House of Representatives

Explanatory Memorandum

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

Chapter Seven: Transfer of Exploration Expenditure

Note: Unless otherwise indicated, references to clauses in this chapter are to clauses of the Schedule being inserted by this Bill.

1. Summary of Proposed Changes

The amendments proposed by this Bill are to provide for the transfer of undeducted exploration expenditure from projects and exploration rights to projects that would otherwise have PRRT liabilities.

Once an amount of transferable exploration expenditure has been calculated there must be a mechanism to allow a transfer to take place. This chapter discusses that mechanism.

Exploration expenditure incurred by a person will be deductible against all projects held by that person. In the case of a company in a company group the expenditure will be deductible against all projects held by the group.

Broadly, where a person has an amount of transferable exploration expenditure in a financial year, that person must transfer as much of that expenditure as can be transferred to petroleum projects in which the person holds an interest. In the case of a company group, the obligation is on the company holding the exploration right or project with the transferable exploration expenditure to transfer that expenditure to projects held by other companies in the group. In all cases the project to which the expenditure is being transferred (the receiving project) must otherwise have a PRRT liability.

Broadly, transfers of exploration expenditure are subject to the following rules:

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there must be a taxable profit in relation to the receiving project;

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the person must have held an interest in both the transferring project or exploration right and the receiving project from the time the transferable expenditure was incurred up until the time of the transfer;

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if there is more than one project to which expenditure can be transferred, then the expenditure must go to the project that has the most recent production licence;

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transferable expenditure incurred in a financial year before the year of transfer will be compounded only when transferred and then by reference to the receiving project's production licence;

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where there are amounts of transferable expenditure that were incurred in different financial years, expenditure compounded at the augmented bond rate (starting with the oldest expenditure) must be transferred first and then expenditure compounded at the GDP factor rate (again starting with the oldest); and

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the amount of expenditure transferred (including compounded amounts) cannot exceed the taxable profit of the receiving project otherwise calculated.

In relation to group companies the above rules generally apply on a group-wide basis.

Notice of a transfer must be given to the Commissioner. If the transfer is not done in accordance with the rules the Commissioner may act and make the transfer according to the rules. The Commissioner's power to make transfers of expenditure is subject to the objection and appeal process.

2. Background

Under the existing law, exploration expenditure is generally deductible from assessable receipts on a project basis. Undeducted expenditure relating to a project is compounded forward, to be offset against future assessable receipts of the project. Except in the case of a project group (broadly, projects held by the same person with production licences drawn from the same exploration permit) undeducted exploration expenditure cannot be transferred out of a project.

3. Clauses involved in the changes

Clause 4 of the Bill: inserts the definition of "company" and "transferable exploration expenditure".

Clause 5 of the Bill: inserts section 2B which will define group companies.

Clause 19 of the Bill: inserts Division 3A which contains the provisions governing transfers.

Clause 22 of the Bill: inserts a Schedule to the Principal Act and the relevant parts are Parts 5, 6, and 7 for these changes.

4. Explanation of the Amendments

Transfers - generally

A person with transferable exploration expenditure in a financial year - as calculated under Parts 2, 3, and 4 - must transfer as much of the expenditure as they can according to the rules set out in Part 5 of the Schedule. Transfers of expenditure outside these rules are ineffective.

The Commissioner must be given written notice of a transfer. This notice would normally be lodged with the PRRT return of the receiving project for the year of tax in relation to which the transfer was made. [Clause 19 of the Bill, section 45A; paragraph 4(f) new definition "transferable exploration expenditure"]

A person who does not make a transfer in accordance with the rules is guilty of an offence under the Principal Act.

The transfer rules under Part 5

Section 45A imposes the obligation to make transfers on any person that has transferable expenditure. The transfer must be made in accordance with the rules set out in Part 5 of the Schedule which are discussed below.

Notional taxable profit needed

A person who has transferable expenditure in relation to a project or exploration right (the transferring entity) may only transfer the expenditure to a project (the receiving project) if the receiving project otherwise has a taxable profit (notional taxable profit). [Clauses 19, 20 and 21]

The amount transferred cannot exceed the notional taxable profit. [Clause 24]

Amounts transferred may include expenditure incurred before the year the transfer takes place (the transfer year). This expenditure when transferred will be compounded by reference to the receiving project's production licence. Therefore it is the compounded amounts of transferable exploration expenditure, if any, that cannot exceed the notional profit. [Clause 19 of the Bill, subsection 45D(2)]

Transferred expenditure is brought into the taxable profit calculation of a person in relation to the receiving project under section 22 of the Principal Act.

A person must hold interests in transferring entity and receiving project

Transferable expenditure of a transferring entity may only be transferred if the person held an interest in both the transferring entity and the receiving project at the beginning of the financial year the expenditure was incurred, at the end of the transfer year and any intervening period. [Subclause 22(1)]

What is an interest?

