Edited version of your written advice

Authorisation Number: 1012681423169

NOTICE

The private ruling on which this edited version is based has been overturned on objection.

This notice must not be taken to imply anything about the correctness of other edited versions.

Edited versions cannot be relied upon as precedent or used for determining how the ATO will apply the law in other cases.

Ruling

Subject: Ordinary income- native title payments

Question

Are the native title payments derived by X Trust ("X") in each relevant year the ordinary income or the statutory income of X, such that the native title payments are required to be included in X's Assessable income or net income in each relevant year?

Answer

Yes.

This ruling applies for the following periods

01 July 2010 to 30 June 2011

01 July 2011 to 30 June 2012

01 July 2012 to 30 June 2013

01 July 2013 to 30 June 2014

01 July 2014 to 30 June 2015

01 July 2015 to 30 June 2016

The scheme commences on

01 July 2010

Relevant facts and circumstances

1. The indigenous group are registered Native Title Claimants under the Native Title Act 1993 ("NTA") over the X Claim Area;

2. The claim was lodged with the Federal Court of Australia;

3. The Federal Court has not yet made a determination in relation to the indigenous group's Native Title Claim;

4. X Company is a mining joint venture comprising;

5. X Company is conducting mining in the indigenous people's Native Title Claim Area;

6. To ensure that the Business could be carried out in a mutually beneficial manner, a Binding Initial Agreement ("BIA") was entered into;

The Participation Agreement

7. Following the execution of the BIA and the Letter Agreement, X Company and the indigenous people negotiated and entered into the X Agreement;

8. The X Agreement contains a comprehensive framework that acknowledges and finalises the negotiations between X Company and the indigenous people;

9. The X Agreement was registered with the National Native Title Tribunal as an ILUA;

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-5(4) of the Income Tax Assessment Act 1997

Section 59-50 of the Income Tax Assessment Act 1997

Subsection 59-50(5) of the Income Tax Assessment Act 1997

Subsection 59-50(6) of the Income Tax Assessment Act 1997

Section 237A of the Native Title Act 1993

Section 11 of the Native Title Act 1993

Reasons for decision

All references are to the Income Tax Assessment Act 1997 ("ITAA 1997") unless otherwise stated.

Are the payments to the X Trust made by X Company on behalf of the indigenous people?

The private ruling application proceeds on the premise stated at paragraph 13, which reads:

On a proper interpretation of the Participation Agreement and the relevant payment arrangements between the respective parties, we consider that the applicable X Company pays the Native Title Payments to the X Trust pursuant to a direction or nomination made by the indigenous people.

At paragraph X of your Private Ruling application, it is restated in slightly different terms:

…We consider that for income tax law purposes, the applicable X Company entity pays the Native Title Payments to the indigenous people, who subsequently directs the Native Title Payments to X Trust such that for income tax law purposes, the X Trust receives the Native Title Payments from the indigenous people, and not from the applicable X Company entity.

It follows from the above contention that, at the time X Company makes the payment, the money corresponding to that payment is, in law, the property of the indigenous people (or in the alternative, a debt due to the indigenous people), and in making the payment, X Company is undertaking a specific act for, or on behalf of, the indigenous people. In that respect, the contention corresponds to X Company acting as a specific agent for the indigenous people in making the payment. In essence, your argument is that there is constructive derivation by the indigenous people of the Mining Benefit Payment.

There is an express statutory recognition of constructive derivation in subsection 6-5(4), which states:

In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

Thus, the question that requires resolution is whether or not the Mining Benefit Payments made by X Company to X Trust are paid on behalf of (or at the direction of) the indigenous people. It should be observed that, if the contention you have made is correct, it follows that the indigenous people would have standing to recover the unpaid monies directly from X Trust.

The Participation Agreement governs the obligation of X Company to make the Mining Benefit Payment. An examination of the relevant terms to that agreement is therefore required to determine the issue. In undertaking that examination, it is necessary to read the contract as whole, in order to determine the true intentions of the parties, rather than reading particular clauses in isolation.

