Private ruling: Mining compensation payments
Date of advice: 7 February 2019
Published: May 2019
Ruling period: For the year ended 30 June 2018 | For the year ended 30 June 2019 | For the year ended 30 June 2020 | For the year ended 30 June 2021 | For the year ended 30 June 2022 | For the year ended 30 June 2023 | For the year ended 30 June 2024 | For the year ended 30 June 2025
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the one off agreement completion payment received be characterised as compensation under the conduct and compensation agreement? | A1: Yes | Q2: Will the compensation received under the conduct and compensation agreement for permanent damage to the land be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No | Q3: Will the compensation received under the conduct and compensation agreement for permanent damage to the land be treated as capital proceeds from any capital gains tax event under Part 3-1 of the ITAA 1997? | A3: No | Q4: Will the compensation received under the conduct and compensation agreement for permanent damage to the land reduce the cost base of the relevant property for any future capital gain under section 110-40 or section 110-45 of the ITAA 1997? | A4: Yes | Q5: Will the payments for the water taken from your land form part of your assessable income under section 15-20 the ITAA 1997? | A5: Yes Issue 2: Goods and Services Tax (GST) | Q6: Will you incur a GST liability on the receipt of compensation received under the conduct and compensation agreement? | A6: No | Q7: Will the supply of water give rise to a GST liability? | A7: No

Relevant facts and circumstances: You are an Australian resident for taxation purposes. You have an ABN however you are not registered for GST. You and another landholder are the legal land owners of property (the Land). You acquired the Land after 20 September 1985. Company A is an entity holding a license to enter the Land for exploration purposes. You signed a Conduct and Compensation Agreement (“CCA”) with Company A for the purpose of compensating the landholders for the construction and impact of coal seam gas (“CSG”) activities on the Land. The compensation amounts to be paid are set out in the CCA. These compensation amounts relate to the impacts of Company A constructing infrastructure, testing, operating, maintenance, noise, decommissioning and rehabilitation on the Land. You are concerned by the potential biosecurity risk associated with weeds and the ongoing noise impacts from the activities being carried out on the Land There is a water resource on the property and Company A has advised that they will use the water from the Land. The CCA provides that the landholders will be paid for each litre of water taken.

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 15-20 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 104-40 | Income Tax Assessment Act 1997 section 110-40 | Income Tax Assessment Act 1997 Subsection 110-45 | Income Tax Assessment Act 1997 Subsection 116-20 | A New Tax System (Goods and Services Tax) Act 1999 s ection 9-5 | A New Tax System (Goods and Services Tax) Act 1999 s ection 9-10 | A New Tax System (Goods and Services Tax) Act 1999 s ection 38-285

Reasons for decision: Detailed Reasoning - Question 1 and 2: Summary : The compensation payments received by you are not ordinary income for the purpose of section 6-5 of the ITAA 1997. Detailed reasoning : Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes income according to ordinary concepts, which is called ordinary income. There is no definition of 'ordinary income' in the tax law. In order to determine whether the compensation payments constitute ordinary income it is necessary to consider how the courts have determined when a receipt is ordinary income. In G.P. International Pipecoaters Pty. Ltd. v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 ( GP International ) the High Court stated that: ‘To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.’ Therefore, when elements of periodicity, regularity and recurrence in a receipt are present, question arises as to whether the payments are instalments of a capital amount or are in the nature of income. The scope of the transaction in respect of which the receipt is received and the recipient's purpose in engaging in that transaction will also be relevant in determining the character of the receipt. The character of the receipt also is assessed by reference to its character in the hands of the recipient. It is in this context that the character of the payments is determined ( GP International ). For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142). Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts (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. In broad terms, compensation receipts take the character of the item they replace. Accordingly, a payment which is compensation for an item that would have been assessable income is itself assessable income. Whether a one off payment constitutes ordinary assessable income according to ordinary concepts depends on the circumstances of the case. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) states at paragraph 6 that 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 transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. The above do not apply to any amounts received by you as a landholder from Company A as there is no profit making intention. The payments are to compensate you for damages caused by the activities and are made in accordance with the Common Provisions Act. 