Edited version of your written advice

Authorisation Number: 1051207459093

Date of advice: 28 March 2017

Ruling

Subject: Payments received from contract - Revenue or Capital

Question 1

Are amounts received as a “Royalty” pre-payment under the terms of the contract assessable income?

Answer

Yes

Question 2

Are amounts received by a primary producer for the sale of loose aggregate by the tonne assessable income?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts

The partnership is not the owner of the land containing the extraction area.

The land is owned by X members of the partnership.

The land that the extraction licence grants access rights to is 2 lots in an Australia state.

The other business activities being conducted by the Owners are primary production.

The Owners of the land were approached by company XYZ to obtain the loose aggregate.

XYZ have been granted an exclusive licence by the partnership to extract and remove a natural resource from the extraction area contained in the property.

The contract commencement date is November 20XX.

You do not actively participate in the extraction activities.

You will receive a “Royalty” pre-payment (excluding GST) per annum, which is paid in equal monthly instalments.

You will receive a “Royalty” of $ per unit (excluding GST) for the extracted natural resource.

You will raise purchase orders to have the amount paid by XYZ after receiving the necessary documentation.

XYZ is responsible for determining the amount of the natural resource that has been extracted from the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-25

Income Tax Assessment Act 1997 Section 15-20

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 115-25

Reasons for decision

Question 1

Summary

Amounts received by way of “Royalty” are assessable income when the royalty is provided as a result of a contact right to enter the land to harvest or remove a product

Detailed reasoning

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the financial year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

● are earned

● are expected

● are relied upon, and

● have an element of periodicity, recurrence or regularity.

It was noted in Federal Commissioner of Taxation v McNeil [2007] HCA 5 (McNeil's case) at paragraphs 20 and 21, that:

… whether a particular receipt has the character of the derivation of income depends upon its quality in the hands of the recipient, not the character of the expenditure by the other party. …

… as a general proposition, a gain derived from property has the character of income and this includes a gain to an owner who has waited passively for that return from property.

It is considered that you have voluntarily entered into a commercial agreement by way of a contract, with XYZ to allow them exclusive access rights to the extraction area for the purpose of removing loose aggregate from the land held by the owners.

Section 104-35 of the ITAA 1997 identifies that capital gains tax (CGT) event D1 happens if you create a contractual right or other legal or equitable right in another entity.

The timing of this event is when you enter into the contract or create the other right. As it is not possible to acquire this CGT asset 12 months prior to the CGT event taking place the discount capital gains provisions under section 115-25 of the ITAA 1997 can not apply.

Section 6-25 of the ITAA 1997 identifies that when more than one provision applies an amount can only be included once in your assessable income and that the provisions on ordinary income will prevail.

Generally, situations that result in the creation of royalty rights and resulting in payments being made for these rights are in forestry operations.

The treatment in these instances for when a “royalty” is received by a taxpayer from the grant of a right to fell timber on land owned by the taxpayer is that these amounts are assessable income of the taxpayer (subsection 25(1) ITAA 1997). The royalties are assessable income of the recipient even if the taxpayer granting the right is not carrying on a business of forest operations.

In your circumstances you have granted a right to XYZ to have loose aggregate extracted on your land. Under the terms of the contract XYZ are required to make a monthly pre-payment to you in order to maintain exclusive access to this right.

Section 15-20 of the ITAA 1997 includes in your assessable income amounts that you receive as or by way of royalty within the ordinary meaning of 'royalty' if the amount is not assessable as ordinary income under section 6-5 of the ITAA 1997.

In your circumstance, the “royalty” pre-payment amounts are not handled under the royalties provisions (Section 15-20) of the ITAA 1997. These payments take on the characteristics of being income in nature, as they are regular, earned, expected and can be relied upon. As such these amounts would form part of your ordinary income and be assessable under section 6-5 of the ITAA 1997.

Therefore you will need to include these amounts as ordinary assessable income in your tax return.

Question 2

Summary

Income received from the sale of loose aggregate by the tonne is assessable income in the hands of the partnership.

Detailed reasoning

As outlined above, income that is regular, earned, expected and can be relied upon is captured under the ordinary income provisions of section 6-5 of the ITAA 1997.

In your circumstances under the terms of the contract you also receive an amount per tonne of loose aggregate that is removed from the extraction area by XYZ.

You do not actively participate in the extraction activities that are conducted by XYZ, however you are responsible for the raising of invoices in order to have payment made.

The amounts being received from XYZ as a result of these activities are assessable under the income provisions as ordinary income. This is because although you are not carrying on a business which includes the sale of loose aggregate, you have entered into a commercial agreement with XYZ.

Your significant intention or purpose of entering the commercial agreement was to derive ordinary income from the commercial transaction. This means the payments to you under the agreement are assessable as ordinary income under section 6-5 of the ITAA 1997.