Tax agenda 2013
Exploration – uncertainty in tax treatment adds to inherent business risks
Many resources companies are currently facing increasing headwinds in their pursuit of appropriate tax treatment for their exploration expenditure.
There are specific provisions that provide tax deductibility for exploration expenditure under the tax laws relating to income tax, Petroleum Resource Rent Tax (PRRT) and Minerals Resource Rent Tax (MRRT).
Meaning of Exploration
The meaning of ‘exploration’ is one of the central issues.
The income tax law specifically defines ‘exploration’ to include the search for minerals and petroleum, appraisal of discoveries and analysis of economic feasibility. This definition also applies when calculating the MRRT.
PRRT law, on the other hand, does not specifically define ‘exploration’. As such, the word ‘exploration’ retains its ‘ordinary’ meaning. Significantly, in the recent ZZGN case, the AAT restricted the ordinary meaning of exploration to identifying and determining the existence and scale of a discovery and limiting feasibility studies only to those that have a ‘reasonably direct relationship’ to this exploration activity. Determining the economic viability of development and production was found to be outside the ordinary definition.
See our Oil and Gas Update Tax Alert of June 2013 for further discussion of the ZZGN decision.
At present, the ATO is rewriting its various rulings on the meaning of “exploration”.
On 21 August the ATO released the draft PRRT ruling, TR 2013/D4, for public comment, together with a discussion paper and supporting legal opinion. Prior to the release of this draft Ruling the ATO has not been clear in its messaging on the scope of “exploration” for PRRT purposes while at the same time it has challenged historical positions adopted by the industry. The Commissioner’s position as stated in TR 2013/D4 aligns with ZZGN case. However at this time the Commissioner has left open the question of the date of effect of the ruling and the Commissioner has signalled that it may make the ruling retrospective, though Industry could justifiably argue that the lack of clarity on this matter previously would make a prospective application more appropriate. We expect the ATO will release a draft re-write of its ruling on the income tax definition of exploration before the end of the year.
Response to Increased ATO Compliance Activity
Currently, the ATO is also engaged in a campaign to review exploration deductions through its compliance programmes.
As a result of this activity, many resources companies have been required to commit significant additional resources in substantiating and defending their exploration deductions.
We recommend resource companies consider reviewing their processes to capture and substantiate the underlying nature of exploration and feasibility expenditure in order to be well placed to defend their positions in the event of future ATO activity.
The issue of exploration expenditure and its subsequent classification is a significant issue not only for the entity which incurs it but also for subsequent owners of the entity. We advise prospective buyers to conduct due diligence on carried forward exploration expenditure as inherited deductions may increase, decrease or change in classification in parallel with the ZZGN ruling and the views of the ATO.
The treatment of exploration for income tax has been subject to recent policy announcements:
- The 2013 Budget announcements included the removal of the immediate deduction for the costs of acquiring exploration rights and information (not associated with certain farm-out transactions) that were first used for exploration purposes. This change was predicated on a view from Treasury that the previous provisions allowed for exploration deductions that were outside the original policy intent.
- The Coalition announced on 3 September its policy to implement an Exploration Development Incentive (‘EDI’). The proposed EDI would allow an investor in a mining company to receive a tax deduction as a result of the company’s underlying exploration expenditure on a ‘flow through’ basis. The Coalition has announced that the benefit passed back will be capped to $100m over the FY15, 16 and 17 years, and any ‘over-subscription’ will be dealt with by proportionately reducing the tax credit to investors. A flow-through tax credit is something that the junior mining community has been asking for some period, so the policy initiative has been initially well received. The test of the effectiveness of this policy in encouraging new investment in exploration will be dependent on whether potential investors can achieve certainty in the tax benefit that may receive. In this respect, the implementation of the policy will be critical.