Edited version of private advice

Authorisation Number: 1051944734279

Date of advice: 28 January 2022

Ruling

Subject: Assessable income - compensation - mining receipts

Question 1

Will the upfront, construction and annual compensation payments received under the Conduct and Compensation Agreement (the CCA) with QGC Upstream Holdings Pty Ltd (QGC) be treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No. Compensation payments related to permanent damage to, or permanent reduction in the value of, an underlying asset 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.

Question 2

Will the upfront, construction and annual compensation payments received under the CCA be treated as capital proceeds under Division 116 of the ITAA 1997 from any capital gains tax event in Division 104 of the ITAA 1997?

Answer

No. Compensation payments related to permanent damage to, or permanent reduction in the value of, an underlying asset you received under the terms of the CCA, do not constitute capital proceeds in respect of a CGT event happening.

Question 3

Will the upfront, construction and annual compensation payments received under the CCA reduce the cost base of the relevant property for any future capital gain under section 110-40 of the ITAA 1997?

Answer

Yes. Compensation payments related to permanent damage to, or permanent reduction in the value of, an underlying asset will reduce the cost base of the relevant property for any future capital gain in accordance with section 110-40 of the ITAA 1997.

Question 4

Will the Landholders incur a goods and services tax (GST) liability on the receipt of the upfront, construction and annual compensation payments amounts from under the CCA?

Answer

No, the Landholder will not incur a GST liability on the receipt of the upfront, construction and annual compensation payments under the agreement.

This ruling applies for the following periods:

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

year ended 30 June XXXX

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

The Trustee for the Estate ("the Landholder/s") owns land which is under XXX hectares in size.

Based on the deceased passing away in the late 19XXs, the land is a pre-CGT asset.

Person 1 and Person 2 live on the property as their principal place of residence.

The majority of the property is currently used to carry on business operations undertaken by the Estate.

The business operates using a conservative stock management system and they carry on average XX head of cattle on this property during good seasons.

The conservative stock management typically allows the estate to carry on business as usual during dry seasons and avoid excessive fodder costs.

Currently there are only approximately XX head of cattle due to the intense dry seasons over the past few years and the plan is to breed their own replacement stock rather than buying which means that building back up the stock numbers will take quite some time.

XYZ has previously negotiated CCA's with Person 1, Person 2 and Person 3 as trustees of the Estate.

The occupiers of the property are the business run by the Trust and Person 1 & Person 2 who reside on the property.

The compensation in the CCA is to compensate the landholder for the impact of the mining activity on the land. The compensation is being paid in accordance with the Petroleum and Gas (Production and Safety) Act 2004.

The activities outlined in the agreement include drilling numerous exploration wells and associated access tracks, laydown and storage areas, and all other associated infrastructure on Lot X on the property.

It is understood that the mining activities proposed under the CCA will not impact on the business operations.

XYZ and others hold petroleum authorities (Petroleum Leases 505, 507 and PL 498) which cover parts of the land.

The petroleum authorities are governed by the Mineral and Energy Resources (Common Provisions) Act 2014 (Qld) (the Petroleum Legislation').

The Petroleum Legislation gives rise to the landholder's entitlement to compensation for "Compensatable Effects" caused by holders of Petroleum Authorities carrying out certain authorised activities on their land (section 81) and provides for the entry into Conduct and Compensation Agreements with respect to such compensation (section 83).

The Landholder entered into a CCA with XYZ in the 20XX income year. The CCA:

• allows XYZ to enter the land and carry out the activities during the Term; and
• requires XYZ to pay you the compensation in accordance with the terms of the CCA.

The CCA provides for the following types of compensation payments to be paid by XYZ:

• Upfront Compensation Payment for the Activities as defined in the CCA.
• Professional costs necessarily and reasonably incurred in the negotiation and preparation of the CCA.
• Construction Compensation Payment for the activities as described in Section 3 of the Reference Schedule.
• Annual Compensation Payment for the Activities as defined in the CCA.

