Edited version of your private ruling

Authorisation Number: 1012361490039

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Ruling

Subject: GST and the acquisition of a Farm-in Interest as a going concern

Question

Will the acquisition of the 'Farm-in Interest' by you under the terms of a written agreement, constitute the acquisition of a GST-free going concern pursuant to section 38-325 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?

Answer

Yes, the acquisition of the 'Farm-in Interest' by you under the terms of a written agreement will constitute the acquisition of going concern pursuant to section 38-325 of the GST Act provided the supply and acquisition is completed in accordance with that agreement. Accordingly, that acquisition is not a creditable acquisition for which there is an entitlement to GST credits.

Relevant facts and circumstances

A vendor and the purchaser (you) executed a written agreement (Agreement) to effect the assignment and transfer of the Farm-in Interest.

The Farm-in Interest is defined in the Agreement as an unencumbered legal and beneficial right, title and interest in the Permit and any petroleum recovered from the Permit Area, together with all relevant property, data and information (whether held by the vendor or otherwise) relating to the Permit.'

The Permit was granted to the vendor some years ago and provides the vendor the right to assess a geographical area's petroleum energy potential via a proposed work programme submitted with the vendor's permit application. The geographical area, the subject of the Permit (Permit Area), is located in offshore Australia.

The Permit is defined in the Agreement as:

ð the exploration permit granted pursuant to the Offshore Petroleum and Greenhouse Gas Storage Act 2006 (Cth) (OGGGSA06),

ð any extension, renewal, replacement,…of any such permit…in respect of the Permit Area, and

ð without limitation to the foregoing, includes any other instrument issued or granted in substitution for, or pursuant or ancillary to that instrument, and any other instrument conferring the same or similar rights previously the subject of that title authority or licence.

Relevant property is a reference to all areas defined within the Permit along with one partially abandoned and one suspended well, both of which carry an abandonment liability.

All relevant data and information relating to the Permit include:

ð seismic data

ð well data, and

ð all existing geological, well completion, well testing, engineering and reserves reports and past cash flows, cash balance, PRRT balance and annual certificates and any other financial data.

The Agreement recites that the vendor is the registered holder of the Permit and that the vendor wishes to assign to you and you wish to acquire a part of an interest in the Permit on the terms of the Agreement.

Under the terms of the Agreement, the vendor warrants that it is the sole unencumbered legal and beneficial owner of the Permit.

The Agreement provides that in exchange for the Farm-in Investment, the vendor will assign and transfer to you the Farm-in Interest at completion.

Terms defined in the Agreement include:

Farm-in Activities which involve:

ð drilling appraisal wells in a particular prospect in the Permit (including any testing and down time),

ð establishing appraisal wells in that particular prospect in the Permit, and

ð using reasonable endeavours to drill an exploration well preferably in another prospect in the Permit.

Farm-in Investment: $X towards Joint Operations in respect of the Farm-in Activities, comprising a contribution of $X in respect of the proportion of the Farm-in Investment attributable to the vendor's Interest and a contribution of $X in respect of the proportion of the Farm-in Investment attributable to the Farm-in Interest.

The Farm-in Investment is payable as follows:

ð $X to be paid into the Joint Account on the Completion Date,

ð $X to be paid into the Escrow Account on the Completion Date and released into the Joint Account, and

ð $X to be paid into the Escrow Account on the date on which Investment 2 is released into the Joint Account.

The terms of the Agreement provide that both you and the vendor agree the sale of the Farm-in Interest will constitute the supply of a going concern and accordingly, will be GST-free pursuant to section 38-325 of the GST Act.

As such, the vendor agrees to:

ð supply to you all the things necessary for the continued operation of the enterprise, and

ð carry on the enterprise until the day of completion.

Under the Agreement, you warrant that you are registered or required to be registered for goods and services tax (GST). You have confirmed in a joint private ruling application (ruling application) that you and the vendor are registered for GST.

In the ruling application, the vendor describes the enterprise it carries on as a petroleum exploration and development enterprise directed at ultimately extracting and delivering petroleum to the market. In accordance with its work programme, the vendor submits it has undertaken a number of petroleum exploration activities within the confines of the Permit. To date, this has included drilling of appraisal and exploration wells, mapping, seismic studies, geological and geophysical studies, as well as a review of various development concepts.

As a result of the activities undertaken by the vendor, it has built up a bank of intellectual property, data and information relevant to its exploration for petroleum in the geographical area in question. Future work programs for the coming years have been scheduled and will involve further geological and geophysical studies, pre-drill preparatory works and the drilling of additional exploration wells.

