Example 1: water treatment facility costs and insurance premium
Knight Ltd is the operator and participant (50%) of an unincorporated joint venture that governs (among other things) the operations of two petroleum projects (Earth and Moon) that are not combined projects. Lewis Ltd is the other participant (50%) and is not connected with Knight (within the meaning of section 328–125 of the Income Tax Assessment Act 1997).
The joint venture agreement states that the obligations of each participant in respect of joint venture expenditure are only to the extent of their respective interests in the projects, that is, an equal share for both Knight Ltd and Lewis Ltd. It also states that Knight Ltd will incur expenditure as agent for all participants in the projects.
To meet statutory environmental requirements, Earth and Moon share a water treatment facility that is necessary and integral to the operations of each petroleum project.
In the tax year ending 30 June 2019, the volume of waste water separated from recovered petroleum was measured as 35 gigalitres (20 gigalitres originating from Earth project, and 15 gigalitres originating from Moon). This volume of water is sent for treatment via pipelines to the facility that Knight Ltd constructed as part of its commitment and legal requirement to a sustainable environment.
For that tax year, Knight Ltd made payments on behalf of the joint venture participants totalling $350,000, which relate solely to processing and treating the waste water, for which they kept records, including the volume of water flow.
Both Knight Ltd and Lewis Ltd kept these records, as well as maintaining their own records in order to substantiate and work out their respective PRRT liabilities from the two petroleum projects.
Knight Ltd also insured the four petroleum recovery wells against industrial accidents on behalf of the joint venture participants, for which it paid Hodge Industry Insurers an annual premium of $1.3 million. The premium is based on the estimated insured values of the wells ($1 billion) as follows:
- $200 million each for wells 1, 3 and 4
- $400 million for well 2.
These insured values are based on a detailed risk and economic assessment of the costs to replace the wells. Knight Ltd kept records of the insurance policy and the risk and economic assessments.
Apportionment by Knight Ltd
Since Knight Ltd incurred half of the $350,000 payment as agent for Lewis Ltd, it can only claim a maximum of $175,000 for processing and treating the waste water. As a result, it apportions the $175,000 to the extent to which it has incurred it for Earth and to the extent to which it has incurred it for Moon.
Knight Ltd has control systems in place to monitor the volume of waste water flowing to and from the facility and uses the data to allocate the $175,000 between the two petroleum projects. The allocation is based on the respective proportion of the total volume of waste water (35 gigalitres) as follows:
- Earth (20 gigalitres) – 20 / 35 × $175,000 = $100,000
- Moon (15 gigalitres) – 15 / 35 × $175,000 = $75,000.
Knight Ltd allocates the respective payments above in carrying on petroleum project activities in each project.
Similar to the water treatment costs, Knight Ltd recognises that it can only claim a maximum amount of $650,000 for insuring the wells because half of the $1.3 million dollar payment was incurred as agent for Lewis Ltd. As a result, it apportions the $650,000 to the extent to which it is incurred for Earth and to the extent to which it is incurred for Moon.
Knight Ltd may apportion the amount based on the proportion of the total estimated insured values ($1 billion) to repair and rebuild wells as follows:
- Earth (gas wells 1 and 2 for $600 million) – $600 million ÷ $1 billion × $650,000 = $390,000
- Moon (gas wells 3 and 4 for $400 million) – $400 million ÷ $1 billion × $650,000 = $260,000
Knight Ltd allocates the respective payments above in carrying on the petroleum project activities in each project.
Apportionment by Lewis Ltd
Lewis will make payments for PRRT purposes equal to half of the payments by Knight for the water treatment costs and the insurance premium because Knight is acting as an agent for Lewis.
Lewis Ltd needs to work out the most reasonable basis of apportionment looking at the facts and circumstances of its operations. It may be able to apportion the payments in the same way as Knight Ltd (if the facts and circumstances are similar) or it may apportion the payments differently (if the facts and circumstances are materially different).
End of example
Example 2: integrated gas-to-liquids operation
Mitchell Recovery Ltd owns and operates the processing and liquefaction plant of an integrated gas-to-liquids operation. For the current year of tax, it makes salary payments of $3 million for maintenance of the facilities, and $1 million (payable in four quarterly amounts) for the purchase of electricity from the state grid for use in operating its facilities.
Mitchell Recovery Ltd reviewed its employees' time sheets and took into account relevant job descriptions, work undertaken and job schedules to identify that the $3 million in salary payments for maintenance were based on a total of 30,000 labour hours. The labour hours were incurred by workers maintaining the facilities, which operated for a total of 300,000 machine hours. Mitchell Recovery Ltd found that the amount of time spent by the maintenance workers (in labour hours) and the salaries in maintaining the facilities are directly related to the operational time of the facilities (in machine hours).