The Activities as outlined in the CCA are as follows:

• Construction of twenty-two well pads, the drilling, (including, if necessary, redrilling and renaming) completion, production testing, operation, stimulation and maintenance of twenty-four (24) coal seam methane production wells, which includes the conversion of a couple of two existing wells from exploration and production testing wells to production wells; and
• Operation and maintenance of one (1) existing exploration and production testing well.
• (together the Well/s).
• Construction, operation and maintenance of above and below ground gathering systems, or other infrastructure (such as high point vents, low point drains and isolation valves) including pipelines, for the transport of gas, its by-products and water (including existing above and below ground gathering systems) (Gathering) including any ancillary equipment, cables (including telecommunications and fibre optic cables), conduits, connections, fittings, signs, communications equipment, and other ancillary equipment required for the construction, operation or maintenance of the Gathering.
• Laying down or storing pipe, other infrastructure, equipment (or parts thereof) or earthworks pending construction of the infrastructure.
• Construction, operation and maintenance of access tracks (including existing access tracks) to and from the infrastructure, and the adjacent properties being three separate lots.
• Decommissioning of the infrastructure in accordance with Relevant Laws and this Agreement.
• Rehabilitation in accordance with Relevant Laws.
• Environmental monitoring activities required to be undertaken by us for the purpose of complying with Relevant Laws including monitoring, inspections and sampling of ecological features including, but not limited to vegetation, soil, and sediment.
• Other activities required to be undertaken by us for the purpose of complying with Relevant Laws (including, for example, the Environmental Authority) or any lawful activity we elect to undertake to meet your reasonable requests (e.g. environmental protection works, water sampling, noise monitoring, other monitoring, inspections or surveys). However, we may, in our absolute discretion, elect not to meet your requests for whatever reason.
• Construction, operation and maintenance of any ancillary equipment, fittings and structures as may be reasonably necessary in connection with or incidental to the construction, operation and maintenance of any infrastructure.
• Any other activities reasonably necessary for or incidental to any Activity described in this Section 3 of the Reference Schedule (Activities).

The Landholder is registered for GST in respect to its business operation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Section 110-40

Income Tax Assessment Act 1997 Subsection 116-20(1)

Taxation Ruling TR 95/35.

A New Tax System (Goods and Services Tax) Act 1999 Section 9-5

A New Tax System (Goods and Services Tax) Act 1999 Section 9-10

A New Tax System (Goods and Services Tax) Act 1999 Section 9-15

A New Tax System (Goods and Services Tax) Act 1999 Section 9-40

Reasons for decision

Question 1: Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income 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 from 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.

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, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

The compensation payment you will receive is not earned by you as it does not relate to services performed or from carrying on a business. Although the compensation relates to your property, the payment is not akin to rent. Rather the compensation is being received for the impact of the mining activity on your land. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from any personal services performed or business activity.

Accordingly, the compensation payments paid under the terms of 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. As such, these payments are not assessable income under section 6-5 of the ITAA 1997.

Question 2: Capital proceeds in respect of a CGT event happening

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 an 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.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts provides the Commissioner's view as to the CGT consequences of receiving a compensation payment 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 (CGT event A1); or
• not in respect of any underlying asset but in relation to the disposal of the right to seek compensation (CGT event C2).

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.

TR 95/35 states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

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 the Land is the asset to which the compensation under the CCA most directly relates. The Land is therefore the underlying asset and the relevant CGT asset.

As there has been no disposal of the land, CGT event A1 does not occur.

Further, as the amounts are paid in respect of an underlying asset (being the land) CGT event C2 will not happen.

As such, the compensation amounts you receive under the terms of the CCA, do not constitute capital proceeds in respect of a CGT event happening.

Question 3: Reduction in the cost base of the Land

Under section 6-10 of the ITAA 1997 some amounts that are not 'ordinary income' are included in your assessable income due to another provision of the tax law. These amounts are 'statutory income'. Statutory income may arise from CGT events as consequence of an eligible claimant being entitled to receive compensation for the loss and destruction of a CGT asset.

Taxation Ruling TR 95/35 provides the Commissioner's view as to the CGT consequences of receiving a compensation payment. The ruling states that it is necessary to identify the underlying asset to which the payment relates and what has occurred to that asset.

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

If there is more than one underlying asset, the relevant asset is the asset which leads directly to the payment of the amount of compensation.

If an amount of compensation is received by a taxpayer wholly in respect of the disposal of an underlying CGT asset, or part of an underlying CGT asset, of the taxpayer the compensation represents consideration received on the disposal of that asset. In these circumstances, the Commissioner considers that the amount is not consideration for the disposal of any other asset, such as the right to seek compensation.

If an amount of compensation is received by a taxpayer wholly in respect of permanent damage suffered to a CGT underlying asset of the taxpayer or for a permanent reduction in the value of a CGT underlying asset of the taxpayer, and there is no disposal of that underlying asset at the time of the receipt, we consider that the amount represents a recoupment of all or part of the total acquisition costs of the asset.

Compensation received by a taxpayer has no CGT consequences if the underlying asset which has suffered the permanent damage or a permanent reduction in value was acquired by the taxpayer before 20 September 1985 or is any other exempt CGT asset.

The activities will result in permanent damage to, or a permanent reduction in the value of the property. As the property was acquired before 20 September 1985, there are no CGT consequences at the time of entering into the CCA or at the time of receiving the compensation payments.

Question 4: GST and compensation amounts

Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that GST is payable on taxable supplies.

Section 9-5 of the 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.

Where a business receives compensation payments the question to address is whether this receipt gives rise to a GST liability to a business that is registered for GST. The starting point with respect to GST is to determine if the compensation is consideration for any supplies that the business has made in the course or furtherance of an enterprise

Supply

'Supply' is defined in subsection 9-10(1) of GST Act as 'any form of supply whatsoever'. The statutory definition of 'supply' is very broad. Essentially, a supply is something which passes from one entity to another, and may be one of goods, services or something else.

Consideration

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is 'in connection with' a supply and 'in response to' or 'for the inducement' of a supply. Thus, there must be a sufficient nexus between a particular supply and a particular payment, which is provided for that supply, for there to be a supply for consideration.

Sufficient nexus

A sufficient nexus between the compensation amounts and a supply must exist to create the 'supply for consideration' relationship.

In the current case, the issue is whether the Landholder has provided something to QCG, in return for the compensation amounts that are paid to it.

The Landholder is entitled under the Petroleum Legislation to receive compensation for certain kinds of loss or effects caused by QCG carrying out the Activities on the Land.

By entering into the CCA, the Landholders are giving up certain rights to further compensation in respect of these Activities. This raises the question of whether giving up such rights would be a separate supply or as termed in Goods and Services Tax Ruling 2001/4: Goods and Services Tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) a 'discontinuance supply'.

Paragraphs 106 to 109 in GSTR 2001/4 discuss discontinuance supplies as follows:

106. Where the only supply in relation to an out-of-court settlement is a 'discontinuance' supply, it will typically be because the subject of the dispute is a damages claim. In such a case, the payment under the settlement would be in respect of that claim and not have a sufficient nexus with the discontinuance supply.

107. In most instances, a 'discontinuance' supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement.

108. We do not consider that the inclusion of a 'no liability' clause in a settlement deed alters this position. 'No liability' clauses are commonly included in settlement agreements and we do not consider their inclusion to alter the substance of the original dispute, or the reason payment is made.

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

In the process of QGC carrying out the Activities on the Land, significant damage and adverse effects will impact the Land, for which the QGC must compensate the Landholder under the law. Upon receipt of the compensation amounts under the CCA, the Landholder accepts that it gives up its rights to pursue further compensation in relation to the Activities.

Applying the principle in paragraphs 106 to 109 in GSTR 2001/4, it is considered that the Landholder giving up its right for further compensation is not a separate supply for GST purposes. Rather, it is considered an inherent part of the legal machinery to bring finality to the amount of compensation that will ultimately be sought by the Landholder.

GSTR 2001/4 states the following in relation to damages, at paragraph 73:

The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss or injury in itself does not constitute a supply under section 9-10 of the GST Act.

Paragraphs 110 and 111 of GSTR 2001/4 further explain:

110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply made by the aggrieved party...

111. If a payment is made under an out-of-court settlement to resolve a damages claim and there is no earlier or current supply, the payment will be treated as payment of the damages claim and will not be consideration for a supply at all, regardless of whether there is an identifiable discontinuance supply under the settlement.

Although the above explanation in GSTR 2001/4 is made in respect of court orders and out-of-court settlements, the underlying principles are equally relevant in this case.

The Landholder received or will receive the amounts as a landholder under the Petroleum Legislation, as compensation for any economic loss, hardship and inconvenience as a result of petroleum activities carried out on the Land by QCG.

The payment by QCG to the landholders is compensation in respect of any damage caused or likely to be caused to the land and any inconvenience suffered by the landholders as a consequence of the Activities carried out on the Land.

In applying the above principles in GSTR 2001/4 to the present circumstances, we consider that, the compensation amounts are paid to the Landholder to resolve a damages claim. A claim for damages (or payment that the Landholder receives as a consequence of such claim) due to activities conducted by QCG on the Land, does not constitute a supply under section 9-10 of the GST Act.

The Landholder does not provide QCG with any supply in return for the compensation amounts. As such, the compensation payments made by QCG are not consideration for a supply from the Landholder to QCG, and accordingly no taxable supply will be made by the landholders.

Therefore, the receipt of the compensation amounts by the Landholder from QCG will not give rise to a GST liability.

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