Edited version of private advice

Authorisation Number: 1012655117456

Ruling

Subject: Balancing adjustment event on the disposal of mining rights

Question 1

At what time does a Balancing Adjustment Event ('BAE') arise under Division 40 of Part 2-10 of the Income Tax Assessment Act 1997 on the disposal of mining rights and information under a Sale and Purchase Agreement with Company B?

Answer

A balancing adjustment event occurred under paragraph 40-295(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) when the Sellers stopped holding the Sale Interest on the effective date of the Sale and Purchase Agreement ('SPA').

This ruling applies for the following periods:

Year ended 30 July 2014

Year ended 30 July 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Company A is the parent entity of a number of companies (which are referred to collectively as the Sellers) which are predominantly involved in the mining industry.

The Sellers hold a free-carried interest ('FCI') in a tenement. The Sellers have explored these tenements both prior to and in joint venture with Company B.

Company B ('the Buyer') have entered into a binding conditional agreement with the Sellers to, inter alia, acquire their interest in an Exploration Licence.

The acquisition consideration comprises of:

• Company B shares;

• cash; and

• A percentage net royalty payment only on any production resulting from future discoveries made within that portion of the Exploration Licence.

The acquisition by Company B was subject to shareholder approval, of which approval was obtained. Completion of the acquisition has occurred.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Paragraph 40-295(1)(a)

Income Tax Assessment Act 1997 Subdivision 40-D

Income Tax Assessment Act 1997 Subsection 40-295(1)

Income Tax Assessment Act 1997 Subsection 40-30(1)

Income Tax Assessment Act 1997 Subsection 40-30(2)

Income Tax Assessment Act 1997 Paragraph 40-30(2)(a)

Income Tax Assessment Act 1997 Section 40-40

Income Tax Assessment Act 1997 Section 40-285

Income Tax Assessment Act 1997 Paragraph 40-300(1)(b)

Income Tax Assessment Act 1997 Section 40-305

Income Tax Assessment Act 1997 Subsection 995-1

Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 Paragraph 1.35

Reasons for decision

Summary

A balancing adjustment event occurred under paragraph 40-295(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) when the Sellers stopped holding the Sale Interest on the effective date of the Sale and Purchase Agreement ('SPA').

Detailed reasoning

Where a balancing adjustment event occurs in respect of a depreciating asset, the entity holding the asset will generally be required to make an adjustment to its taxable income in accordance with Subdivision 40-D of the ITAA 1997.

Subsection 40-295(1) provides that a balancing adjustment event occurs for a depreciating asset if:

(a) you stop holding the asset; or

(b) you stop using it, or having it installed ready for use, for any purpose and you expect never to use it, or have it installed ready for use, again; or

(c) you have not used it and:

(i) if you have had it installed ready for use - you stop having it so installed; and

(ii) you decide never to use it

Depreciating asset

A depreciating asset is defined in subsection 40-30(1) of the ITAA 1997 as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. The definition specifically excludes land, trading stock, and intangible assets except for those listed in subsection 40-30(2) of the ITAA 1997.

Paragraph (a) of subsection 40-30(2) of the ITAA 1997 provides that a 'mining, quarrying or prospecting right' is an intangible asset that is also a depreciating asset. Subsection 995-1 of the ITAA 1997 relevantly provides that a mining, quarrying or prospective right is:

a) an authority, licence permit or right under an Australian law to mine, quarry or prospect for minerals, petroleum or quarry materials; or

b) …

c) An interest in such an authority, licence, permit, right or lease; or

d) …

In this case, the asset to be considered is the Sale Interest, which was disposed of by the Sellers under the Sale and Purchase Agreement ('SPA'). The Sale Interest is a mining, quarrying or prospecting right within the meaning of that term in subsection 995-(1) of the ITAA 1997, and therefore an intangible depreciating asset pursuant to paragraph 40-30(2)(a) of the ITAA 1997.

Did the Sellers stop 'holding' the Sale Interest that was disposed of under the SPA at the SPA Completion date?

Section 40-40 of the ITAA 1997 considers the meaning of holding a depreciating asset. The table in section 40-40 is used to work out who holds a depreciating asset. The first nine items are specific items because they apply to particular depreciating assets in different circumstances. Item 10 of the table in section 40-40 applies to any depreciating asset. Item 10 provides that you hold a depreciating asset if you are the owner of the asset, or the legal owner, if there is both a legal and equitable owner. As the specific items of the table apply in preference to the general item, item 10 applies as a default rule.