It is possible, as you claim, that X Company have contracted with the indigenous people, whereby X Company has agreed to make payments to the indigenous people, and that the indigenous people have then undertaken to pay to the X Trust. Contract law dictates that the indigenous people may enforce the contract between themselves and X Company but, due to privity of contract, the X Trust may not do so because they are not a party to the Participation Agreement.

In the alternative, it is also possible that X Company and the indigenous people may contract whereby X Company agrees to make a payment directly to the X Trust, in consideration for the promises made by the indigenous people to X Company. Again, X Trust cannot enforce the payment by X Company due to privity of contract, but the indigenous people may do so. The law in these situations is well settled- see Carter JW, Peden E, Tolhurst GJ, 2007, Contract Law in Australia, 5^th edn, LexisNexis Butterworths, Australia, paragraphs [16-10] & [16-11].

Ultimately, what will determine the matter will be the nature of the terms in the contract between X Company and the indigenous people. X Company may have, in the alternative to what is contended by you, validly contracted with the indigenous people to make payments directly to the Charitable Trust and the Direct Benefits Trust on its own account, and in consideration for the promises made by the indigenous people under the Participation Agreement.

Clause X of the Participation Agreement says that the Mining Benefit Payments are to be accepted by the indigenous people as final compensation for X Company's mining activities. But that does not mean that X Company has contracted to pay these monies directly to the indigenous people, or to a Mining Benefits Structure on behalf of the indigenous people. It is more likely that X Company has contracted to pay the Mining Benefits payment directly to the Benefit Management Structures, and not on behalf of the indigenous people.

In such a scenario, the indigenous people could still enforce the agreement with X Company, but the orders sought would be for X Company to make the payments directly to the Charitable Trust and Direct Benefits Trust. In this eventuality, the indigenous people would have no standing in any cause of action for X Company to make a payment directly to the indigenous people. It should also be noted that the Charitable Trust and Direct Benefits Trust would have no standing due to privity of contract.

The above is put beyond doubt in the Participation Agreement, where it is expressly provided at clause X that the trustee of the Charitable Trust and Direct Benefits Trust are not party to the Participation Agreement, and therefore, have no such standing in any cause of action enforcing that agreement.

For the concept of constructive derivation to apply, the income must have initially come home to the indigenous people under ordinary derivation principles (CT v Executor & Trustee Agency Co of South Australia (1938) 63 CLR 108 (Carden's case)). The taxpayer need not have actual receipt of the income, but they must at least have a recoverable debt (Gasparin v. Commissioner of Taxation (1994) 50 FCR 73; 94 ATC 4280; (1994) 28 ATR 130, Farnsworth v. Federal Commissioner of Taxation (1949) 78 CLR 504; (1949) 9 ATD 33; Henderson v. Federal Commissioner of Taxation (1970) 119 CLR 612; 70 ATC 4016; (1970) 1 ATR 596; J Rowe & Son Pty Ltd v. Federal Commissioner of Taxation (1971) 124 CLR 421; 71 ATC 4157; (1971) 2 ATR 497).

In FCT v Rozman [2010] FCA 324, the relevant income had come home to the taxpayer in the relevant sense. That is, the taxpayer had a recoverable debt in respect of the particular amount, which was then dealt with, or applied, on their behalf. In summarising the facts of that case, Perram J said:

5. Tredex made sales (presumably of recycled paper) to a United States corporation called Fibre Trade Inc ("Fibre") in the amount of AUD$144,533 and earned commission on containers from another United States' corporation, Triton Container Inc ("Triton"), in the sum of AUD$26,525. Tredex's return for the year ended 30 June 2001 should have included, but did not, those two items as income totalling AUD$171,058. In fact, although that money was earned by Tredex it was never received by it. This is because, at Tredex's direction, the two debtors, Fibre and Triton, paid the moneys owed to Tredex elsewhere.

6. So far as Fibre is concerned, its debt to Tredex (or nearly all of it) was discharged by wire transfers on dates between 10 April 2001 and May 2001 to an account with the Bank of America held in Ms Rozman's name.

