On 17 December 2014, the Commissioner of Taxation released Taxation Ruling 2014/9: “Petroleum resource rent tax – what does "involved in or in connection with exploration for petroleum" mean”? The ruling confirms the Commissioner’s view that feasibility expenditure is not deductible under section 37 of the Petroleum Resource Rent Tax Assessment Act 1987.
The release of TR 2014/9 follows extensive industry consultation on PRRT “exploration” deductions following the AAT decision in ZZGN v Commissioner of Taxation  AATA 351 (ZZGN).
The ATO’s Decision Impact Statement for ZZGN, which was also issued on 17 December 2014, indicates that TR 2014/9 incorporates the Tribunal’s views on the ordinary meaning of “exploration” and the expression “in connection with exploration for petroleum” in section 37 of the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTA Act).
Meaning of “involved in or in connection with exploration for petroleum”
The key principles stated in TR 2014/9 are as follows:
- The words “exploration for petroleum” in section 37 of the PRRTA Act bear their ordinary meaning, which is “limited to the discovery and identification of the existence, extent and nature of petroleum”. “Exploration” will include “searching in order to discover the resource, as well as the process of ascertaining the size of the discovery and appraising its physical characteristics”.
- The expression “involved in or in connection with” encompasses operations and facilities that have a “reasonably direct relationship” with exploration for petroleum. It does not include operations and facilities carried on or provided to evaluate a discovery, including to evaluate the economic feasibility or most viable method of development.
- A Final Investment Decision (FID) is not the dividing line between expenditure which qualifies under section 37 of the PRRTA Act, and expenditure which does not. Phase-based decision-making frameworks and industry resource classification systems are not relevant in determining whether operations have a sufficiently direct relationship with exploration for the purposes of section 37. The nature of the relevant operations, not the phase in which they occur, determines the qualification of the expenditure under section 37.
The above principles are largely consistent with the decision in ZZGN.
TR 2014/9 distinguishes the definition of “exploration or prospecting” in section 40-730(4) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). It notes that expenditure on feasibility studies of the kind described in section 40-730(4)(c) (“feasibility studies to evaluate the economic feasibility of mining minerals… once they have been discovered”) would not qualify under section 37 of the PRRTA Act, because the studies would not have a sufficiently direct relationship with exploration.
The content of the ruling has not changed significantly from the text of the draft ruling released in 2013 (TR 20143/D4).
TR 2014/9 applies to expenditure incurred from 21 August 2013, which is the date on which TR 2013/D4 was issued.
Prior to ZZGN, the Commissioner’s practice was to accept a “wider range of feasibility expenditure” as qualifying for deduction under section 37 of the PRRTA Act. Accordingly, for expenditure incurred on or before 21 August 2013, the Commissioner will not seek to disturb claims for expenditure where taxpayers have self-assessed, or will self-assess, on the basis that “exploration for petroleum” includes certain feasibility expenditure including:
- “Expenditure which is directed at making a full assessment or evaluation of the commercial or economic viability of an entire project to develop a petroleum pool, including how best to develop the pool as part of that assessment or evaluation”.
- “Expenditure on engineering and design work that is required in order to specify the project to a point where cost and project schedule can be estimated with sufficient definition for project shareholders to assess the economic or commercial feasibility of the project” (though not extending to detailed engineering and design directed to development or construction of the project, or expenditure on early development/execution or long lead items).
Affected taxpayers have been asked to review their exploration claims and, where appropriate, make any amendments to their assessments, by 2 March 2015.
TR 2014/9 highlights the significant difference between the treatment of feasibility expenditure for PRRT and income tax purposes.
In a PRRT context, it is likely that feasibility expenditure will only be deductible if it satisfies the definition of “general project expenditure” in section 38 of the PRRTA Act. If it does not satisfy that definition, or if the relevant project does not proceed, it may not be able to be utilised at all for the purposes of the PRRTA Act (i.e. it is “black hole” expenditure). In any case, it cannot be transferred to another petroleum project.
In an income tax context, there is no dispute that expenditure on certain feasibility studies qualifies as exploration expenditure. The focus of the debate is on the scope of the feasibility studies “extension” in section 40-730(4)(c) and how that extension can practically be applied in the context of a large oil or gas project.
The application of TR 2014/9 is confined to the concept of exploration in the PRRTA Act. However, it may influence the Commissioner’s approach to the long-awaited redraft of Taxation Ruling 98/23, which deals with the deductibility of mining, exploration and prospecting expenditure for income tax purposes. A draft of the replacement ruling for TR 98/23 is expected to be released in early or mid-2015.