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. | Detailed Reasoning - Question 3: Summary : The compensation amounts received by you will not constitute capital proceeds in respect of a CGT event happening. Detailed reasoning : Under subsection 116-20(1) of the ITAA 1997, money you have received (or are entitled to receive) and the market value of any property you have received (or are entitled to receive) are the capital proceeds from a CGT event. For the compensation payments under the Agreement to constitute capital proceeds, there must be a CGT event. CGT events occur in respect of CGT assets. The definition of a CGT asset is contained in subsection 108-5(1) of the ITAA 1997. It provides that a CGT asset is any kind of property or a legal or equitable right that is not property. Not all things often referred to as ‘rights’ will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law. TR 95/35 provides the Commissioner’s view on the CGT consequences for the recipient of compensation receipts and relevantly, it states that a CGT event will occur (and any consideration form part of capital proceeds) where the amount of compensation is received by the taxpayer: ● either wholly or partly in respect of the disposal of an underlying asset (paragraph 4); or ● not in respect of any underlying asset but in relation to the disposal of the right to seek compensation (paragraph 11). The above relate to CGT event A1 (section 104-10 of the ITAA 1997) and CGT event C2 (section 104-25 of the ITAA 1997) respectively. The underlying asset is identified using the ‘look-through approach’ in order to determine the asset to which the compensation amount most directly relates. Paragraph 70 of TR 95/35 states that the underlying asset is identified by looking through to the transaction which generates the compensation receipt. Applying the look-through approach to the facts of this case, the Land is the asset to which the compensation under the Agreement most directly relates. The Land is therefore, the underlying asset and the relevant CGT asset for the purposes of this ruling. As there has been no disposal of the Land, CGT event A1 does not occur. Further, as the amount is paid in respect of an underlying asset (being the Land), CGT event C2 will not occur. In this case compensation payments will be made as a result of petroleum activities being carried out on your land. These activities will result in the permanent damage to, or permanent reduction in the value of, the land. As you do not intend to dispose of all or part of the affected land, there are no CGT consequences at the time of entering the CCA or receiving the compensation payments. The compensation amounts received by you under the Agreement will not constitute capital proceeds in respect of a CGT event happening. | Detailed Reasoning - Question 4: Summary : The compensation amounts reduce the cost base of the Land under subsection 110-45(3) of the ITAA 1997. Detailed reasoning : Paragraphs 6 and 7 of TR 95/35 provide that compensation received wholly in respect of permanent damage or reduction in value of a post-CGT underlying asset that is not disposed of represents a reduction in either the CGT cost base under either subsection 110-40(3) of the ITAA 1997 (for assets acquired before 7.30pm on 13 May 1997) or subsection 110-45(3) of the ITAA 1997 (for assets acquired after 7.30pm on 13 May 1997). As the Land was acquired by you in 20XX, subsection 110-45(3) of the ITAA 1997 is relevant. For the purposes of TR 95/35, permanent damage or reduction in value does not mean everlasting damage or reduced value, but refers to damage or reduction in value that has permanent effect unless the taxpayer takes action to put it right. The activities permitted under the Agreement will cause such damage and reduction in value. The compensation amounts in the Agreement are paid to the landholders in respect of permanent damage and reduction in value of the Land and therefore, reduce the cost base of the Land under subsection 110-45(3) of the ITAA 1997. | Detailed Reasoning - Question 5: Summary : It is considered that any proceeds you receive from the sale of the water is a royalty and assessable under section 15-20 of the ITAA 1997. Detailed reasoning : Section 15-20 of the ITAA 1997 states your assessable income includes an amount that you receive as or by way of royalty if the amount is not assessable as ordinary income under section 6-5 of the ITAA 1997. Royalties are statutory income. The Commissioner’s view on the definition of a royalty is provided by Taxation Ruling IT 2660. The ordinary meaning of the term ‘royalty’ has been considered by the Courts on many occasions. In Stanton v. FC of T (1955) CLR 630, the High Court of Australia described the essence of a royalty and stated that: … the modern applications of the term seem to fall under two heads, namely the payments which the grantees of monopolies such as patents and copyrights receive under licences and payments which the owner of the soil obtains in respect of the taking of some special thing forming part of it or attached to it which he suffers to be taken. Paragraph 10 of IT 2660 provides that in the Commissioner’s view there are four key characteristics of a common law royalty: ● 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 (McCauley v. FC of T (1944) 69 CLR 235) ● the payment is made to the person who owns the right to confer that beneficial privilege or right ( Barrett v. FC of T (1968) 11 CLR 666) ● the consideration payable is determined on the basis of the amount of use made of the right required ( McCauley, Stanton) , and ● the consideration will usually be paid as and when the right acquired is exercised. 