In this case, the Sellers stopped holding the Sale Interest when the Buyers began to hold that interest. In the facts, item 5 of the table in section 40-40 of the ITAA 1997 is the relevant item to consider.

Item 5 of the table in section 40-40 of the ITAA 1997

Item 5 of the table in section 40-40 of the ITAA 1997 provides that the economic owner, and not the legal owner, is the holder of an intangible depreciating asset that is a right, if the following four requirements are satisfied.

1. There is an intangible depreciating asset which is a right that an entity legally owns (the legal owner)

The intangible depreciating asset is the Sale Interest which is a mining, quarrying or prospecting right that is legally owned by the Seller, and was disposed of under the SPA.

2. Another entity (the economic owner) exercises the right, or has a right to exercise it immediately

The second requirement of item 5 of the table in section 40-40 of the ITAA 1997 is discussed in paragraph 1.35 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM), which introduced Division 40 of the ITAA 1997. Paragraph 1.35 of the EM provides that another entity must exercise the 'subject matter' of the right, or have the right to exercise it immediately.

In this case, as the Buyer is already exploiting the inherent character of the Sale Interest by reason of its activities under the existing Joint Venture and ownership of an interest in the Exploration Licence, it is considered that this requirement is satisfied.

Whilst a clause of the SPA states that the Buyer assumes risk on and from Completion, the rights, entitlements and obligations (together with inherent risks) attaching to the interest were in reality exercisable from the date the SPA was executed. Company B's inherent rights and obligations (including risks) in relation to the mining tenements were not increased, enlarged or enhanced on acquiring the Company A's interest as they already held a greater percentage interest over the same asset. Post execution of the SPA there was no change in the manner or extent to which Company B were exploiting/exercising their rights under the mining tenements.

3. The economic owner has a right to become the right's legal owner

The SPA gives the Buyer a right to acquire the Sale Interest.

Notwithstanding that the SPA contains a condition precedent (namely the Buyer securing shareholder approval), the existence of that condition will not extinguish the Buyer's right to become the legal owner of the Sale Interest until such time as that condition is not met and the SPA is terminated.

The Buyer's contractual right to become the legal owner in this circumstance is sufficient for the purposes of this requirement.

4. It is reasonable to expect that the economic owner will become the legal owner of the right; or the right will be disposed of at the direction and for the benefit of the economic owner.

Taxation Ruling TR 2005/20 Income tax: the interaction of deemed ownership under Division 240 of the Income Tax Assessment Act 1997 with the 'holding' rules in Division 40, considers the meaning of 'reasonable to expect' in the context of item 6 of the table in section 40-40 of the ITAA 1997. Paragraph 28 of TR 2005/20 states that:

"The cases suggest for it to be 'reasonable to expect' something to occur requires a sufficiently reliable prediction that it will occur, or at least an expectation or prediction based on reasonable grounds".

It is the Commissioner's view that the meaning of 'reasonable to expect' in item 6 of the table in section 40-40 of the ITAA 1997 will be the same for the purposes of item 5 of the table in section 40-40.

Whilst the Buyer had an obligation to obtain shareholder approval for the purchase, it is likely that its major shareholders would have been canvassed for their views on such a purchase before incurring the expense and management time associated with negotiations leading to entering into the SPA and convening a meeting of the shareholders.

The shareholder's approved the resolution to acquire with proxies running in favour of the transaction, which supports the reasonable expectation that shareholder approval would be obtained.

Accordingly, it is reasonable to expect that the Buyer will become the legal owner of the Sale Interest from the date the SPA was executed.

In conclusion, all the requirements of item 5 of the table in section 40-40 of ITAA 1997 are satisfied. The Seller will stop holding the Sale Interest from the date it executed the SPA, as that is the date the Buyer started to hold the Sale Interest as economic owner, and it follows that will be the date on which the BAE occurs.

The Balancing Adjustment will take into account the Termination Value of the asset sold under section 40-285 of the ITAA 1997, that amount being taken to be the amount the Sellers are taken to have received under section 40-305 (paragraph 40-300(1)(b), none of the items of the Table being applicable).

The relevant item under the Table in Section 40-305 is Item 6, being the grant of the right pursuant to the SPA to be issued with Company B shares.

It follows that the Balancing Adjustment will be calculated by reference to the market value of the right to be issued Company B shares at the time such a right was granted, together with the cash consideration. This coincides with the time that the Balancing Adjustment occurs.