Importantly, and for the present purposes, nowhere in the Participation Agreement does X Company confer on the indigenous people a right to the Mining Benefit Payments, such that in the event of a breach by X Company in failing to make a payment directly to a Benefit Management Structure, the indigenous people might have standing in a cause of action to recover the unpaid Mining Benefit Payments directly.

Furthermore, the clauses in the Participation Agreement you refer to in your private ruling request, when read together, demonstrate that the agreement between the parties is for X Company to make a payment only to the Benefit Management Structure, in consideration for the promises made by the indigenous people (that is, the indigenous people have in no circumstances a right of direct receipt from X Company).

It is clear from the clauses referred to above that X Company will only make payment to a Benefit Management Structure if:

• that Benefit Management Structure meets with X Company's stipulations; and

• the Benefit Management structure continues to be strictly administered in accordance with the applicable trust deed.

Additionally, the fact that X Company must agree to the Benefits Management Structure nominated by the Indigenous people, is particularly instructive. That is, the Indigenous people cannot unilaterally determine the Benefits Management Structure. This is inconsistent with the proposition that the indigenous people derived the Mining Benefits Payments directly.

If the income was truly derived by the indigenous people, then it must have unequivocally come home to the indigenous people (that is, it must not be subject to any contingency- Henderson v. FCT 70 ATC 4016). If the income had truly come home, then it would be for the indigenous people to determine how it should be dealt with, including whether or not it might be settled on a trust such as the X Trust.

It is accepted that an agent cannot refuse to pay money over to a third party on the direction of their principal, should they not agree with how the third party deals with that money. An agent must do as directed by their principal.

It is also instructive that X Company reserves the right to have the accounts of the Benefit Management Structures independently audited, and that the Mining Benefits Payment can be suspended should there be non-compliance with the terms of the trust deed.

These reserve powers of X Company are entirely consistent with X Company having contracted to make payments to a trust structure, as opposed to the indigenous people. That is, X Company has contracted in such a way as to reserve oversight of how the Mining Benefit Payments are received and dealt with.

It should also be observed that the identity of the indigenous people will change over time, and in order for X Company to ensure that compensation reaches the indigenous people, both now and into the future, a trust structure is necessary, so that the Mining Benefits Payments can be held for the benefit of all claimants, both current and future.

Conclusion

Two points can be concluded following an analysis of the Participation Agreement.

• Firstly, the destination of the Mining Benefits Payments is not a matter that is at the unilateral discretion, or direction, of the indigenous people. The destination of the Mining Benefit Payments is very much controlled by the stipulations of X Company, as set out in the Participation Agreement and X Company's ongoing audit and review that those stipulations are being met. Paragraph 18.3(c) of the Participation Agreement makes it clear that the Benefit Management Structure is merely nominated by the indigenous people for approval by X Company. X Company may withhold its approval unless the Benefits Management Structure meets with its stipulations; and

• Secondly, after reading the Participation Agreement as a whole, it is very much apparent that X Company has deliberately contracted for the matters set out in the first point, such that the indigenous people cannot access the Mining Benefit Payments other than by resolutions of the trustee, and in accordance with the applicable trust deed of each of the Benefits Management Structure.

For the above reasons, the contention made in your private ruling application, that X Trust constructively derives the Mining Benefit Payments, cannot be accepted.

Significance of section 59-50 of the ITAA 1997 relating to native title benefits

You have previously sought a private ruling, in which it was determined that:

• the native title payments derived by the X Trust are native title benefits in accordance with subsection 59-50(5); and

• X Trust is not an Indigenous holding entity as defined in subsection 59-50(6) of the ITAA 1997, essentially because the X Trust includes non-indigenous beneficiaries.

Section 59-50 has been deliberately inserted to exempt Native Title payments from taxation, so long as the express requirements set out in the section are satisfied. The term 'native title benefit' is a defined term that is limited in application to situations where section 59-50 applies. Its application does not extend to the consideration of income according to ordinary concepts.