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 ( IR Commissioners v. Longmans Green & Co Ltd (1932) 17 TC 272). In your case you have agreed to receive payments for the volume of water extracted from the land and sold to Company A. Water is a natural resource. It is considered that the payment for each mega litre of water extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997. | Detailed Reasoning - Question 6 and 7: Summary : The landholders do not make a taxable supply of rights when entering into the agreement to receive compensation payments. GST will not be payable on the sale of water. Detailed reasoning : Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that: You make a taxable supply if: (a) you make the supply for consideration; and (b) the supply is made in the course or furtherance of an enterprise that you carry on; and (c) the supply is connected with the indirect tax zone, and (d) you are registered, or required to be registered. However, the supply is not a taxable supply to the extent that it is GST-free or input taxed. ‘Supply’ is broadly defined in section 9-10(2) of the GST Act to include ‘a creation, grant, transfer, assignment or surrender of any right’ or ‘an entry into, or release from an obligation’ ‘to refrain from an act’ or ‘to tolerate an act or situation’. Goods and Services Tax Ruling GSTR 2001/4 Goods and services tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4), sets out the Commissioner’s views relating to GST consequences of court orders and out-of-court settlements. In relation to the meaning of supply, paragraphs 22 and 25 of GSTR 2001/4 state: 22. Essentially, a supply is something which passes from one entity to another. The supply may be one of particular goods, services or something else. 25. Subsection 9-10(2) refers to two aspects of a supply; the thing which passes, such as goods, services, a right or obligation; and the means by which it passes, such as its provision, creation, grant, assignment, surrender or release. Goods and Services Tax Ruling GSTR 2006/9 Goods and services tax: supplies (GSTR 2006/9), examines the meaning of ‘supply’ in the GST Act. Paragraph 71 of GSTR 2006/9 explains that ‘an entity will make a supply whenever that entity (the supplier) provides something of value to another entity (the recipient)’. ‘This is consistent with the ordinary meaning of ‘supply’ being to furnish or provide’. In this case, Company A hold a permit which allows them to enter the Land to carry out authorised activities. However, generally, resource authority holders cannot access private land to carry out certain activities unless there is an agreement in place to compensate land owners and occupiers. Pursuant to the Common Provisions Act, resource authority holders are required to compensate the landholders for any compensatable effect caused by these activities carried out on their land. The compensation amounts under the agreement, therefore, are not paid for the right to enter and carry out authorised activities on the Land by Company A. The right to access the Land and carry out authorised activities has already been granted under the Petroleum Lease. The landholder(s) do not create, transfer or surrender any rights related to these activities on the Land to Company A. Hence, there is no supply made by the landholders to Company A instead the payments in the agreement are compensation in respect of any damage caused or likely to be caused to the Land as a consequence of authorised activities being carried out. Accordingly, the landholders do not make any supply to Company A when they entered into the agreement. As there is no supply, there is no taxable supply for the purpose of section 9-5 of the GST Act. Sale of water Subsection 9-30(1) provides that a supply is GST-free if: a) it is GST-free under Division 38 or under a provision of another Act, or b) it is a supply of a right to receive a supply that would be GST-free under paragraph (a). A supply of water in section 38-285 of the GST Act refers to the delivery or the making available of water, as goods. A supply of water is GST-free under subsection 38-285(1) of the GST Act. However a supply of water is not GST-free under subsection 38-285(2) of the GST Act where it is ‘supplied in a container’, or ‘transferred into a container, that has a capacity of less than 100 litres’. Goods and Services Tax Ruling GSTR 2000/25 Goods and service tax: GST-free supplies of water, sewerage and sewerage-like services, storm water draining services and emptying of a septic tank explains the Commissioner's view of what activities are covered by Subdivision 38-I of the GST Act. Paragraphs 25 and 26 of GSTR 2000/25 deal with the application of paragraph 9-30(1)(b) of the GST Act to the supply of water rights, and discuss trading ‘water rights that may be exercised for a specified period or for a specified quantity of water’. The water right is for a tangible and quantifiable amount of water. These rights are GST-free Your agreement is a right to supply water for a specified period. As the supply of the water is GST-free under section 38-2 of the GST Act, the supply of a right to supply water for a specified period is GST-free. Accordingly, the supply of water is GST-free under paragraph 9-30(1)(b) of the GST Act. The consideration for this supply will not be subject to GST.