Edited version of private ruling

Authorisation Number: 1011823546182

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Ruling

Subject: Capital gains tax - income or capital - sale of timber

Question 1

Is the payment received under the agreement a royalty?

Answer

Yes.

Question 2

Is the payment received under the agreement a capital payment?

Answer

No.

Question 3

If the above payment is capital, is the standing timber being disposed of as a pre-CGT asset?

Answer

Not applicable. The payment is not capital.

Question 4

If the above payment is capital, is the right to the timber being disposed of as a post-CGT asset?

Answer

Not applicable. The payment is not capital.

Question 5

If the above disposal is a post-CGT right to the timber, is the capital gain eligible for the small business concessions?

Answer

Not applicable. The disposal is not a post-CGT right to the timber.

This ruling applies for the following periods:

The 2010-11 income year

The 2011-12 income year

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You purchased land before 19 September 1985.

On this land you and your spouse conducted a business.

The land has a stand of mature trees.

These trees were not planted for the purpose of sale, and are the remnants of naturally occurring forest.

You are entering into an agreement with a company for the sale of this timber.

The company is the sole judge of the suitability of the timber.

The company are offering a purchase price for an estimated quantity of wood.

Payment is to be in equal monthly instalments, with the first payment due within 30 days of the end of the month in which the company commences to remove the timber.

The company may leave the stumps in the ground and the heads and branches of the trees felled on the ground.

The wood is to be measured at the company's weighbridge.

The contract allows the company the right to enter the property for the purpose of removing the timber.

The company has the right to terminate the agreement if they are unable to access the timber for any reason. If the agreement is terminated, for the purposes of determining the purchase price, it shall be deemed to have been available on the property only the pulpwood taken prior to the termination.

The company will take all measures to minimise disturbances to soil, water and wildlife.

Damages to fencing, telephone lines or other structural improvements directly resulting from the company's operations, will be made good by the company.

The company will comply with the requirements of the Worker's Compensation Act, but shall not be liable for any claim, demand or compensation.

The company has the right to assign the contract.

The pulpwood is to be removed from the property as soon as possible.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 15-20 and

Forestry Act 1916-1935 (NSW) Sections 30, 41 (c).

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

Summary

A royalty is defined as a payment in relation to quantity. You are being paid an amount for a quantity of timber. Therefore the payment received is a royalty and is assessable income.

Detailed reasoning

Taxation Ruling IT 2660 provides the definition of 'royalty'. IT 2660 discusses the ordinary meaning of 'royalty' and considers Stanton v. FC of T (1955) 92 CLR 630; 11 ATD 1 (Stantons Case). In Stantons Case it is stated that the modern applications of the term seem to fall under two heads…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 lists the key characteristics of a common law royalty as:

· a payment made in return for the right to exercise a beneficial privilege or right to remove minerals or natural resources such as timber

· the payment is made to the person who owns the right to confer that beneficial privilege or right

· the consideration payable is determined on the basis of the amount of use made of the right acquired; and

· the consideration payable 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.

Stantons Case discusses royalties. The judgement states:

In my opinion the word 'royalty' is properly used for the purpose of describing payments made by a person for the right to enter upon land for the purpose of cutting timber of which he becomes the owner, where those payments are made in relation to the quantity of timber cut or removed.

In relation to the word 'royalty' the judgement later explains:

In other words it is inherent in the conception expressed by the word that the payments should be made in respect of the particular exercise of the right to take the substance and therefore should be calculated either in respect of the quantity of timber taken or the occasions upon which the right is exercised.

Royalties are also discussed in McCauley v. Federal Commissioner of Taxation 69 CLR 235 (McCauleys Case). In the judgement, Latham CJ explains that in Australia payments for the right to cut and take away timber are commonly described as royalties in the states which relate to this matter (Forestry Act 1916-1935 (NSW) ss 30, 41 (c)).

Woellner, Barkoczy, Murphy and Evans, 2005, Australian Taxation Law, CCH, Sydney states at paragraph 8-510:

While royalties are normally calculated by reference to actual exploitation or usage, a direct connection between the payment and exploitation or usage is not essential so long as the payment is calculated indirectly by reference to the exploitation or usage. For example, a lump sum payment may be a royalty where it is a pre-estimate of the anticipated amount of further use.

Taxation Ruling TR 95/6 discusses primary production and forestry. TR 95/6 explains that payments received for a right to remove trees on the basis of the amount of timber cut or removed under a right to do so are receipts as or by way of royalty and constitute assessable income.

TR 95/6 explains that royalties received by a taxpayer from the grant of a right to fell timber on land owned by the taxpayer is assessable income of the taxpayer. The royalties are assessable income of the recipient even if the taxpayer granting the right is not carrying on a business of forest operations. Section 15-20 of the Income Tax Assessment Act 1997 (ITAA 1997) confirms that your assessable income includes an amount that you receive as or by way of royalty within the ordinary meaning of 'royalty'.

Application to your circumstances

Your agreement states that the company purchases the right to the timber that is suitable for its purpose. The purchase price is for an approximate quantity.

You are being paid in instalments to commence within a month of the company commencing to remove the timber. This payment is to purchase a quantity of wood. The agreement provides for the company to be the sole judge of what is suitable for wood, and the amount deemed to be available can be reduced to that which is already taken if the agreement is terminated. The measurement of the wood is to be at the company's weighbridge.

A royalty is defined as a payment in relation to quantity. You are being paid an amount for a quantity of timber. Therefore the payment received is a royalty and is assessable income.