House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon. P.J. Keating, M.P.)

Chapter Six: Calculation of Transferable Expenditure

Note: Unless otherwise indicated, references to clauses in this chapter are to clauses in the Schedule that will be inserted by this Bill.

1. Summary of Proposed Changes

Class 2 augmented bond rate exploration expenditure and class 2 GDP factor expenditure of a project will be transferable to other projects. These expenditures - being made up of exploration expenditure incurred on or after 1 July 1990 - will be transferable only after first being offset against the project in relation to which they were incurred. The amendments proposed by this Bill will insert a Schedule to the Principal Act. Parts 2 and 3 of the Schedule contain rules that calculate the amount of class 2 augmented bond rate exploration expenditure and class 2 GDP factor expenditure, respectively, taken to be incurred by a person in relation to a project and a relevant financial year. Any expenditure not taken to be incurred will be available to be transferred. [Clauses 6 and 10]

Consistent with the general rule in relation to deductible expenditures, the expenditure taken to be incurred in relation to a project and a financial year under Parts 2 and 3 - and therefore included in deductible expenditure of the project - may be made up of actual amounts of expenditure and compounded amounts of actual expenditure.

Amendments proposed by this Bill will also allow the transfer of exploration expenditure incurred in respect of an exploration permit or a retention lease (an exploration right) prior to the issue of a production licence related to the permit or lease.

Part 4 of the Schedule calculates the amount of transferable expenditure in respect of an exploration right.

The calculated amounts of transferable expenditure under Parts 2, 3 and 4 are amounts of actual expenditure incurred in relation to a financial year. However, once an amount of exploration expenditure is transferred and if the transferred expenditure was actually incurred in a financial year before the year the transfer took place the expenditure is compounded by reference to the project to which the expenditure is transferred. Part 7 of the Schedule compounds transferred expenditure.

2. Background

PRRT is currently assessed on a project basis - the essential boundary of a project being a production licence. Only assessable receipts and deductible expenditure of the project are taken into account when calculating the taxable profit of the project.

A limited exception to this rule is that augmented bond rate exploration expenditure and GDP factor expenditure incurred by a person in relation to a project that is within a project group can be offset against assessable receipts of that person from any project within that group. Broadly, a project group is made up of projects with production licences drawn from the same exploration permit.

3. Clause Involved in the Change

Clause 22 of the Bill: inserts the Schedule to the Principal Act; in particular Parts 2, 3 and 4 of the Schedule.

4. Explanation of the Amendments

When is class 2 augmented bond rate exploration expenditure taken to be incurred?

Under Part 2 of the Schedule a person will only be taken to have incurred an amount of class 2 augmented bond rate exploration expenditure in relation to a project and a particular financial year (called the assessable year in Part 2) if there is an excess (the notional taxable profit) of assessable receipts over the following deductible expenditure:

•

class 1 augmented bond rate general expenditure;

•

class 1 augmented bond rate exploration expenditure;

•

class 2 augmented bond rate general expenditure; and

•

class 1 GDP factor expenditure. [Clause 5]

Effectively class 2 augmented bond rate exploration expenditure is deducted only after the above project specific expenditures have been deducted. Transferable expenditures then follow in the order of deductibility.

What happens if there is no taxable profit?

If there is no notional taxable profit, then a person is taken not to have incurred any class 2 augmented bond rate exploration expenditure in relation to the project and the relevant assessable year. Any expenditure that would have been included in class 2 augmented bond rate exploration expenditure becomes transferable expenditure. [Clause 7]

What expenditure is included in class 2 augmented bond rate exploration expenditure?

Class 2 augmented bond rate exploration expenditure is made up of the following expenditure:

For a project including the Bass Strait project, but not a combined project:

•

exploration expenditure incurred by a person in relation to the project in a financial year starting on or after 1 July 1990; and

•

expenditure taken to be incurred by a person in relation to a project under section 48 of the Principal Act in a financial year starting on or after 1 July 1990.

For a combined project:

•

expenditure actually incurred in relation to the combined project in a financial year starting on or after 1 July 1990;

•

expenditure taken to be incurred by the person in relation to the combined project under section 48 in a financial year on or after 1 July 1990; and

•

where the financial year is the year the project combination certificate came into force the amounts actually incurred or amounts taken to be incurred by section 48 in the financial year in relation to the pre-combination projects.