The Agreement provides that from the date of the Agreement and up to completion, the vendor will, amongst other things:

ð conduct all activities on the Permit in accordance with its usual practices

ð maintain the Permit in good standing

ð consult with you with regard to the vendor's work proposals and not incur any expenditure in excess of a certain amount or enter into any contract or commitment that has a duration of 12 months or longer

ð comply with the conditions of the Permit and any Authorisations

ð comply with the requirements of the Act and all relevant laws applicable to or affecting the Permit, and

ð maintain its accounts and keep all records and documents in relation to the Permit.

Under the terms of the Agreement, the vendor will during the period up to completion deliver to you a copy of all reports, invoices and communications given or received by the vendor in relation to the Permit or operations relating to the Permit which would reasonably be relevant to an intending purchaser of the Farm-in Interest. The vendor will allow you or any person authorised by you, reasonable access during normal business to inspect the books of account, records and documents held by the vendor in relation to the Permit and the Farm-in Interest.

The Agreement provides that in consideration of the assignment of the Farm-in Interest, you shall

ð pay Investment 1 into the Joint Account

ð pay Investment 2 into the Escrow Account

ð provide to the vendor a counterpart of the Joint Operating Agreement executed by you

ð provide to the vendor a counterpart of the transfer of the Farm-in Interest to you executed by you, and

ð provide to the vendor all information reasonably requested by the vendor in relation to the application for registration of all dealings and the transfer of the Farm-in Interest to you.

The Agreement provides that the participating interest in the Permit on and from the Completion Date will be as follows:

ð you will hold X%, and

ð the vendor will hold X%.

Under the Agreement, you and the vendor have agreed to form an unincorporated joint venture to conduct operations in the Permit Area from the Completion Date. You submit that following completion, both you and the vendor will jointly carry out the relevant petroleum exploration and other activities necessary to ultimately deliver petroleum to the market.

Pursuant to the terms of the Agreement, you and the vendor will each use reasonable endeavours to obtain the grant of a production licence over a particular Prospect as soon as practicable after completion of the Agreement.

A copy of an unexecuted Joint Operating Agreement (JOA) annexed to the Agreement was provided.

The JOA recites that following registration of the transaction, the subject of the Agreement, the parties (you and the vendor) will be the holders of the Permit located offshore Australia and that the parties enter the JOA to define their respective rights and obligations with respect to the Permit.

Under the terms of the JOA, you will be designated as the Operator and will have all of the rights, functions and duties of the Operator and you will have exclusive charge of and conduct of all Joint Operations.

Under the Agreement, notwithstanding the terms of the JOA, you will be entitled to receive XX% of the petroleum produced from the Permit until the sales revenue of that petroleum actually realised by you is equal to the amount of the Farm-in Investment actually paid into the Joint Account.

You explained that an entity which holds an exploration permit such as the Permit would, upon completion of the exploration works and the discovery of a promising petroleum field, be in a position to obtain licences/permits to extract the petroleum with a view to ultimately delivering petroleum to the market for sale. You advised that the exploration activity is a necessary 'process/step' to achieve the ultimate objective of the project to extract and deliver petroleum.

In the ruling application, the vendor advised that its focus is transitioning from an explorer to a petroleum producer. To this end, it executed the Agreement to assign, in accordance with the terms and conditions of the Agreement, a certain percentage interest in the Permit to you.

The funding of the exploration expenditure by you is intended to not only reduce the costs which the vendor would otherwise need to fund in its own right, but to also reduce the time spent on exploration activities. Specifically, the funding will be used to initiate the development of a field which involves the drilling of further appraisal wells. It is anticipated that once exploration and development has been completed, the field will be capable of producing barrels of oil.

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 Section 7-1,

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

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

A New Tax System (Goods and Services Tax) Act 1999 9-20,

A New Tax System (Goods and Services Tax) Act 1999 11-5,

A New Tax System (Goods and Services Tax) Act 1999 subsection 38-325(1) and

A New Tax System (Goods and Services Tax) Act 1999 subsection 38-325(2).

A New Tax System (Goods and Services Tax) Act 1999 195-1,

Income Tax Assessment Act 1997 section 995-1.

Reasons for decision

Legislation

Section 7-1 of the GST Act provides that GST is payable on taxable supplies.