A person is taken to hold an interest in a project or an exploration right at a particular time if that person was entitled to receive receipts from the sale of petroleum recovered in relation to the project or right. [Clauses 2 and 3]

The rules on the holding of interests require looking at a project or exploration right at two points in time - in the year the transferable exploration expenditure is incurred and in the transfer year. Consequently, when explaining what is meant by holding an interest, clause 2 covers situations where the status of a project has changed in the period between the two points in time. For example expenditure may be transferred to a receiving project that is a combined project. At the time the expenditure was incurred the person may have had an interest in an exploration permit from which the production licence of one of the pre-combination projects was excised. In this situation the person is taken to hold an interest in the combined project at the time the expenditure was incurred.

The rule on the holding of interests will not require a person to hold an interest in a transferring entity or a receiving project if it does not exist. The proposed provisions will ensure this. Broadly, a project's starting day will be the day the exploration permit related to the project's production licence is granted. Similarly an exploration right's starting day will be the day the relevant exploration permit is granted.

Therefore the rule that a person must hold an interest in the transferring entity at the beginning of the financial year in which the expenditure was incurred does not mean a person must hold an interest in the transferring entity before its starting day. [Subclause 22(2)]

Similarly, a person is not required to hold an interest in the receiving project before that project came into existence if the transferring project and the receiving project came into existence in the same financial year. [Subclause 22(3)]

There is an exception to the rule that a person must have held an interest in the receiving project at the beginning of the financial year in which the expenditure was incurred. Broadly, a person may transfer the expenditure to the receiving project:

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if the exploration permit from which the receiving project's production licence was excised was granted after the financial year the expenditure was incurred;

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if the person to whom the permit was granted was the person involved; and

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if that person held the interest in the project up until the transfer year.

[Subclause 22(4)]

Transfer to the project with most recent production licence

Where transferable exploration expenditure was incurred in a financial year before the transfer year and there are two or more projects to which a person can transfer the expenditure, that person must transfer the expenditure to the project with the most recent production licence. [Clause 23]

Transferable exploration expenditure from different years

Where there are amounts of transferable exploration expenditure incurred in different years, the first step is to classify an amount of expenditure according to the year in which the expenditure was incurred. This is done by referring to the receiving project. The year will be either an ABR expenditure year (broadly, a financial year not occurring more than 5 years before the issue of the receiving project's production licence) or a GDP expenditure year (all other years).

The rule is that expenditure of the earliest ABR expenditure year must be transferred first followed by expenditure of later ABR expenditure years. Expenditure of GDP expenditure years follow, again commencing with the oldest year first and moving to the most recent. [Clauses 24 and 25]

Expenditure incurred in a financial year before the transfer year will be compounded forward. The effect of this rule will be that the amounts of expenditure subject to the greatest amount of compounding will be transferred first.

Transfers between group companies

After a company has made transfers under section 45A (person includes a company for the purposes of the Principal Act) in an assessable year the company may still have amounts of transferable exploration expenditure that has not been transferred (unused transferable exploration expenditure).

If the company (the loss company) is part of a company group and there are other companies in that group with projects at otherwise have taxable profits, then the loss company must transfer as much of the unused transferable exploration expenditure to those other companies' projects in accordance with the rules set out in Part 6. [Clause 19 of the Bill section 45B]

The obligation to make the transfer is with the loss company which must give written notice of any transfer to the Commissioner. As with transfers generally, group transfers not in accordance with the rules are ineffective. If a loss company contravenes the transfer rules without reasonable excuse, it will be guilty of an offence.

What is a company group?

Group companies are defined for the purposes of the Principal Act. The definition follows closely that found in Section 80G of the Income Tax Assessment Act 1936. Broadly, unused transferable exploration expenditure will be transferable where there is 100% common ownership between the company which incurred the transferable expenditure and the company to which the right to the deduction for the expenditure is to be transferred. [Clause 4 of the Bill, definition "company", clause 5 of the Bill section 2B]

The two basic tests are that throughout the period one of the companies was a subsidiary of the other company or each of the companies was a subsidiary of the same parent. This test must be satisfied during the whole period or, if either or both of the companies was not or were not in existence for part of the period, for the period during which both companies were in existence. A company is to be treated as coming into existence during a period if it was incorporated during that period.

Generally where an existing company is acquired or disposed of during the period by the company group concerned, it will not be taken to be part of the group for the period. The exception is the acquisition of shelf companies.

Rules relating to group transfers

The rules applying to group transfers under Part 6 of the Schedule will be effectively the same as those applying to transfers under Part 5 of the Schedule.