How should the native title payments be characterised?

There are no specific provisions in tax law, apart from section 59-50, dealing with the assessability, or non-assessability, of native title compensation receipts. It has been established in your previous private ruling that section 59-50 does not apply to make the native title payments derived by X Trust non-assessable, non-exempt income.

Furthermore, a search of case law shows that there are no cases that specifically discuss the issue in the context of native title. Therefore, it is necessary to return to fundamental principles of tax law to see if the nature of the native title payments can be identified.

Income vs. capital

At paragraph 36 of your private ruling application, you argue that the Native Title payments derived by the X Trust represent amounts received by X Trust on capital account, and do not represent the ordinary income of the X Trust.

It is noted that the correct taxation treatment of payments depends on the characterisation of the payments as either 'income' or 'capital'. There is no definition of 'ordinary income' contained in either the ITAA 1997 or the Income Tax Assessment Act 1936 ("TAA 1936"). The characteristics of ordinary income have been developed by a substantial body of case law, which have identified a number of relevant features.

In G P International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 at CLR 138; ATR 7; ATC 4420, the Full High Court attempted to outline a set of factors which they considered to be indicative of whether an amount was received by an entity on income or capital account:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character if a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging the transaction, venture or business.

Amounts that are periodical, regular or recurrent, relied upon by a recipient for their regular expenditure, and paid to them for that purpose, are likely to be ordinary income, as are amounts that are the product, in a real sense, of any employment of, or services rendered by, the recipient (Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 95 ATC 4691; (1995) 31 ATR 392).

Amounts paid in substitution for salary, or wages foregone or lost, may also be ordinary income (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540 at 568; (1952) 10 ATD 82 at 92; (1952) 5 AITR 443 at 456 (per Fullagar J)).

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The entirety of the circumstances must be considered (Squatting Investment Company Limited v. Federal Commissioner of Taxation (1953) 86 CLR 570 at 627-628 per Kitto J), and the motive of the payer may be relevant to this consideration (Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 at 527-528; (1966) 14 ATD 286 at 293; (1966) 10 AITR 367 at 376).

Two of the fundamental principles used to determine the appropriate taxation treatment of compensation payments are discussed below:

• The general principle relating to the taxation of a compensation receipt is that the receipt takes on the character of the item it replaces (CoT (NSW) v. Meeks [1915] HCA 34; (1915) CLR 568); and

• The fundamental question is what is the 'compensation' being paid for- in essence, what it is trying to replace (Glenboig Union Fireclay Co Ltd v. Inland Revenue Commissioners (1922) 12 TC 427; S.C. 112).

Thus, consideration of the distinction between capital and income indicates that the tax implications arising from compensation payments made pursuant to agreements negotiated between native title groups and companies (such as mining companies) can be summed up as follows:

• If the payment is compensation for extinguishment of native title, or permanent damage and/or interference with the land, then it is capital in nature; and

• If the payment is for temporary impairment or loss of rights and/or the right to an income stream, then it is income in nature.

Ultimately, it will depend on whether the payments are characterised as compensation for extinguishment or impairment to native title, or whether a right to income is being sought. Payments received by native title holders pursuant to commercial exploitation of their native title interests will be taxable.

Extinguishment of native title

The source of native title is found in traditional aboriginal laws and customs, and for this reason, it is highly susceptible to extinguishment. In a recent case, the Northern Territory of Australia v Alyawarr, Kaytetye, Warumungu, Wakaya Native Title Claim Group [2005] FCAFC 135 (29 July 2005), the Full Bench of the Federal Court described extinguishment (at paragraph 64) as follows:

The term 'extinguishment' merely refers to the withholding or withdrawal of recognition of native title rights and interests where the exercise of non-indigenous sovereignty is reflected in legislative acts inconsistent with such recognition.