A supply will be a taxable supply if pursuant to section 9-5 of the GST Act:

ð you make the supply for consideration

ð the supply is made in the course or furtherance of an enterprise that you carry on

ð the supply is connected with Australia, and

ð you are registered, or required to be registered for GST.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

Section 9-10 of the GST Act defines a supply as any form of supply whatsoever and includes amongst other things:

ð a supply of goods

ð a supply of services

ð a creation, grant or transfer, assignment of any right

ð an entry into or release from an obligation to do anything or to refrain from an act or to tolerate an act or situation, or

ð any combination of any two or more of the matters referred to above.

The meaning of 'acquisition' in section 11-10 of the GST Act is the corollary to the meaning of supply in section 9-10 of the GST Act. Subsection 11-10(1) of the GST Act provides that, an acquisition is any form of acquisition whatsoever and includes an acquisition of goods, services, a receipt of information or an acceptance of a grant, transfer, assignment or surrender of real property or of any right and the acquisition of a right to require another person to do anything (subsection 11-10(2) of the GST Act).

If you make an acquisition and the other requirements of section 11-5 of the GST Act are met then the acquisition is a creditable acquisition for which the recipient is entitled to input tax credits (GST credits). An essential requirement under section 11-5 of the GST Act is that the supply of the thing to you is a taxable supply.

You submit in the joint private ruling application that the supply of the Farm-in Interest to you by the vendor is not a taxable supply on which GST is payable (and therefore not a creditable acquisition), on the basis that the supply of the Farm-in Interest constitutes a GST-free supply of going concern under section 38-325 of the GST Act.

There is no issue that the assignment of the Farm-in Interest (Interest) by the vendor comes within the definition of a supply by the vendor and an acquisition by you for GST purposes. Nor is there an issue that the supply of the Farm-in Interest is for consideration or connected with Australia or that the vendor and you are registered for GST. On the facts provided, the supply of the Farm-in Interest, the subject of the Agreement, is not input taxed. The vendor states that its supply of the Farm-in Interest is made in the course of an exploration enterprise that it carries on.

Accordingly, the question to be decided is whether the acquisition of the Farm-in Interest by you and the corresponding supply by the vendor under the terms of the Agreement constitutes a going concern that is GST-free for the purposes of section 38-325 of the GST Act.

Section 38-325 of the GST Act

Subsection 38-325(1) of the GST Act provides that a supply of a 'going concern' is GST-free if:

ð the supply is for consideration

ð the recipient is registered or required to be registered, and

ð the supplier and the recipient have agreed in writing that the supply is of a going concern.

On the facts provided by you and the vendor:

ð the Farm-in Interest is to be supplied in exchange for consideration (being the Farm-in Investment referred to in the Agreement)

ð you as the recipient are registered for GST, and

ð you and vendor, on executing the Agreement, agreed in writing that the supply of the Farm-in Interest constitutes the supply of a going concern.

On that basis, the elements of subsection 38-325(1) of the GST Act will be satisfied.

Under subsection 38-325(2) of the GST Act, a 'supply of a going concern' is defined as a supply under an arrangement under which:

ð the supplier supplies to the recipient all of the things that are necessary for the continued operation of an enterprise (paragraph 38-325(2)(a) of the GST Act), and

ð the supplier carries on, or will carry on, the enterprise until the day of the supply (whether or not as a part of a larger enterprise carried on by the supplier) (paragraph 38-325(2)(b) of the GST Act).

The transfer of the Farm-in Interest will be GST-free provided that the arrangement between you and the vendor is one that constitutes a going concern under subsection 38-325(2) of the GST Act.

Goods and Service Tax Ruling GSTR 2002/5 provides guidance on the application of the going concern provisions. It does not discuss the application of the provisions to specific industries. However, the examples used in the ruling do illustrate the application of relevant principles to particular factual circumstances relating to some specific industries.

Paragraph 195 of GSTR 2002/5 provides that each joint venturer in a business that is structured as a joint venture is an entity which is capable of conducting an enterprise. It is possible for a joint venturer to make a GST-free supply of a going concern, in circumstances where all the requirements of section 38-325 of the GST Act are satisfied. This may be when part or all of the enterprise conducted by a joint venturer is supplied, provided that what is supplied is all of the things that are necessary for the continued operation of the identified enterprise. On the facts provided, the JOA will not be executed until the Agreement has completed and the Farm-in Interest is assigned to you by the vendor.

Supply under an arrangement

Although the word 'arrangement' is not defined in the GST Act, GSTR 2002/5 explains at paragraph 19 that the phrase 'supply under an arrangement' includes a supply under a single contract or supplies under multiple contracts which comprise a single arrangement provided the things supplied relate to the identified enterprise. The assignment of the Farm-in Interest under the Agreement will be a supply under an arrangement.

