The ATO released the long awaited draft Practical Compliance Guideline (PCG 2016/D17)on exploration expenditure on 14 November 2016. The Guideline provides guidance on how the ATO will allocate compliance resources to income tax deductions for exploration expenditure.
The Guideline makes it clear that whilst there is no bright line test, expenditure incurred well before a decision to mine is likely to be uncontroversial and unlikely to be challenged. Accordingly, much of the focus relates to expenditure incurred around the time a decision to mine is made.
A key focus of the Guideline is the extent to which the taxpayer has systems in place governing progression through the various phases leading to development and subsequent operation of a mine or petroleum field. Larger taxpayers may be at an advantage here as they are likely to have tighter internal procedures in place which clearly demonstrate the requirements to progress from one phase to the next. They are also likely to clearly identify and require specific approvals for expenditure that is not necessary for the current phase (for example, costs for purchasing long lead items).
A taxpayer will likely be low risk where it has such internal governance procedures in place and it can demonstrate the internal tax processes use the general governance processes to determine expenditure that cannot be claimed as exploration expenditure. For example, if internal processes clearly set out what is required for a feasibility study and this aligns with the section 40-730 deduction for economic feasibility studies then this will go a long way to keeping the ATO happy. Additional assurance will be provided, if long lead items for example, require separate approval and the taxpayer can demonstrate that all such approvals have been identified and taken into account in determining its deduction for the feasibility expenditure.
Unfortunately, the news is not so good for smaller taxpayers that do not have sufficiently robust internal governance processes (to enable ATO assurance that the relevant non-exploration expenditure can be identified). To the extent they are audited then they will need to substantiate exploration deductions which could prove difficult. Such taxpayers may wish to consider what they can do now to better document and support their exploration deductions in case of audit. This may assist in preventing a line by line analysis of any exploration deductions! This is particularly so, given the ATO comments that contemporaneous documentation is viewed much more favourably than documentation prepared at the time of audit.
Having established then general principles, the Guideline provides a particular emphasis on the following high risk items:
- claiming of 8-1 deductions for expenditure that is too soon or too late – it would seem that this is focused on claims which wouldn’t qualify for an exploration deduction under 40-730 and are incurred too early (ie, before a business is commenced) or too late (ie they are capital in nature because they are incurred in securing a benefit of an enduring nature);
- long lead assets – as noted above, the ATO will want an assurance that processes are in place to identify such items;
- feasibility studies – the ATO will want assurance these studies do not go beyond what is necessary to determine economic feasibility – as noted above, the internal governance procedures may demonstrate this;
- financing feasibility – if the ability to obtain external finance is not a prerequisite to a decision to mine then the ATO considers this type of feasibility expenditure problematic;
- expenditure after the decision to mine – the ATO notes that a decision to mine can be made before this is formally documented and various factors are outlined on when this can happen – again, larger taxpayers may be at an advantage as internal processes may make this relatively clear;
- project management costs – especially where a taxpayer division has finished its stage of feasibility work but continues to do additional work not necessary for the feasibility study.
The Guideline provides that the ATO will generally scrutinise expenditure claims that are in these categories, but if the taxpayer has appropriate governance processes in place, by way of a sample check as an initial step
Submissions on the draft are due by 9 December.