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ATO finalises its view on taxation of natural resource income paid to non-residents

11 December 2020 

In brief

The Australian Taxation Office (ATO) has issued Taxation Ruling TR 2020/5 which considers the tax treatment of natural resources income which is derived by a non-resident and calculated by reference to the value or quantity of natural resources produced and/or sold (“override royalties”). This Ruling finalises the ATO’s preliminary views that were originally issued in draft form in 2016 (TR 2016/D3). Notwithstanding the nearly four years that it has taken to finalise the Ruling, there have been limited substantive changes to its contents.

In short, the Ruling takes a relatively expansive interpretation of already broadly drafted tax provisions and suggests that in most circumstances payments made in respect of override royalties will be natural resource income (and therefore deemed to have an Australian source), subject to natural resource withholding (if paid to a non-resident), and that most (but not all) of Australia's double tax treaties provide Australia with taxing rights over this income under the “income from real property” article.

In detail

TR 2020/5 considers the scope of Australia's natural resource income deemed source rule (section 6CA of the Income Tax Assessment Act 1936 (ITAA 1936) and non-final withholding tax (section 12-325 of Schedule 1 of the Taxation Administration Act 1953 (TAA)) rules, as well as the application of Australia's double tax agreements' income from real property articles (i.e. whether Australia is allocated taxing rights over these payments under its network of tax treaties).

Background

Australia's domestic tax law provides (section 6CA of the ITAA 1936) that certain income calculated in whole or in part by the value of natural resources produced or recovered in Australia will be deemed to have an Australian source (i.e. it will be subject to tax in Australia irrespective of common law source considerations). The TAA then provides for a non-final withholding tax to apply to such payments when they are paid to non-residents, effectively operating as a collection mechanism for income that is deemed to have an Australian source (section 12-325 of Schedule 1 of the TAA). As an administrative point, this withholding is not at a fixed rate; instead payers are obliged to request a withholding rate from the Commissioner and anecdotally this rate generally is, or is close to, the corporate tax rate of 30 per cent.

Position taken in Ruling

The Ruling is principally concerned with "override royalties" which is an industry term with a more precise meaning but which is used in the context of the Ruling to include arrangements under which payments are made to a non-resident where the payment is calculated by reference to the value of resources produced or recovered in Australia. Override royalties under this definition would likely include related types of arrangements such as certain smelter returns and other types of royalty financing.

Under the interpretation taken in the Ruling, income and payments made under the majority of override royalties (and potentially also net smelter returns) would be considered to be natural resource income, and therefore would also be subject to withholding under the natural resource payment regime.

Importantly, the Ruling does not consider the interaction of the deemed sourced and collection provisions with Australia's debt-equity rules. It is possible that override royalties granted as part of a financing arrangement may instead be subject to withholding under interest or dividend provisions.

The Ruling also considers the application of Australia's double tax agreements which all include “income from real property” articles and the majority of which treats as real property “a right to receive variable or fixed payments either as consideration for or in respect of the exploitation of, or the right to explore for or exploit, mineral, oil or gas deposits, quarries or other places of extraction or exploitation of natural resources...”. Broadly, the Ruling suggests that most (but not all) “income from real property” articles are broadly aligned with section 6CA / section 12-325 and confirms that the scope of these articles is not broader than the relevant domestic law provisions.

However, certain Australian treaties do have income from real property articles that differ from the norm (discussed above). The Ruling identifies those differing treaties as the treaties that Australia has with the United States (US), Ireland, Malta and the Republic of Korea, but only considers the application of the US treaty. The key difference between the income from real property article in the US treaty and the "ordinary" income from real property article in other treaties is that the US treaty only affords Australia with taxing rights over payments made to a US resident where the recipient of the payment also possesses rights to exploit or explore for natural resources (i.e. active participation).

Whilst the treaty does not consider the specific application of the Irish, Maltese or Korean treaties, a review of these treaties reveals that their income from real property articles include a similar requirement for the recipient of real property payments to possess (and / or exercise) the right to work the place of exploitation or exploration of natural resources.

The takeaway

This Ruling confirms the Commissioner's views, first publicly expressed in 2016, that the natural resource income provisions of the tax law should generally be interpreted broadly to capture most forms of royalty-type payments to non-residents. This means that companies making such payments (often gold or precious metal mining companies) may be required to request a rate of withholding from the Commissioner, and withhold accordingly, and recipients of these payments may be obliged to lodge Australian tax returns.

Importantly, the Ruling leaves many technical questions unanswered including the interaction of these rules with Australia's debt-equity rules, the deductibility of these payments for the payer, whether the arrangements are taxed as financial arrangements (TOFA), and what, if any, deductions may be available for the recipient of these payments. There are also significant commercial questions which will need to be considered including whether the relevant commercial agreement permits a withholding of taxes, and whether any gross-up or indemnity payment may be required.

It is useful to finally have a concluded view from the Commissioner on this area of the law. However, given the broader tax technical and commercial issues raised by this interpretation, taxpayers paying or receiving income of the type discussed in this Ruling may need to carefully consider the appropriate taxation treatment on a holistic basis.

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