Identified Enterprise

Subsection 38-325(2) of the GST Act can only operate in circumstances where an enterprise has been identified as comprising particular activities that relate to that identified enterprise (paragraph 21 of GSTR 2002/5).

Once an enterprise is identified, a supply of a going concern arises if an arrangement is shown to subsist under which the vendor supplies to you as the recipient all of the things that are necessary for the continued operation of that enterprise.

The term 'enterprise' is defined in section 9-20 of the GST Act as an activity or series of activities done in a certain manner or by certain entities. The activities covered include, amongst others, those done in the form of a business or an adventure or concern in the nature of trade. The meaning of the term 'activity or series of activities' for an entity can range from a single act or undertaking to groups of related activities, to the entire operations of the entity (paragraph 10 of Goods and Services Tax Determination GSTD 2006/6).

The phrase 'in the form of a business' is broad and has as its foundation in the longstanding concept of a business. The definition clearly includes a business and the use of the phrase 'in the form of' indicates a wider meaning than the word 'business' on its own.

The definition of 'business' in section 195-1 of the GST Act is the same as that used in subsection 6(1) of the Income Tax Assessment Act 1936 and in section 995-1 of the Income Tax Assessment Act 1997. It follows that the meaning of 'business' should be interpreted in a similar way. As such, it is appropriate to refer to Taxation Ruling TR 97/11 which considers the meaning of 'business'. A business is defined in section 195-1 of the GST Act as:

business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

The term 'carrying on' is defined in section 195-1 of the GST Act and ensures that activities done in the course of commencement or termination of an enterprise are included in determining whether the activities of the entity amount to an enterprise (paragraphs 12 and 15 of GTD 2006/6).

It follows from this definition that activities done by an entity that are part of a process of beginning or bringing into existence an enterprise are activities in carrying on an enterprise.

The Agreement does not specifically identify the 'enterprise' that the vendor agrees to carry on until the day of completion or for which the vendor will supply all things necessary.

You and the vendor submit, in your joint private ruling application, that the relevant enterprise in the present circumstances is that of petroleum exploration and development. The vendor confirms that it has to date undertaken a number of petroleum exploration activities within the confines of the Permit including drilling of appraisal and exploration wells, mapping, seismic studies, geological and geophysical studies as well as a review of various development concepts. Work programs for subsequent years have already been scheduled and will involve further geological and geophysical studies, pre-drill preparatory works and the drilling of additional exploration wells. The vendor and you contend that such activities constitute significant commercial activity, conducted on a material scale and intended to ultimately result in the delivery of petroleum to the market.

The Agreement confirms that following the completion of the Agreement, you and the vendor have agreed to form an unincorporated joint venture to conduct Farm-in Activities in the Permit Area. Those activities include drilling of further appraisal wells in a particular Prospect in the Permit, establishing further appraisal wells in that Prospect and using reasonable endeavours to drill exploration wells preferably in another Prospect in the Permit.

You contend that the lifecycle of this petroleum exploration and development enterprise typically involves a number of phases including, exploration, development, processing and the sale of the end product which, in this case, are hydrocarbons. The exploration activity is a necessary step to achieve the ultimate objective of the project which is to discover and then extract and deliver petroleum to the market.

The Agreement confirms that from the date of the Agreement and up to completion, the vendor has conducted all activities on the Permit in accordance with its usual operating practices as a reasonable and prudent operator and to maintain the Permit.

On the facts provided, the exploration activities undertaken to date by the vendor in relation to the Permit Area are systematic, organised and carried on in a businesslike manner. The vendor has advised that the activities are in accordance with its work program in which detailed records have been kept, budgeting was carried out and assets were created.

On that basis, it is possible to conclude that the series of activities undertaken by the vendor in relation to the Permit Area answer the description of an enterprise for the purposes of section 9-20 of the GST Act being carried on by the vendor notwithstanding that it is in the exploration phase of the life cycle.

Subsection 38-325(2) of the GST Act recognises that a supplier might carry on an enterprise, described as a 'larger enterprise' (paragraph 38-325(2)(b) of the GST Act) within which the enterprise contemplated by paragraphs 38-325(2)(a) and (b) forms a part. The GST Act does not require that a whole enterprise be transferred for the supply to be GST-free under section 38-325 of the GST Act. The section requires that 'an enterprise' be continued and this may be part of a larger enterprise carried on by the supplier.

