Publications / Resources

26 Aug 11
ATO ruling on farm-out arrangements - ten years in the making, worth the wait?

Download PDF

The ATO released the second of two draft rulings relating to the tax treatment of farm-out arrangements for exploration activities in the resources industry on 24 August 2011.

A ‘farm-out’ typically involves an agreement between:

  • a holder of a mining tenement (the farmor) wanting to explore that tenement, and
  • another party (the farmee) who may expend funds exploring the tenement, in exchange for an interest in the tenement.

Previous ATO position

Mining tenements acquired before 1 July 2001 are normally treated as CGT assets.

The ATO has a longstanding ruling IT 2378 on the CGT consequences on farm-out arrangements. Under that ruling while the ATO did consider that the farmor would be subject to CGT based on the market value of the tenement at the time of entering into the agreement it also accepted that:

  • the amount of exploration commitment did not necessarily indicate that there was significant market value on entry of the agreement, and
  • in the early ‘grass roots’ exploration stage it was quite possible that the market value would only be nominal.

This ruling will continue to apply to the holders of those pre 1 July 2001 tenements but does not apply to tenements acquired from 1 July 2001.

Those post 1 July 2001 tenements are not taxed as CGT assets but are depreciating assets and are dealt with under the Uniform Capital Allowance (UCA) rules. Given the ruling does not apply to them there has been considerable uncertainty as to the tax implications including a real risk that the tenement holder (the farmor) could have a tax liability based on the market value of the tenement at the time of transfer (which would typically be after significant expenditure had occurred).

The draft rulings, while complex, provide some clarity around these issues as well as providing a detailed analysis of how GST applies to farm-out arrangements.

What is the new ATO position?

While the old ruling on CGT treatment was a mere 8 pages long, the new drafts total 100 pages, reflective of the complexity and more comprehensive nature of the new draft rulings.

Having said that, at least for farm-outs that occur while in the exploration phase, the net tax outcomes should on the whole be considered to be favourable to the industry.

In most cases, tenement holders (the farmors) should only be taxed on amounts, if any, that they actually receive from the farmee. In basic terms the value of the exploration benefits (i.e. the obligations on the farmee) will, to the extent it is income to the farmor, be offset by the market value of the interest in the mining tenement transferred by the farmor to the farmee under the farm-in arrangements. Through some complex reasoning, the ATO conveniently takes the position that, ignoring any payments to the farmor, the value of these exploration benefits and the value of the interest in the tenement which is being transferred, is the same. Therefore, there will be a complete offset when interests are transferred meaning no tax liability will arise to the farmor on the transfer of interests in the mining tenements other than for amounts actually paid to the farmor.

When in exploration phase, the farmee should be entitled to a deduction for exploration both for any payments to the tenement holder (the farmor), as well as expenditure on exploration to earn the interest.

While there are GST consequences, provided the contractual arrangements deal with these appropriately and relevant tax invoices issue, there should be no net GST or timing costs from the arrangements, at least where both parties account for GST on an accruals basis.

The draft ATO rulings, while mechanically complex, take a position that means that at least in the exploration phase, farm-in arrangements will not trigger any unfunded net tax obligations for the farmor irrespective of the market value of the tenement.

Immediate transfer farm-out arrangements (MT 2011/D1)

The first draft ruling issued, Miscellaneous Tax Ruling MT 2011/D1 (27 July 2011), gave the ATO’s views on the income tax and GST implications from so called ‘immediate transfer farm-out arrangements’. That is, the ruling dealt with circumstances where the part interest in the mining tenement is transferred from the farmor to the farmee at the start of the arrangements.

For income tax, the ATO concludes that the entering into a farm-out arrangement is a sale by the farmor of an interest in a mining tenement. For that sale, the farmor is taken to receive the market value of exploration benefits to be provided to it by the farmee (being a taxable amount). However, there is an offsetting deduction to the farmor for the market value of the interest in the mining tenement transferred to the farmee, on the basis that the giving of that property secures the exploration benefits (being the obligations on the farmee to spend funds on exploration). The Ruling makes it reasonably clear that, ignoring any payments to the farmor, the market value of the tenement interest and the market value of the exploration benefits are the same and therefore has the effect of offsetting each other (i.e. no excess or shortfall after the offset). Consequently only amounts paid to the farmor will be taxable.