[Clause 1 definitions, "financial year", "incurred exploration expenditure amount"]

Broadly, section 48 deals with the transfer of a person's entitlements to assessable receipts and deductible expenditure.

An amount of expenditure described above will be an "incurred exploration expenditure amount". This amount is expenditure actually incurred. An incurred exploration expenditure amount can be included in either class 2 augmented bond rate exploration expenditure or class 2 GDP factor expenditure.

Distinguishing class 2 augmented bond rate Exploration expenditure from class 2 GDP factor exploration expenditure

An incurred exploration expenditure amount must then be classified. What distinguishes class 2 augmented bond rate exploration expenditure from class 2 GDP factor expenditure is that, in relation to the former, the expenditure must be incurred in a financial year in which the "relevant pre-commencement day" occurred or a later year. [Clause 2 definitions, "ABR expenditure year" and "GDP expenditure year"]

The relevant pre-commencement day is the day occurring 5 years before the issue of the production licence in relation to the project. For the Bass Strait project or a combined project it is the day of issue of the oldest production licence that relates to that project. [Clause 2 definition, "relevant pre-commencement day"]

It should be noted that the approach taken here to distinguish expenditure that is compounded by the augmented bond rate or by the GDP factor will differ slightly from existing provisions in the Principal Act. Under the proposed provisions, where expenditure is incurred at any time during the financial year in which the relevant pre-commencement day falls the expenditure will be, if otherwise eligible, included in class 2 augmented bond rate exploration expenditure. Under the existing provisions the expenditure would have to be incurred after the actual relevant pre-commencement day to be compounded at the augmented bond rate.

Expenditure included in class 2 augmented bond rate exploration expenditure taken to be incurred in relation to a project and a financial year cannot be included in expenditure taken to be incurred in a later financial year or as amounts transferred to other projects. [Clause 16 of the Bill, subsection 35A(2)]

What happens if there is a notional taxable profit?

The amounts of class 2 augmented bond rate exploration expenditure in relation to a person, a project and an assessable year may include expenditure actually incurred in that financial year and amounts incurred in previous financial years that are compounded forward at the augmented bond rate.

If there is a notional taxable profit in relation to the assessable year the first step is to calculate the total of the "available exploration expenditure amounts". For each financial year that there is an actual incurred exploration expenditure amount, that amount is compounded forward at the augmented bond rate up to the assessable year. This compounded amount is the available exploration expenditure amount in relation to that year.

Note that the financial year must be an ABR expenditure year.

If the financial year is the assessable year the available exploration expenditure amount will be the amount of expenditure actually incurred. [Subclauses 8(1), (2) and (3)]

If the total of the available exploration expenditure amounts is less than or equal to the notional taxable profit then a person is taken to have incurred an amount of class 2 augmented bond rate exploration expenditure in the assessable year equal to that total. Consequently there can be no amount of exploration expenditure available to be transferred from that project. [Subclause 8(4)]

Notional profit less than total available exploration expenditure amounts

If the total of the available exploration expenditure amounts is greater than the notional taxable profit then a person is taken to have incurred an amount of class 2 augmented bond rate exploration expenditure in the assessable year equal to the notional taxable profit. [Subclause 8(5)]

What has to be done next is to work out which of the incurred expenditure amounts for each financial year contributed to the available exploration expenditure amount that is equal to the notional taxable profit. In other words, what amounts of actual expenditure contributed to class 2 augmented bond rate exploration expenditure taken to be incurred? It should be remembered that the available exploration expenditure amounts of a financial year are the compounded equivalents of the incurred exploration expenditure amounts except where the financial year is the assessable year.

The basic rule is to start with the oldest incurred exploration expenditure amount and move forward progressively to the most recent amount.

Any incurred exploration expenditure amounts that did not contribute to the available exploration expenditure amounts - and therefore the amount of class 2 augmented bond rate exploration expenditure taken to be incurred by a person - is transferable.

Example

The following example illustrates the manner in which a person calculates the amount of class 2 augmented bond rate exploration expenditure taken to be incurred in relation to a project and an assessable year. The example will also show how to calculate the transferable amount of exploration expenditure in relation to the assessable year.