A supply of all things necessary for the continued operation of an activity which is part of an enterprise cannot be a supply of a going concern unless the conduct of the activity is itself an enterprise as defined in section 9-20 of the GST Act (paragraph 32 of GSTR 2002/5).

Things necessary for the continued operation of an enterprise

The 'things' which are necessary for the continued operation of an enterprise will depend on the nature of the enterprise carried on and the core attributes of that enterprise (paragraph 72 of GSTR 2002/5). A 'thing' is necessary for the continued operation of an 'identified enterprise' if the enterprise could not be operated by the recipient in the absence of the thing (paragraph 73 of GSTR 2002/5). A supplier will only be treated as having supplied all things necessary for the purposes of subsection 38-325(2) of the GST Act if you, as the purchaser, are put in a position on the day of the supply to, if you choose, continue to operate the identified enterprise.

Paragraph 75 of GSTR 2002/5 explains that two elements are essential for the continued operation of an enterprise:

ð the assets necessary for the continued operation of the enterprise including, where appropriate, premises, plant and equipment, stock-in-trade and intangible assets such as goodwill, contracts, licences and quotas; and

ð the operating structure and process of the enterprise consisting of the commercial or economic activity relevant to the type of enterprise being conducted, for example, ongoing advertising and promotion.

It is clear from paragraph 75 of GSTR 2002/5 that what is transferred must be more than the business assets of an identified petroleum exploration enterprise. The provision of a percentage of an exploration permit without more is unlikely to be regarded as a supply of a going concern.

You and the vendor submit that each of you will be carrying on an enterprise constituted by your respective participating interest in the joint venture. In assigning the Farm-in Interest, it is submitted, that what is being supplied to you would put you in a position where you would otherwise be able to separately and independently carry on the identified petroleum exploration enterprise to the extent of your interest, notwithstanding that the vendor and you intend on jointly carrying on the petroleum exploration enterprise following the assignment of the Farm-in Interest under the joint venture structure.

There is a distinction between an enterprise, a part of an enterprise and a mere asset of an enterprise. Based on the information provided, the vendor will supply and you will acquire an interest in the two elements essential for the continued operation of the identified petroleum exploration enterprise being:

ð the assets such as a X% unencumbered legal and beneficial right, title and interest in the Permit as well as any petroleum recovered from the Permit Area, and

ð the operating structure such as an interest in all relevant property including partially abandoned and suspended wells, both of which carry an abandonment liability, data and information relating to the Permit.

The provision of these things puts you in the position to separately and independently operate the petroleum exploration and subsequent development enterprise to the extent of your interest, should you choose to.

The supply by the vendor and acquisition by you of the Farm-in Interest is therefore regarded as the provision of all things necessary for the continued operation of an enterprise. Accordingly, the requirement in paragraph 38-325(2)(a) of the GST Act will be satisfied.

Supplier carries on enterprise until day of supply

GSTR 2002/5, at paragraphs 141 to 165, provide guidance on the meaning of 'supplier carries on the enterprise until the day of supply' for the purposes of paragraph 38-325(2)(b) of the GST Act.

Paragraph 150 of GSTR 2002/5 explains that a supplier is unable to supply all of the things that are necessary for the continued operation of an enterprise unless the relevant enterprise is not only being carried on, but is also operating. All of the activities of the enterprise must be active and operating on the day of the supply.

The enterprise must be carried on by the supplier which may do so itself or have another entity carry on the enterprise on its behalf.

Paragraph 161 of GSTR 2002/5 further explains that the day of the supply occurs when the supplier has done everything to satisfy the obligations under the contract or arrangement governing the supply and the recipient assumes effective control and possession of all things that are necessary for the continued operation of the enterprise.

The Agreement provides that from the date of the Agreement and up to completion, the vendor will, amongst other things, conduct all activities on the Permit in accordance with its usual practices, maintain the Permit in good standing and maintain its accounts and keep all records and documents in relation to the Permit etcetera.

These activities are ongoing and will continue until the day of supply. On that basis, the requirements of paragraph 38-325(2)(b) of the GST Act which requires the supplier to carry on the enterprise until the day of supply will be satisfied.

As all the requirements of subsection 38-325(2) and subsection 38-325(1) of the GST Act will be satisfied, the acquisition by you of the Farm-in Interest as defined in the Agreement will be the acquisition of a going concern that is GST-free. That being the case, the acquisition of the Farm-in Interest is not a creditable acquisition.