Under Part 6, those rules under Part 5 that apply in relation to the transferring entity will apply to the loss company. Similarly those Part 5 rules relating to the receiving project will apply to the company receiving the unused transferable exploration expenditure (the profit company).

In effect the transfer rules will apply as if the group were a person and all projects held by companies in the group were held by that person. [Clauses 27, 29, 30 and 34]

Companies to have held their interests at relevant time

The general transfer rule requiring the holding of interests in projects at the time the expenditure was incurred and at the time the transfer takes place applies to the company group situation. However, there will be an additional requirement. The general rule, as modified for the group situation, is that the loss company must have held its interest in the transferring entity and the profit company must have held its interest in the receiving project from the beginning of the year the transferable expenditure was incurred up until the end of the transfer year and any intervening period.

In addition, under Part 6 the loss company and the profit company must have been group companies during the same period. [Paragraph 31(1)(c)]

For example, a loss company may have incurred transferable expenditure during a financial year. Also the loss company acquired a 100% owned subsidiary company subsequent to that year. Even if the subsidiary company held an interest in a receiving project at the time the relevant transferable expenditure was incurred, the loss company cannot transfer the expenditure to any receiving project of the subsidiary because the subsidiary was not a group company at the time the expenditure was incurred. Any transferable expenditure incurred in a financial year subsequent to the acquisition of the subsidiary would be transferable to receiving projects of the subsidiary.

Commissioner's power in relation to general and group transfers

If a person or a loss company fails to make a transfer or the transfer is not in accordance with sections 45A and 45B then the Commissioner can step in and make the transfer according to those rules. [Clause 19 of the Bill, section 45C]

Section 64 of the Principal Act is being amended so that the Commissioner can make transfers under section 45C at any time [Clause 20 of the Bill].

This authority is in addition to the Commissioner's general authority to amend assessments under section 64 of the Principal Act.

A transfer made by the Commissioner has effect as if it had been made by the person or the loss company. A transfer can be varied or revoked if new information comes to the notice of the Commissioner that has a bearing on the original transfer.

The Commissioner is required to give notice in writing within 30 days to the person - or in relation to a group transfer, to the loss company and the profit company - of the particulars of a transfer, variance or revocation.

These parties can object to the Commissioner's action within 60 days of being given the notice. The objection should be in the same form as if it were an objection against an assessment of PRRT. It will also be treated in the same way as an objection against an assessment under the Principal Act. Therefore the Commissioner will be required to consider the objection and either disallow it or allow it wholly or in part. The person objecting, if dissatisfied with that decision may within a further 60 days request the Commissioner to refer the decision to the Administrative Appeals Tribunal or to the Federal Court of Australia.

No double deductions

Any amount of actual expenditure that has been transferred by a person or a loss company in a financial year cannot be transferred again in that or any later year.

Further it cannot be counted again when working out any PRRT liability of a later year of the transferring entity in relation to which the expenditure was actually incurred.

An amount of actual expenditure will only ever give rise to one deduction. This will be either as deductible expenditure of a project in relation to which it was incurred or as an amount of transferable expenditure in relation to a receiving project. [Clause 19 of the Bill, section 45D]

Examples

Examples 1 and 2 illustrate the manner in which a person with transferable exploration expenditure must transfer its expenditure to receiving projects. They also illustrate the application of the rules determining the order in which the expenditures must be transferred.

Example 1

A person has an exploration right with transferable exploration expenditure calculated under Part 4 of $100m. The expenditure was incurred during the period 1 December 1990 to 30 June 1997. The exploration permit came into force on 1 December 1990. The person also has two projects with a notional taxable profit. The production licences for Projects 1 and 2 came into force during the financial years ended 30 June 2000 and 1991 respectively. The transfer year is the year ended 30 June 2001.

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Transfer to the project with the most recent production licence. [Clause 23]

Example 1 - Transfer of Exploration Expenditure
                    

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Since the expenditure ($100m) was incurred before the transfer year (2001), it must be transferred to the project with the most recent production licence i.e., Project 1. [Clause 23]

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Any transferable exploration expenditure remaining after that transfer, will then be transferred to Project 2.

Example 2

The transferring entity in the previous example has total transferable exploration expenditure of $100m, which was incurred over several years as shown below:

The order in which transferable exploration expenditure is transferred to receiving projects is determined in accordance with the rules set out in clauses 24 and 25.

Step 1

Identify each amount of expenditure according to whether it was incurred in an ABR or GDP expenditure year. This is done by reference to when the production licence of the receiving project (Project 1) came into force (the financial year ended 30 June 2000).