The extinguishment of native title is regarded as irreversible. This principle is now reflected in the Native Title Act 1993 ("NTA") under section 237A:

The word extinguish, in relation to native title, means permanently extinguish the native title. To avoid any doubt, this means that after the extinguishment the native title rights and interests cannot revive, even if the act that caused the extinguishment ceases to have effect.

The High Court has made it clear that extinguishment is to be governed by the statutory scheme provided in the NTA. Accordingly, native title cannot be extinguished contrary to the NTA (refer to section 11 of the NTA). Thus, by virtue of the operation of the NTA, it is not possible for an agreement between a native title body and another party, such as a mining company, to extinguish native title contrary to the NTA.

In the present case, a native title claim has been lodged by the indigenous people under the NTA, but their claim has not yet been finalised. There is nothing to indicate that their native title has been extinguished in accordance with the NTA.

Purpose of payments

In determining the underlying purpose of the payments, it is necessary to look closely at the Participation Agreement made between the indigenous people and X Company.

It should be noted that the manner in which the payments are characterised in the agreement by the contracting parties is not determinative. In Cliffs International Inc v Federal Commissioner of Taxation (1979) 142 CLR 140; 24 ALR 57; 9 ATR 507; 53 ALJR 321 the High Court held that the description of the payments in the option agreement as 'deferred payments' was not a decisive factor in determining the true nature of those payments. Similarly, in your circumstances, the description given by the parties in the Participation Agreement does not clarify what the payments are for.

The text box at clause X of the Participation Agreement, which is further articulated at clauses X and X states the following:

…the indigenous people have agreed to, and continue to agree to X Company's Business and its expansion in the indigenous people's country. This includes the grants of interests and Approvals to X Company or associated companies generally anywhere within the external boundaries of the claim areas of the indigenous people…

The text box at clause x of the Participation Agreement, which is specifically dealt with at paragraphs x and x, states:

The indigenous people must not do things that would be inconsistent with what has been agreed to. This clause sets out what those things are and includes a prohibition on objecting to certain approvals and interests of X Company or its associated companies, objecting to X Company's Business and helping others to object.

The wording in the Participation Agreement does not recognise that the payments to the X Trust are being paid as consideration for the deprivation of part of a capital asset, such as the extinguishment of native title. Further, the text box at clause X of the Participation Agreement expressly states that:

If the Grant of an Interest or Approval will mean Native Title is extinguished, X Company has to look at alternative Approvals or Interests to see if there is an equivalent alternative that would mean Native Title is not extinguished. An equivalent alternative is one that gives X Company the same security of tenure, can be granted as quickly and allows X Company to do what it needs to do.

If X Company cannot find a non-extinguishing equivalent alternative to the Interest of Approval it wants, then the Interest or Approval can be granted, even if Native Title is being extinguished.

When an ILUA is registered, Native Title should generally not need to be extinguished. This is one of the reasons why X Company and the indigenous people want an ILUA Registered over the whole of the Agreement Area.

On an analysis of the Participation Agreement, it can be seen that, in return for providing the payments:

• the mining operators are able to secure necessary approvals, and/or removal of objections- clause x);

• that the indigenous people will agree with, consent to and support, and continue to agree with the existing operations, including all X Company's existing titles (clause x); and

• secure agreement that the indigenous people will not interfere with X Company's business.

It is considered that the true purpose and effect of the payments under the Participation Agreement are to procure the accommodation and co-operation of the indigenous people, allowing X Company to undertake its mining operations in an unfettered manner.

There is nothing in the Participation Agreement that demonstrates a permanent extinguishment of native title. Rather, the agreement demonstrates the utilisation of native title to generate an income stream for the benefit of the indigenous people. Importantly, clause x of the Participation Agreement expressly states that acquisitions of native title, including extinguishment, are to be avoided where possible.

The above discussion suggests that the payments under the agreements are providing benefits, as opposed to consideration for, the extinguishment and impairment of native title rights and interests. It is considered that the ongoing payments are assessable as ordinary income under section 6-5.