A company has total assessable receipts of $600m and total deductible expenditure other than class 2 augmented bond rate exploration expenditure or class 2 GDP factor expenditure of $400m for the year ended 30 June 1994. The augmented bond rate (ABR) for all years is 28% and the incurred exploration expenditure amounts are as follows:

Step 1

Calculate Notional Taxable Profit in accordance with Clause 5:

(notional taxable profit) = (total assessable receipts) less (total other expenditure)


= $600m - 400m


= $200m


Step 2

Clause 7 does not apply to this example, as there is a notional taxable profit of $200m. However, if the person did not have a notional taxable profit for year ended 30 June 1994, all the expenditure included in the incurred exploration expenditure amounts for the ABR expenditure years would be transferable.

Step 3

Calculate the available exploration expenditure amounts for each year:

•

The available exploration expenditure amount for year ended 30 June 1994 (assessable year) is $10m. [Subclause 8(2)]

•

The available exploration expenditure for year ended 30 June 1993 is calculated as follows: [Paragraph 8(3)(a)]

(available exploration expenditure) = (incurred exploration expenditure) x (ABR)


= $20m x 1.28


= 25.6m


•

The available exploration expenditure amounts for years ended 30 June 1991 and 1992 are calculated as follows: [Clause 8(3)(b)]

1992	$50m X 1.28 x 1.28	=	$81.9m
1991	$50m X 1.28 x 1.28 x 1.28	=	$104.9m

•

Therefore in accordance with clause 8, the available exploration expenditure amounts for years ended 30 June 1991 to 1994 are:

Year	$M
1991	104.9
1992	81.9
1993	25.6
1994	10.0
Total Available Exploration Expenditure	222.3

Step 4

Subclause 8(4) does not apply to this example, as the total available exploration expenditure ($222.4m) is greater than the notional taxable profit ($200m). However, if the total was less than or equal to the notional taxable profit, the person has incurred class 2 augmented bond rate exploration expenditure equal to the total of the available exploration expenditure amounts in relation to the assessable year and the project. It follows that there would be no transferable exploration expenditure in relation to the assessable year.

Step 5

Since the total available exploration expenditure ($222.4m) exceeds the notional taxable profit ($200m), the amount of class 2 augmented bond rate exploration expenditure taken to be incurred in the assessable year (1994) in relation to the project is the notional taxable profit of $200m.

Step 6

The next step is to work out exactly what expenditure included in the incurred exploration expenditure amounts contributed to the class 2 augmented bond rate exploration expenditure taken to be incurred. Any incurred exploration expenditure amount of a financial year, or part of those amounts, that did not contribute will be transferable.

Subclause 8(6) does not apply to this example as the available exploration expenditure amount for the earliest ABR expenditure year (1991, $104.9m) is less than the notional taxable profit ($200m). If the available exploration expenditure amount for the earliest year was equal to or exceeded the notional taxable profit, then the amount of class 2 augmented bond rate exploration expenditure taken to be incurred is attributable to that amount of actual expenditure incurred in the earliest year that would equal, after compounding, the notional taxable profit.

Step 7

Since the notional taxable profit ($200m) exceeds the available exploration amount for the earliest ABR expenditure year ($104.9m) calculate the whole incurred exploration expenditure amounts: [Paragraph 8(7)(a)]

•

starting with the earliest year first, add the available exploration expenditure amounts for each ABR year, until the total equals the notional taxable profit. [Subparagraph 8(7)(c)(i)]

Year	Available Exploration Expenditure ($m)
1991	104.9
1992	81.9
	186.8

The available exploration expenditure amounts for later ABR expenditure years cannot be added, as the total would exceed the notional taxable profit. [Subparagraph 8(7)(c)(ii)]

•

The incurred exploration expenditure amounts for those years under subparagraph 8(7)(d)(i) are

Year	$M
1991	50
1992	50

Step 8

Calculate the part incurred exploration expenditure amount:

•

(notional taxable profit) less (Step 7 available exploration amounts)


= $200m - $186.8m


= $13.2m


Call the $13.2m the added part.

