Further tax complexities for deferred farm-out arrangements
The Australian Taxation Office has now released a second draft ruling on farm-out arrangements – MT 2011/D2 – which highlights additional tax complexities when the acquisition of an interest by a farmee in a mining tenement is deferred.
As discussed in Farm-out arrangements in ATO’s sights, the ATO’s view of farm-out arrangements as essentially involving a barter transaction gives rise to compliance costs and the potential for unanticipated and unfunded income tax or GST liabilities. Those difficulties are exacerbated when applying those principles to deferred farm-out arrangements because the farmee will incur expenditure in advance, and without certainty, of obtaining any interest in the farmor’s mining tenement.
Under the ATO analysis, a farmee provides “exploration benefits”, ie. the benefits that flow from the farmee’s expenditure commitments, in return for the right to acquire an interest in the mining tenement to be provided by the farmor. In a deferred farm-out arrangement, these benefits are provided by the farmee in advance of the provision of the interest in the tenement by the farmor. Under ordinary principles, GST on a supply is triggered on receipt of any of the consideration for the supply. Accordingly, in a deferred farm-out arrangement, this might trigger an up-front GST liability for the farmor that is not matched by input tax credits for GST in respect of the acquisition of the exploration benefits from the farmee down the track. To address this, the ATO has proposed a new legislative instrument that will defer the attribution of GST on the supply of the interest in the tenement until the farmee exercises its right to acquire the interest.
But what happens if the interest in the tenement is never provided? In this case, the ATO takes the view that as there is no supply of an interest in the mining tenement, there are no GST consequences for either party. However, in contrast, the farmor is still viewed as receiving an assessable non-cash business benefit from an income tax perspective reflecting the exploration benefits provided, although this may be reduced to nil if the farmee’s expenditure would have been deductible to the farmor if the latter had incurred the expenditure.
Some of the other issues with the draft ruling include:
- identifying the value of the mining tenement/exploration benefits at the time of entry into a farm-out agreement;
- the potential for GST mismatches where the supply of the interest in the mining tenement qualifies for going concern relief such that no GST is payable by the farmor, but the farmee remains liable for GST on the supply of the exploration benefits; and
- the possibility that a farmee will be assessed on the full value of the exploration benefits when it obtains an interest in the mining tenement, but only receive a deduction for the acquisition over an extended period.
If you are interested in this development and would like to attend a briefing which will discuss the rulings in detail, please send us an email or contact a member of our Energy and Resources Industry Division.”