Private ruling: CGT – income versus capital
Date of advice: 20 September 2018
Published: October 2018
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20YY | Year ended 30 June 20ZZ
Date scheme commenced: 1 July 20AA

Ruling: Q1: Are the payments for extraction of materials by Company A from your pre-CGT farmland assessable as ordinary income? | A1: Yes | Q2: Are the payments for extraction of materials by Company A 100% tax free receipts? | A2: No | Q3: Are the payments for extraction of materials by Company A deemed to give rise to a separate CGT event? | A3: No

Relevant facts and circumstances: You signed an agreement with Company A in 20AA under which this entity would pay “royalties” for extraction of material from land you own. This land is farmland which is on two titles. These titles were acquired prior to the introduction of CGT in Australia. Company A is responsible for rehabilitation of the land after extraction of various materials. The farmland has been leased since 20BB. Prior to the lease this land was used to conduct a farming business. Company A commenced extraction of materials in approximately Spring 20XX.

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 102-5 | Income Tax Assessment Act 1997 Section 118-20

Reasons for decision: Summary: 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, under an agreement with Company A you receive payments for the volume of material extracted from your property. This material is a natural resource. It is considered that the payment for each cubic metre of material extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997. | Detailed Reasoning - Capital gains tax (CGT): For CGT purposes, the sale of materials from an asset previously acquired before 20 September 1985 results in the original asset (the property containing the materials) being split into a post-CGT asset (the materials) and a pre-CGT asset (the land). Any net capital gain arising on the disposal of the materials is then assessable income in the year of income in which the disposal occurs. This means that the income earned from the sale of your materials is assessable as both ordinary income from an isolated transaction, and as a capital gain. However, section 118-20 of the ITAA 1997 prevents the amount from being taxed twice by reducing any capital gain from the disposal of the materials by any amount included in your assessable income. This will have the effect of avoiding double taxation. | Detailed Reasoning - Conclusion: It is considered that the payment for each cubic metre of material extracted will be a payment by way of royalty and assessable under section 15-20 of the ITAA 1997.