•

Calculate the amount of expenditure included in the incurred exploration expenditure amount that, when compounded at the augmented bond rate, produces the added part. [subparagraph 8(7)(d)(ii)]

•

(Incurred exploration expenditure amount) * 1.28 = $13.2m


•

(Incurred exploration expenditure amount) = ($13.2m)/(1.28)


•

(Incurred exploration expenditure amount) = $10.3m


Step 9

The incurred exploration expenditure amounts available for transfer under paragraph 8(5)(c) are -

What expenditure is included in class 2 GDP factor expenditure?

Broadly, any exploration expenditure incurred in a financial year starting on or after 1 July 1990 that is not included in the expenditure that makes up class 2 augmented bond rate exploration expenditure will be included in class 2 GDP factor expenditure. This expenditure will be the incurred exploration expenditure amounts that were incurred in GDP expenditure years (the financial years occurring before the earliest ABR expenditure year).

When is class 2 GDP factor expenditure taken to be incurred?

Class 2 GDP factor expenditure ranks one class below class 2 augmented bond rate exploration expenditure in the order of deductibility for deductible expenditure. Therefore class 2 GDP factor expenditure will be taken to be incurred by a person in relation to a project and a financial year if there is an excess (the notional taxable profit) of assessable receipts over the sum of:

•

class 1 augmented bond rate general expenditure;

•

class 1 augmented bond rate exploration expenditure;

•

class 2 augmented bond rate general expenditure;

•

class 1 GDP factor expenditure; and

•

class 2 augmented bond rate exploration expenditure. [Clause 9]

A test is that if subclause 8(4) of Part 2 applies because the total available exploration expenditure amounts were less than the notional taxable profit in relation to class 2 augmented bond rate exploration expenditure, then a person will be taken to have incurred an amount of class 2 GDP factor expenditure in relation to the project and the assessable year.

Part 3 of the Schedule to operate in the same way as Part 2

If there is a notional taxable profit, the next step is to calculate the amount of class 2 GDP factor expenditure taken to have been incurred and to what amount of actual expenditure it is attributable. If there is any amount of actual expenditure remaining it will be transferable.

Part 3 of the Schedule will operate in the same way as Part 2. One minor difference is in the calculation of the available exploration expenditure amounts for class 2 GDP factor expenditure when compared with class 2 augmented bond rate exploration expenditure. There cannot be a GDP expenditure year for the assessable year - the year the calculation is being made - or the year prior to the assessable year. [Subclause 12(2)]

This is because GDP expenditure years occur at least five years before a production licence is granted, that is five years before there is taken to be a project. There must be a project in the assessable year in order to be able to make a calculation.

If there is no notional taxable profit in relation to a person, a project and an assessable year, then under Part 3 of the Schedule no amount of class 2 GDP factor expenditure is taken to be incurred in relation to the project and the assessable year: all expenditure actually incurred (the incurred exploration expenditure amounts) is transferable in that year. [Clause 11]

If there is a notional taxable profit, then the amount of class 2 GDP factor expenditure taken to be incurred by a person in relation to an assessable year will be the lesser of the notional taxable profit and the total of the available exploration expenditure amounts. [Subclauses 12(3) and (4)]

The incurred exploration expenditure amounts that contributed to the class 2 GDP factor expenditure is calculated in the same way as for class 2 augmented bond rate exploration expenditure. [Subclauses 12(5) and (6)]

The example above can be followed after varying the assumptions that the incurred exploration expenditure amounts were incurred in ABR expenditure years. Also the incurred exploration expenditure amounts will be compounded by the GDP factor rather than by the augmented bond rate.

Part 3 of the Schedule, in the same way as Part 2, will work out in relation to a project and an assessable year the incurred exploration expenditure amounts, if any, that did not contribute to the amount of class 2 GDP factor expenditure taken to be incurred. These amounts will be transferable.

Compounding of transferred amounts

It should be noted that while transferable amounts of actual expenditure are calculated under Parts 2 and 3 of the Schedule, when those amounts are transferred, they are not classified according to the part under which they were calculated. An amount of transferable expenditure calculated under Part 3 of the Schedule would not necessarily be compounded by the GDP factor when transferred to another project. This is because the compounding rate is set by reference to the production licence of the project to which the expenditure is transferred.

