Private ruling: Natural resource income
Date of advice: 31 May 2022
Published: August 2022
Ruling period: Year ended 30 June 20YY
Date scheme commenced: 1 July 2020

Ruling: Q1: Are the Close-out Payments 'natural resource income' as defined in section 6CA of the Income Tax Assessment Act (ITAA 1936)? | A1: No. | Q2: Are the Close-out Payments 'income from real property' under Article 4A of The Agreement between the Government of the Commonwealth of Australia and the Government of the Republic of Singapore for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income [1969] ATS 14 (Singapore Treaty)? | A2: No.

Relevant facts and circumstances: 1. Company A is an Australian tax resident company, and a wholly owned subsidiary of Company B who is listed on the Australian Securities Exchange. 2. Company A carries on mining operations in Australia from which silver is produced. 3. Company S is a limited liability company incorporated in Singapore. 4. Company S is a non-resident of Australia and is a tax resident of Singapore. 5. Company S does not carry on business in Australia and does not have a permanent establishment or presence in Australia. 6. A financing agreement was entered into and subsequently updated by the following parties: • Company A as 'borrower'; • Company B as the 'parent'; • other subsidiaries of Company B, together with Company B as 'guarantors' • Company S as 'original lender'. 7. Under the financing agreement, Company S must subscribe for loan notes, and by way of such subscription make the facilities available to Company A. 8. Under the financing agreement, interest is payable on outstanding amounts at commercial rates. Outstanding amounts are required to be repaid on maturity. 9. Under the financing agreement, there are Mineral Payments required in respect of each Facility. 10. The Mineral Payments are calculated as a percentage of Company A's total quarterly production of refined silver. 11. The obligation to make the Mineral Payments survives repayment or prepayment of the loan notes. 12. Company A has negotiated with Company S to defer the final repayment date of the facilities for a few months. In exchange for the deferral of the final repayments and the waiver of future rights to Mineral payments, Company S asked for additional consideration in the form of a payment to close-out the right to future Mineral Payments (Close-out Payments). The parties have agreed that the Close-out Payments will consist of cash payments. 13. The payments are made to terminate the right of Company S to receive future Mineral Payments. The payments are not made for silver already produced. Following the receipt of the Close-out Payments, Company S will waive its rights to future Mineral Payments in relation to the facilities. The Mineral Payments would otherwise continue for a period of time after the original drawdown date irrespective of whether the underlying facilities were repaid. 14. The Close-out Payments total a fixed quantum that has no actual relationship to the present value of an estimate of the future Mineral Payments that might otherwise have been paid, but an amount that reflects the mutual interests of both parties. 15. The Close-out payments are not subject to adjustment depending on the amount of silver actually produced. They are once-off, final payments.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 6 | Income Tax Assessment Act 1936 section 6CA | Income Tax Assessment Act 1936 section 128A | Income Tax Assessment Act 1997 section 6-5 | International Tax Agreements Act 1953 section 7 The Agreement between the Government of the Commonwealth of Australia and the Government of the Republic of Singapore for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income [1969] ATS 14 | Taxation Administration Act 1953 Schedule 1 section 12-325

