Yesterday the Commissioner published two rulings dealing with the GST treatment of farm-out arrangements;  MT 2012/1 Miscellaneous taxes: application of the income tax and GST laws to immediate transfer farm-out arrangements and MT 2012/1 Miscellaneous taxes: application of the income tax and GST laws to deferred transfer farm-out arrangements.  The rulings were initially in draft form in MT 2011/D1 and MT 2011/D2.  The rulings also refer to the newly issued A New Tax System (Goods and Services Tax) (Particular Attribution Rules where supply or acquisition made under a contract subject to preconditions) Determination 2012, which are to apply in certain circumstances in place of the attribution rules in Division 29 of the GST Act

Background to farm-out arrangements

The Rulings describe farm-out arrangements as follows:

• they are common in the mining and petroleum industries and broadly speaking are arrangements entered into for the purpose of facilitating exploration for the discovery of minerals and petroleum resources.
• A typical arrangement provides for the owner of an interest in a mining tenement (the farmor) to transfer a percentage of that interest to another party (the farmee) if the farmee meets specified exploration commitments or contributes monetary payments.
• Often the commercial driver for such an arrangement from the farmor’s perspective is funding.  That is, the farmor giving up future economic benefits, in the form of reserves, in exchange for a reduction in future funding obligations.  For the farmee, it provides an opportunity to acquire an interest in a mining tenement.
• Broady, farm-out arrangements may be divided into two types, being “immediate transfer” and “deferred transfer” farm-out arrangements.

Under an immediate transfer farm-out arrangement, an obligation to transfer a percentage interest in a mining tenement from a farmor to a farmee arises for the farmor upon entry into the agreement.  Typically, the farmor and farmee will also establish a joint venture or, if a joint venture is already in existence, the farmee will become a joint venturer.  In return for the transfer of the interest in the mining tenement, the farmee will undertake exploration commitments or contribute to a joint venture account on the farmor’s behalf for that purpose.  The farmee may also make cash payments to the farmor or to third parties to meet expenses incurred by the farmor.
The ruling considers that an immediate transfer farm-out arrangement is treated as a a sale of a percentage interest in a mining tenement by a farmor to a farmee, in return for the non-cash benefit of the services from the farmee undertaking exploration commitments (the “exploration benefit”), constructive receipt of cash payments made by the farmee to a joint venture to meet cash calls to fund expenses and any additional cash payments made by the farmee to the farmor
The GST implications are considered at paras [58] onwards, and can be summarised as follows:

• under the terms of an immediate farm-out arrangement, there is a supply by the farmor to the farmee of an interest in a mining tenement;
• if the supply of the interest is for non-monetary consideration only (ie, the exploration benefit), that is a barter transaction – the farmee also makes a supply to the farmor of the exploration benefit for non-monetary consideration.  On the basis that the parties are at arm’s-length, the GST-inclusive market value of these supplies will be the same.
• the supply of the interest will also be for monetary consideration if the farmee; makes cash payments to the farmor, makes cash payments to third parties to meet expenses incurred by the farmor (thereby relieving the farmor from meeting those expenses) or makes cash payments to the joint venture account on the farmor’s behalf.
• if total consideration is known, and the farmor or farmee accounts on a non-cash basis, the attribution rules in A New Tax System (Goods and Services Tax) (Particular Attribution Rules where supply or acquisition made under a contract subject to preconditions) Determination 2012 apply in place of the attribution rules in Division 29 of the GST Act
• the going concern provisions may be available.

Under a deferred transfer farm-out arrangement, the transfer of the interest only occurs after the farmee has met all of the exploration commitments and any payment requirements to earn that interest (referred to as the “earn-in requirements) within a specified period of time.  The farmee is able to terminate the agreement at any time provided the mining tenement is in good order at the time of giving the notice of termination.  If the farmee does not satisfy the earn-in requirements during the period, the farmee does not earn the specified interest in the mining tenement.
The ruling views a deferred farm-out arrangement as the farmor granting the farmee a right (akin to an option) to acquire an interest in a mining tenement.  The farmee’s exercise of that right is subject to the farmee satisfying the earn-in requirements within the earn-in period.

The GST implications are dealt with at para [83] onwards in the ruling, and can be summarised as follows:

• the grant of the right to acquire an interest in the mining tenement is a supply
• on the exercise of the right, the supply of the interest in the mining tenement is a taxable supply.
• the attribution of GST is determined pursuant to A New Tax System (Goods and Services Tax) (Particular Attribution Rules where supply or acquisition made under a contract subject to preconditions) Determination 2012 apply in place of the attribution rules in Division 29 of the GST Act