Transferable expenditure of an exploration permit or retention lease

Parts 2 and 3 of the Schedule calculate amounts of transferable expenditure incurred in relation to a petroleum project. Broadly, a petroleum project is taken to exist under section 19 of the Principal Act only when there is a production licence in force. Therefore, under the existing law assessable receipts derived and deductible expenditure incurred cannot be brought into the PRRT calculation until a production licence has been granted. The general principle of wider deductibility of exploration expenditure is that any undeducted exploration expenditure be transferred to a project that would otherwise have a PRRT liability. Consequently Part 4 of the Schedule will calculate transferable exploration expenditure that is incurred in respect of an exploration permit or retention lease prior to an issue of a production licence. The undeducted exploration expenditure will be transferable in the same way as transferable expenditure incurred in respect of a project.

What exploration permits and retention leases will be eligible?

An exploration permit or retention lease issued under the Petroleum (Submerged Lands) Act 1967 will be eligible. The exception will be the North West Shelf exploration permits WA-1-P and WA-28-P and any retention leases related to those permits. In effect Part 4 will operate in respect of permits and leases any related production licence of which would give rise to a PRRT liable petroleum project. [Clause 13]

If a production licence that is derived from the permit or lease comes into force during a financial year then Part 4 will not apply in that financial year. Any transferable expenditure would then be calculated in respect of the project that exists in relation to the production licence. The transfer would be from one project to another project. [Subclause 13(2)]

Derivation of production licences

Broadly, a production licence is derived from an exploration permit if the permit ceases to be in force in respect of the area comprising the area of the production licence. A production licence is derived from a lease if the retention lease ceases to be in force on the granting of the production licence.

Amendments proposed by this Bill will restate the meaning of permit derived production licence and lease derived production licence. The meaning of the two terms has not changed. [Clause 4 of the Bill, new definition "lease derived production licence" and "permit derived production licence", clause 6 of the Bill, subsection 4(2)]

How is transferable expenditure calculated?

All calculations are based on the assumption that a production licence derived from the permit or lease is in force. This means the operative provisions in the Principal Act can be applied to the permit or lease with the result that assessable receipts are notionally derived and deductible expenditure notionally incurred in relation to the permit or lease. [Clause 14]

Totals of expenditure and receipts to be used in calculation

The transferable amounts are worked out by reference to the total amounts of receipts derived and the total expenditures incurred from 1 July 1990 up to the end of the financial year in relation to which the transfer is to take place. These total amounts are the "notional" amounts. [Clause 16]

For exploration permits or retention leases, transferable exploration expenditure is transferred from this "basket" of total receipts and total expenditures that may have been incurred over a number of financial years.

Note that once an amount of expenditure is transferred out of this basket it cannot be counted again in working out other transferable amounts in the same or a later financial year. Further, if a production licence comes into force that is related to the exploration permit - and therefore a project is taken to exist - an amount of transferred expenditure cannot be counted again in working out any PRRT liability of that project. [Clause 19 of the Bill, Section 45D]

Only undeducted exploration expenditure will be transferable

Consistent with the calculation of transferable expenditure of a project, only exploration expenditure of a permit or lease that exceeds assessable receipts (after first deducting other expenditure) will be transferable expenditure.

Consequently if notional assessable receipts exceeds notional deductible expenditure no exploration expenditure is transferable. [Clause 17]

Conversely if notional deductible expenditure exceeds notional assessable receipts and the excess equals or exceeds notional exploration expenditure then an amount called the reduced notional exploration expenditure is transferable. This latter amount is the notional exploration expenditure incurred less "non-transferable" expenditure. [Subclause 18(1)]

What is non-transferable expenditure?

Non-transferable expenditure is calculated for each financial year and is then added up to give a total amount. This is in contrast with the general calculation of the transferable amounts under Part 4 in that the year the expenditure is incurred is relevant. Non-transferable expenditure for each financial year is worked out as follows:

•

If assessable receipts equal or exceed deductible expenditure in a financial year all exploration expenditure is non-transferable expenditure in relation to that year. [Subclause 15(1)]

•

If deductible expenditure exceeds assessable receipts in a financial year (the excess) and exploration expenditure is greater than the excess then the amount of non-transferable expenditure is the exploration expenditure less the excess. [Subclause 15(2)]

It follows from this last point that if in relation to a financial year deductible expenditure exceeds assessable receipts but exploration expenditure is less than the excess, then there is no amount of non-transferable expenditure in relation to the year.