Mitchell Recovery Ltd also reviewed the metered amounts of electricity consumption and established that the $1 million payment was for a total of 100 megawatts used by the facilities. It found that the electricity consumption (in megawatts) and the electricity cost of operating the facilities are directly related to the operational time of the facilities (in machine hours).
However, some of the facilities being maintained or consuming electricity were only partially used for the petroleum project activities at the plant.
Apportioning payments
Mitchell Recovery Ltd apportions the $3 million salary payments by working out the time spent by the workers in maintaining the relevant facilities that are either being used solely or not being used solely in carrying on or providing the petroleum project activities. It works out that:
- $1.5 million of the payments is allocated to the 15,000 labour hours identified as having been incurred on the processing facilities
- $1 million of the payments is allocated to the 10,000 labour hours incurred on the liquefaction facilities.
The remaining salary payments of $500,000 for the remaining 5,000 labour hours incurred in maintaining facilities to be apportioned between petroleum project and non-petroleum project activities at the plant can only be allocated using the 3:2 ratio (15,000 labour hours to 10,000 labour hours) if Mitchell Recovery Ltd demonstrates that the facilities are also being used in the same manner and proportion between those activities. It is only entitled to a deduction for the portion of that $500,000 that can be demonstrated as being made in carrying on or providing the petroleum project activities.
Mitchell Recovery Ltd also apportions the $1 million in electricity payments based on the megawatts used by the processing facilities and the liquefaction facilities.
End of example
Example 3: native title payments
Franklin Oil Ltd operates two platforms within a petroleum project to recover crude oil. The crude oil is pumped via pipelines to its onshore processing plant. The crude oil is then transported to a nearby refinery which is part of its non-petroleum project activities.
Under a land use agreement made under the Native Title Act 1993, Franklin Oil Ltd needs to pay an annual amount of $200,000 to the native title owners for use of the land solely for its onshore petroleum processing plant and its refinery. For the 2018–19 year of tax, it made the payment to a trust fund that manages the native title payments.
Apportioning payments
Franklin Oil Ltd can allocate the $200,000 payment arising from the land use agreement based on a ratio of the land area covered by native title that is used for the processing plant and the land area used for the refinery. That is, it can apportion the payment on an equal basis (a 1:1 ratio) of:
- $100,000 based on the 10 hectares of the native title that constitutes the processing plant (petroleum project activities)
- $100,000 based on the 10 hectares of the native title that constitutes the refinery (non-petroleum project activities).
As a result, $100,000 of the payment by Franklin Oil Ltd is considered a deductible native title compensation payment in carrying on or providing petroleum project activities. The other $100,000 is not deductible because it is for non-petroleum project activities.
End of example
Example 4: offshore petroleum recovery with onshore processing and liquefaction
Penguin Ltd is the sole owner and operator of a petroleum project involving recovering gas via subsea infrastructure from its two gas fields. The recovered gas is then transported via pipelines to its onshore integrated processing and liquefaction plant to produce LNG and condensate. The condensate produced in the facility is stored in a site adjacent to the processing area. The supplies needed to produce the LNG are stored in a site adjacent to the liquefaction area.
In the 2017–18 year of tax, Penguin Ltd makes a bulk purchase of five pieces of equipment for a total of $1 million to track hazardous emissions and wastes as follows:
- three relating to the processing area (which relates to petroleum project activities)
- two relating to the liquefaction area (which relates to non-petroleum project activities).
The pieces of equipment are an integral part of the processing of the natural gas into either condensate or feedstock gas, and converting the feedstock gas to LNG by liquefaction.
Penguin Ltd also pays $200,000 in salaries for security guards who monitor and patrol the respective sites that store the condensate and the supplies for the liquefaction operations. It reviews its land records to establish that the area of the condensate storage site is 30 hectares and the area of the storage site of the liquefaction supplies is 20 hectares. A review of the records logged of the time spent by the security guards in patrolling and monitoring the respective sites is directly related to the area.
Apportioning payments
Penguin Ltd looks at the purchase records for the five pieces of equipment and identifies that of the $1 million payment, it paid:
- $650,000 for the three pieces of equipment for use in the processing area
- $350,000 for the two pieces of equipment for use in the liquefaction area.
As a result, Penguin Ltd apportions $650,000 as a payment made in carrying on or providing the petroleum project activities, and $350,000 for non-petroleum project activities.
Penguin Ltd apportions the $200,000 in salary payments for the security guards based on the ratio of the respective area size of the site being monitored and patrolled (3:2) as follows:
- $120,000 for the storage of the condensate ($200,000 × 3 / 5)
- $80,000 for the storage of the supplies for the liquefaction operations ($200,000 × 2 ÷ 5).
As a result, $120,000 of the $200,000 payment is made by Penguin Ltd in carrying on or providing the petroleum project activities, and $80,000 of the $200,000 payment is for non-petroleum project activities.
End of example