The decision in Nullaga distinguished

Nullaga Pastoral Company Pty Ltd v FC of T 78 ATC 4329; (1978) 8 ATR 757 ("Nullaga") is a 1978 decision of Wickham J of the Supreme Court of Western Australia that applies the earlier decision in Barrett v Federal Commissioner of Taxation [1968] HCA 59; (1968) 118 CLR 666; 15 ATD 149; 10 AITR 685 ("Barrett").

Nullaga considers certain compensation payments made by mining joint venturers to a taxpayer company (the Nullaga Pastoral Company), which owned and operated a successful farming property. While the land was privately owned by the taxpayer, the mineral rights in relation to the property belonged to the Crown.

A joint venture exploration and mining company was granted exploration rights for five years; as consideration for those rights, the taxpayer company was to receive $10,000 annually. If the joint venturers started mining, the annual payments were to be replaced by an amount based on each ton of ore removed. The joint venturers were interested in more than one-third of the area of the farm, and their proposed mining activities would considerably interfere with farm planning, operation and development.

The first two payments of $10,000 were assessed by the Commissioner as income. The Commissioner did not argue that the payments were assessable as royalties, but that the periodic nature of the payments was enough to cause them to be analogous to payments for a lease or licence, and therefore income as rent.

In reaching a decision, the terms of the agreement were carefully considered. However, Wickham J considered that the payments were of a capital nature. It was held that the payments were not income because they were compensation for interference and damage to the land, and diminution in its value resulting from the mining. In his opinion, the money was paid and received as consideration for the deprivation of part of a capital asset, and in order to replace that capital.

Nullaga and Barrett distinguished

At paragraph x of your private ruling application, you argue that there are factual similarities between the circumstances arising in Nullaga, and the circumstances described in your private ruling application. The details of the current situation indicate that, while there are commonalities with Nullaga, there are some material differences between that decision and your situation, and it is considered that this distinction leads to the different outcome.

A fundamental difference between the above decisions, and the circumstances in your PBR application, is that in Nullaga the payments were made as compensation for damage to property that formed part of the profit-yielding structure of the taxpayer. In both Nullaga and Barrett, the taxpayers were conducting successful and ongoing farming operations, and the mining operations impacted on the use of the land that was being used for those farming operations. For example, in Nullaga the mining venture affected more than a third of the farm, and it was acknowledged that this would considerably interfere with the planning, operation, and development of the farming business.

A further difference is that the wording of the agreements in Nullaga and Barrett were very clear as to the purpose of the payments. In both cases, the wording acknowledged that the owners of the land were conducting farming operations on the land, and that the land was damaged and/or could not be used for farming due to the mining activities.

Additionally, in both Nullaga and Barrett, the taxpayers were not only owners of the businesses conducted on the land; they were the owners of the farming properties and had exclusive possession of the land. As owners, they were entitled to compensation for the damage and interference to their rights and interests.

Finally, the taxpayers in Nullaga and Barrett were not required to provide any consideration for the payments they received. All of the circumstances in both cases supported the conclusion that the payments were compensation for the damage to the property belonging to the taxpayers.

The above differences are in contrast to your situation. It is considered that the wording in the Participation Agreement does not recognise that the payments are being paid as consideration for the deprivation of part of a capital asset and in order to replace that capital asset that is part of the taxpayer's profit-yielding structure.

There is no acknowledgement of the native title groups conducting any income earning activities on the land, or any evidence that any such operations are, or were, carried on.

Finally, as claimants, the indigenous people are not yet entitled to compensation for the effect on native title rights and interests. A range of consideration is provided under the Participation Agreements as a condition precedent to payments being made, and as a reward for the payments to continue for the life of the projects.

Conclusion

Therefore, in consideration of the above, it is concluded that:

• Payments made by X Company in accordance with the Participation Agreement to the X Trust are not made pursuant to a direction or nomination made by the indigenous people. Rather, the requirement for payment to be made to the X Trust forms an integral part of the agreement to such an extent that they represent income of the X Trust; and

• Upon proper examination, the character of the payments to the X Trust by X Company under the Participation agreement is ordinary income, and should be taxed accordingly.