The practical implication is that there should only be a net assessable amount to the farmor where the farmor receives a cash payment (rather than the farmee merely incurring exploration expenditure on the project).

The ATO applies similar methodology for the farmee, namely that a farmee is entitled to an up front deduction for the cost of acquiring an interest in the tenement based on the value of exploration benefits. However, there is an offsetting assessable amount on the basis that the value (of the interest in the tenement) received is, in effect, income as a ‘reward’ for the farmee providing exploration benefits. As would be expected, the farmee is also entitled to an exploration expenditure deduction for its actual exploration expenditure.

Again, while the reasoning is complex and arguably quite novel, in a practical sense the outcome should be that the farmee receives a net deduction for the amount actually spent, as part of the farm-in arrangements.

For GST purposes, the Commissioner has taken the view that there are offsetting barter transactions between the parties. Therefore, provided the agreements are appropriately drafted to include gross up clauses, preferably nominating offsetting values and enable the issue of tax invoices, there should be no net GST impact on either party.

Deferred transfer farm-out arrangements (MT 2011/D2)

The second draft ruling released on 24 August 2011, MT 2011/D2, deals with the more usual farm-out arrangement where the interest in the tenement is only transferred after exploration expenditure has been incurred by the farmee.

In general terms, the ATO takes a similar approach to that for immediate transfer farm-out arrangements, such that income tax should only be payable where there are cash outcomes. Again, there are offsetting GST amounts which necessitate ensuring that this is provided for and any administrative issues are dealt with in the arrangement and associated documentation.

The actual mechanics are again quite complicated, especially where there are up front payments from the farmee to the farmor for one or both of:

  • the grant of the right to subsequently acquire an interest in the tenement, and
  • the grant of rights to use and access the tenement.

In respect of these grants, the ruling provides that, at the time of the grant, there is likely to be various CGT events for the farmee and farmor, although if a tenement transfer ultimately occurs, the upfront taxable CGT event for the farmor may be retrospectively reversed and replaced with a taxable revenue gain in the later transfer year under the UCA rules. Further, in some circumstances it is possible that the farmee may only receive a capital loss for the amounts paid up front rather than a revenue deduction.

Traps and unresolved issues

While, on one view, the Commissioner’s approach gives a pragmatic and potentially favourable taxation outcome there are some circumstances where there can be significant adverse outcomes.

For projects moving from exploration to development there is a real risk for adverse tax outcomes under the new rulings. In particular, the ATO position involves a gross assessable amount based on the market value of the tenement to both the farmee and farmor and an offsetting deduction under the exploration rules. However, the ruling notes, for example, that if at the time the farmee first holds the mining tenement, it does not then use the tenement for exploration, the offsetting immediate deduction will not be available. In such a case the deduction may be spread over the life of the tenement causing a significant tax timing disadvantage and cash flow issues.

This is a particular risk for deferred transfer arrangements where the transfer occurs after completion of most or all of the exploration has occurred.

Another trap for the farmee in deferred transfer farm-out arrangements is the potential for any upfront payments to not give rise to a revenue deduction but only capital losses.

The GST issues need to be carefully considered and documented, particularly if the farmor accounts for GST on a cash basis, and any timing issues considered and managed.

Duty issues

The stamp duty consequences of farm-out arrangements also need to be carefully considered.

These vary from State to State and also depend on the phase of the project. While, for example, in Queensland, transfers of exploration tenements are generally not subject to duty, this is not the case in other jurisdictions such as New South Wales (at least until 1 July 2012) and, except for limited circumstances, Western Australia.


The draft rulings may generally be welcomed by the industry as a whole as they potentially give favourable outcomes in some simple arrangements and can remove the risk of unfunded tax costs where a project has significant value. However, there remain circumstances where adverse and unexpected tax and duty outcomes may arise.

For this reason, particular care needs to be taken in negotiating and structuring new farm-out arrangements.

Existing arrangements

Also existing arrangements should be reviewed, despite the rulings only formally applying prospectively, with a view to benefit from the certainty or new approaches taken by the ATO in the rulings.

McCullough Robertson Boardroom workshops

McCullough Robertson resources partners Hayden Bentley and Damien Clarke will be holding Boardroom workshops in Sydney and Brisbane to work through the implications, pitfalls and opportunities presented by the new approach in structuring and financing exploration projects.

To register your interest in the Boardroom workshops for:

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

Download PDF

In this section


For enquiries please contact: