Depending on the terms of the arrangement, overriding royalties may not be considered a ‘royalty’ as defined under domestic Australian tax law nor a common law royalty. Similarly, they may also fall outside the definition of ‘royalty’ under a tax treaty with Australia, although ultimately this comes down to the specific definition contained in the relevant treaty. However, they may be regarded as ‘natural resource income’ which gives rise to Australian source and withholding implications where, broadly, an amount is derived by / paid to a foreign resident, and is worked out wholly or partly by reference to the value or quantity of natural resources produced or recovered in Australia.
From the foreign interest holder’s perspective, natural resource income is deemed to have an Australian source and prima facie is assessable income. Relevantly, this outcome may be impacted by the application of any relevant tax treaty between Australia and the foreign entity’s jurisdiction, and it could be the case that such income is not subject to Australian income tax having regard to Australia’s taxing rights under the particular tax treaty. Based on our experience, this requires careful consideration and analysis of the specific facts and circumstances of the overriding royalty arrangements and the tax treaty interaction.
A payer of overriding royalties needs to be aware of their potential withholding obligations, which will need to take into account whether the payments are a ‘royalty’ or ‘natural resource income’ given they are subject to different withholding rates.
Companies that are parties to such arrangements should review their terms to ensure all pertinent tax issues have been appropriately addressed.