Reasons for decision: Detailed Reasoning - Detailed reasoning: It is considered that the Close-out Payments are not of the exact same nature as the underlying Mineral Payments which are 'natural resource income' as defined in section 6CA of the ITAA 1936. As such, it is necessary to consider whether they of themselves satisfy the relevant definition in section 6CA of the ITAA 1936. Under subsection 6CA(1) of the ITAA 1936, 'natural resource income' means income that: (a) is derived by a non-resident; and (b) is calculated, in whole or in part, by reference to the value or quantity of natural resources produced, recovered or produced and recovered, in Australia after 7 April 1986; but does not include: (c) income that consists of royalty; or (d) income where: i. on 7 April 1986, the non-resident had a continuing entitlement to receive the income; ii. the income was derived by the non-resident pursuant to that continuing entitlement; iii. the non-resident was, at 5 o'clock in the afternoon, by standard time the Australian Capital Territory on 7 April 1986, a resident, within the meaning of a double tax agreement, of a foreign country in respect of which the double tax agreement was in force; iv. before 8 April 1986, the Commissioner had given a statement in writing to the effect that income tax would be levied on 50% of income included in a specified class of income; and v. the income is included in that class of income. The relevant components of the definition are considered below. | Detailed Reasoning - Is the payment 'income'?: The Close-out Payment was an amount received by Company S for the primary purpose of inducing Company S to waive its rights to future Mineral Payments under the agreement. In exchange for the deferral of the final repayments under the agreement, Company S asked for and received additional cash consideration from Company A. Following the receipt of the Close-out Payments, Company S will waive its rights to future Mineral Payments in relation to the facilities. The Mineral Payments would otherwise continue to a certain point after the original drawdown date irrespective of whether the underlying facilities are repaid. The Close-out Payments are income derived by Company S. The payments are not a repayment of loan principal, nor a return otherwise of a capital nature. The payments are derived in the ordinary course of Company S' business as a financier. | Detailed Reasoning - Derived by a non-resident: The Close-out Payments are paid by Company A to an Agent for the benefit of Company S. Company S is therefore beneficially entitled to the Close-out Payments. As Company S is a non-resident, paragraph (a) of the definition is satisfied. | Detailed Reasoning - Meaning of 'natural resources': Subsection 995-1(1) of the ITAA 1997 provides that 'natural resource' means minerals or any other non-living resource of the land, sea-bed or sea. 'Minerals' is not defined and so will take its ordinary meaning (although subsection 40-730(5) provides that 'minerals' includes petroleum). The Macquarie Dictionary relevantly defines 'minerals' as: Noun 1. a substance obtained by mining; ore. 2. any of a class of substances occurring in nature, usually comprising inorganic substances (as quartz, feldspar, etc.) of definite chemical composition and definite crystal structure, but sometimes taken to include aggregations of these substances (more correctly called rocks) and also certain natural products of organic origin, as asphalt, coal etc. It is considered that silver falls within the ordinary meaning of 'minerals' and in addition is also a 'non-living resource of the land' and so a natural resource for the purposes of the definition in section 6CA. Calculated, in whole or in part, by reference to the value or quantity of natural resources produced, recovered or produced and recovered, in Australia The Close-out Payments are not calculated (at least in part) by reference to the value of silver (being a natural resource) produced or recovered in Australia. The Close-out Payments are consideration in exchange for two different undertakings on the part of Company S, namely the deferral of the final repayment of the facilities and the termination or close-out of the Mineral Payment arrangement. The calculation method for the quantum of the Close-out Payments took into account, amongst other factors, an estimation of the total future Mineral Payments to which Company S may otherwise have been entitled to. The payment is made to terminate the right to receive future payments. It is not made in respect of silver produced. The Close-out Payments were a mere estimate of the amount likely payable based on forecasts of silver production and potential future pricing. That silver may never be produced and there is no mechanism to adjust the Close-out Payment. Paragraph 4 of Tax Ruling TR 2020/5 Income tax: application of section 6CA of the Income Tax Assessment Act 1936 and Australia's tax treaties and the payer's withholding obligations (TR 2020/5) provides that ...income is calculated, in whole or in part, by reference to the value or quantity of resources produced where the calculation is based on the level of production (emphasis added) It is recognised that the Close-out Payment would in part be computed by reference to the present value of the estimated quantum of Mineral Payments as may otherwise be paid to Company S. However, this calculation method does not satisfy paragraph (b) of the definition of 'natural resource income' for the following reasons: Therefore, as the Close-out Payments do not satisfy paragraph (b), they would not meet the definition of natural resource income' under section 6CA(1) of the ITAA 1936. | Detailed Reasoning - In Australia: The definition requires that the relevant natural resources be produced or recovered in Australia. The ATO position, outlined at paragraph 13 of TR 2020/5, is that a natural resource will be produced or recovered in Australia when all the material processes of production and/or recovery occur in Australia. As all the extraction/recovery and refining of the relevant silver occurs in Australia, this element of the definition is satisfied. | Detailed Reasoning - Are the payments royalties?: Paragraph (c) of the definition of 'natural resource income' excludes 'income that consists of royalty'. The Close-out Payments are not royalties as defined in section 6(1) of the ITAA 1936 as they are not made in consideration for any of the matters referred to in that definition. The payments also do not fall within the definition of royalties as defined in Article 10 of the Singapore Treaty. | Detailed Reasoning - Other exclusions: None of the exclusions in paragraph (d) of the definition of 'natural resource income' are relevant to the Close-out Payments, and so will not apply. | Detailed Reasoning - Conclusion: As all the elements of the definition of 'natural resource income' are not satisfied and none of the exclusions apply, the Close-out Payments are not 'natural resource income' of Company S. | Detailed Reasoning - Question 2: Are the Close-out Payments 'income from real property' under Article 4A of the Singapore Treaty? | Detailed Reasoning - Detailed reasoning: The Singapore Treaty applies under Australian law due to section 7 of the Intemational Tax Agreements Act 1953 . Under Article 4A(2) of the Singapore Treaty, the definition of 'real property' relevantly includes: b) a right to receive variable or fixed payments either as consideration for the exploitation of or the right to explore for or exploit, or in respect of the exploitation of, mineral, oil or gas deposits, quarries or other places of extraction or exploitation of natural resources. For a payment to be considered to be 'in respect of' the exploitation of natural resources there must be 'some discernible and rational link' between the right to receive the payment and the exploitation of the relevant natural resource. Where a payment is calculated by reference to the value or quantity of natural resources produced in Australia such payments will be 'in respect of' the exploitation of the relevant natural resource. There is no discernible link between the Close-out Payments and actual production of natural resources in Australia. Company S will receive the full amount of the agreed quantum for the Close-out Payments, irrespective of the level of production of silver. The actual production or discovery of any natural resources by Company A, and the level and volume of such production has no impact on Company S' right to receive the Close-out Payments, nor the quantum. The Close-out Payments are fixed payments and are not considered to be received by Company S 'in respect of' the exploitation of a natural resource, being silver. Company S' right to receive the Close-out Payments therefore do not constitute 'income from real property' under Article 4A of the Singapore Treaty. This is further supported by paragraph 15 of TR 2020/5 which states that the income from real property articles in Australia's tax treaties will not apply to override royalties in circumstances where subsection 6CA(1) of the ITAA 1936 would not otherwise apply to the override royalty. In relation to override royalties, the scope of the income from real property articles is no wider than section 6CA. As such, Australia would only have taxing rights over the Close-out Payments to the extent Company S has a permanent establishment in Australia (which it does not). Company A is not required to withhold an amount from the Close-out Payments it makes to Company S under section 12-325 of Schedule 1 to the Tax Administration Act 1953 .

Question 1: Are the Close-out Payments 'natural resource income' as defined in section 6CA of the ITAA 1936? | The calculation of the Close-out Payment is based purely on a hypothetical scenario (where Mineral Payments may be received by Company S), instead of the actual production of silver (being the relevant natural resource in this scenario) itself; | the lack of an adjustment mechanism should the estimated future silver production never eventuate shows that it is not a mere prepayment calculated by reference to silver production that eventuates in the future; and | Company S will receive the full amount of the agreed quantum for the Close-out Payments, irrespective of the actual level of production or discovery of silver by Company A.