granted to a third party and the taxpayer received amounts on account of damage, loss and diminution of value of the property. During the years ended 30 June 1954 to 1960, mining operations were carried out by Universal Milling Co. on the land each year and in each year it paid to the taxpayer by monthly instalments an amount calculated at the rate of 5c per ton for every ton of soap stone removed from the land during the year. In each year, the Commissioner had included the payments as assessable income but the High Court ruled the payments were made and received for the purpose of making good the estimated diminution in value of the land and the amount of damage to it which might result from the carrying on of mining operations and were not payment of royalties or payments received by the company as income in return for the grant of a licence to use the land for the purpose of mining. Your case can be distinguished from Barrett's case and Nullaga's case, in that you are the land owner and holder of the licence agreement. You are receiving the monthly payments as the licence holder rather than as the land owner. Your right to compensation is pursuant to section 61 of the Mining Act 1971 . Under this section, the owner of any land upon which mining operations are carried out shall be entitled to receive compensation for any economic loss, hardship and inconvenience suffered by him in consequence of mining operation. In determining the compensation payable under section 61 of the Mining Act 1971 , the following matters are considered: (a) any damage caused to the land by the person carrying out the mining operations, (b) any loss of productivity or profits as a result of the mining operations, and (c) any other relevant matters. Although the amount of compensation takes into account the damage to the land, this is not considered a determinative factor in deciding the nature of the payment. This is because the payments received represent royalties. In Cape Flattery Silica Mines Pty Ltd v FC of T 97 ATC 4552 ( Silica Mines case ), a mining company paid compensation to an Aboriginal community for the carrying out of mining operations on the community's land. Spender J held that the essential character of the compensation payments was that of a series of recurrent payments in the nature of rental, for the right of occupation by the company, a right which otherwise would be enjoyed by the Aboriginal community. The quantum of the recurrent payments was calculated by reference to the value of silica sand that was won from the mining lease. Accordingly, the payments were revenue in nature and assessable. After examining your full circumstances, it is considered that the payments you derive from the licence agreement have the characteristics of ordinary income. The payments are made as royalty payments in respect of your mining licence and are a return from property. The payments are periodical and expected. Although the payments do not relate to services performed or business income, the payments relate to your property. As such, your payments are assessable as ordinary income under section 6-5 of the ITAA 1997. As the payments are assessable as ordinary income, it is not necessary to consider the capital gains tax provisions in relation to these payments. Further, but for the operation of section 6-5 of the ITAA 1997, the payments would also be considered to be assessable under section 15-20 of the ITAA 1997.

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