Where there is an amount of non-transferable expenditure in relation to a financial year it is taken to consist of the oldest amounts of the exploration expenditure incurred in that year. [Subclause 15(3)]

This is relevant where only part of the reduced notional exploration expenditure is transferable in a financial year as a result of total exploration expenditure being greater than the amount by which total expenditure exceeded total receipts of the permits or lease. [Subclauses 18(2) and (3)]

Broadly in this situation, when working out the amount of the reduced notional exploration expenditure that is transferable, the amounts of expenditure are taken in chronological order. In this way the actual amounts of exploration expenditure that are non-transferable and those that are transferable are matched.

Example

The following example illustrates the manner in which a person, with an interest in an exploration right (a permit or lease) that has amounts of assessable receipts and deductible expenditure, calculates the amount of transferable non-project exploration expenditure in accordance with Part 4 of the Schedule.

A person has an exploration right with assessable receipts and deductible expenditure for four years as shown in the table.

Step 1

Calculate the non-transferable expenditure amounts in accordance with clause 15:

•

Subclause 15(1) does not apply as the total amounts of assessable receipts are less than the total amounts of deductible expenditure in relation to each financial year (1994 to 1997). However, if the total assessable receipts equals or exceeds deductible expenditure for any year, all exploration expenditure for that year would be non-transferable.

•

Since the total amount of exploration expenditure incurred in each of the financial years is greater than the "excess", calculate the "non-transferable amount" for each financial year. [Subclause 15(2)]

(non-transferable amount) = (exploration expenditure less excess)


[paragraph 15(2)(b)]

The calculation of the non-transferable amount for each financial year is shown in the example. Therefore, in accordance with subclause 15(2) the amount of exploration expenditure that equals the non-transferable amount is the non-transferable expenditure in relation to each financial year.

•

For the purposes of subclause 15(3), it is assumed that the oldest of the exploration expenditure is greater than the non-transferable amount for each financial year. Therefore, the non-transferable expenditure incurred in relation to each financial year will consist of the oldest of the exploration expenditure. Subclause 15(4) will not apply.

Step 2

Calculate totals of assessable receipts, deductible expenditure, exploration expenditure and reduced exploration expenditure in accordance with clause 16:

Step 3

Clause 17 does not apply to this example as the notional assessable receipts ($140m) do not exceed notional deductible expenditure ($470m). However, if the notional assessable receipts did equal or exceed notional deductible expenditure then no amount of exploration expenditure would be transferable in relation to the assessable year (1997).

Step 4

Subclause 18(1) does not apply to this example, because, even though notional deductible expenditure ($470m) exceeds notional assessable receipts ($140m), the excess ($330m) does not exceed notional exploration expenditure ($400m). However, if the excess exceeded notional exploration expenditure, all of the expenditure included in the reduced notional exploration amount would be transferable in the assessable year (1997).

Step 5

Subclause 18(2) also does not apply to this example, as the oldest amount of reduced notional exploration expenditure ($100m in 1994) is less than the notional loss ($330m). However, if the oldest amount of reduced notional exploration expenditure was greater than or equal to the notional loss, then the oldest amount that equals the notional loss would be transferable in the assessable year (1997).

Step 6

Since the notional loss ($330m) exceeds the oldest amount of reduced notional exploration expenditure ($100m) and paragraphs 18(3)(a) and (b) are satisfied, the amount of transferable expenditure in relation to the assessable year (1997) is calculated as follows:

•

Starting with the earliest year first, add the reduced notional exploration expenditure amounts for each year until the total equals the notional loss. [paragraph 18(3)(d)]

Year ended 30 June	Reduced Notional Exploration Expenditure ($m)
1994	100
1995	80
1996	80
1997	70
	330

•

The amount of transferable non-project exploration expenditure in relation to the assessable year is $330m. [paragraph 18(3)(e)]

It should be noted from the above example, that although the person, incurred $400m of exploration expenditure, only $330m can be transferred, in relation to the assessable year, as part of notional exploration expenditure ($70m) is the non-transferable amount.