Step 2

Starting with the earliest year first, rank the expenditure incurred in ABR expenditure years. [Clause 24]

Step 3

Starting with the earliest year first, rank the expenditures incurred in GDP expenditure years. [Clause 25]

The order in which expenditure should be transferred will be:

Step 4

To calculate the total amount of expenditure to be transferred in relation to Project 1 and the transfer year 2001, assume that the notional taxable profit of the receiving project is $60m.

Step 5

Therefore, the amount of expenditure transferred to the receiving project is the amount when compounded in accordance with Part 7 of the Schedule equals $60m. The expenditure must be transferred in the above order. The total compounded amount of expenditure transferred cannot exceed the notional taxable profit of the receiving project [Clause 26]

Step 6

The amounts of transferable exploration expenditures not transferred remain with the exploration right as uncompounded amounts.

Example 3

The following example illustrates the manner in which a group company with unused transferable exploration expenditures must transfer to receiving projects of other companies in the company group. Such transfers must take place only when there is unused transferable exploration expenditure. In other words, the company must first transfer to its own receiving projects (as shown in Examples 1 and 2). In this example, assume that the person in Examples 1 and 2 was a company (Company A) and has only one receivable project (Project 1) to which transferable exploration expenditure has already been transferred. After the transfer (Example 2), there is unused transferable exploration expenditure remaining with the exploration right of, say, $40m.

Step 1

Company A has unused transferable expenditure of $40m and is therefore called the "loss company": [Clause 28]

Step 2

Company B has an PRRT liable project with a notional taxable profit of $200m. It is called the "profit company". [Clause 28]

Step 3

The unused transferable exploration expenditure ($40m) is transferred to Company B as it has a notional taxable profit ($200m). However, if there was another group company, Company C, which also had a project with a notional taxable profit but a more recent production licence than the receiving project of Company B the unused transferable exploration expenditure would be transferred to the receiving project of Company C. [Clause 32]

Step 4

If the unused transferable exploration expenditure amount when compounded is less than the notional taxable profit ($200m) the total amount is transferred.

Compounding of transferred amounts

Where an amount of exploration expenditure is transferred under either section 45A or 45B and the expenditure was actually incurred in a year prior to the transfer, the amount taken to be transferred will be a compounded amount. [Clause 19 of the Bill, subsection 45D(2)]

The rate of compounding (either the augmented bond rate or the GDP factor rate) is set according to the receiving project's production licence.

The rules relating to transfer are set out in Part 6 of the Schedule.

ABR or GDP expenditure year?

Where transferred expenditure is incurred in a financial year before the transfer year the first step is to work out whether the year the expenditure was incurred was an ABR expenditure year or a GDP expenditure year in relation to the receiving project.

Broadly, if the day occurring five years before the day of issue of the receiving project's production licence falls in a financial year then this and any later financial year will be an ABR expenditure year in relation to the receiving project. Financial years occurring before the earliest ABR expenditure year will be GDP expenditure years.

Expenditure compounded by the augmented bond rate

If the transferred expenditure was incurred in an ABR expenditure year the expenditure is compounded forward by the augmented bond rate up to the transfer year. The amount taken to be transferred is the compounded amount. [Clause 37]

For example, transferable expenditure was incurred by a person in relation to a transferring entity in the year ended 30 June 1991 and the transfer year was the year ended 30 June 1994. The production licence in relation to the receiving project was granted during the year ended 30 June 1994. The expenditure would be progressively compounded by the augmented bond rate for each year ended 30 June 1991 to 1993 and the expenditure would be transferred and included in the taxable profit calculation of the receiving project for the year ended 30 June 1994.

Expenditure compounded by the GDP factor

If the transferred expenditure was incurred in a GDP expenditure year the expenditure is compounded by the GDP factor up to the transfer year. The amount taken to be transferred is the compounded amount. [Clause 38]

Transferred amount not to exceed notional taxable profit

One of the rules relating to transfers of exploration expenditure is that the total amount of transferable expenditure must not exceed the notional tax profit in relation to receiving project and the transfer year [Clause 35].

Where transferred expenditure was incurred in a financial year before the transfer year the amount of transferred expenditure is the amount compounded under Part 7.

In practical terms the Part 7 calculation will operate in reverse. The notional tax profit figure in relation to the receiving project would have been calculated. If, under the transfer rules, a person was required to transfer expenditure starting with, say, the earliest ABR expenditure years in relation to the receiving project then the required calculation would be the one that worked out the amount of the incurred exploration expenditure amounts of the ABR expenditure years that produced the transferred (compounded) amount equal to notional tax profit of the receiving project.

Example 4

The following example illustrates the manner in which transferable exploration expenditure amounts (both project and non-project) must be compounded in accordance with the provisions of the Schedule. This example also differentiates between the compounding rules applicable to expenditure incurred in ABR expenditure years and expenditure incurred in GDP expenditure years.

For the purposes of this example, we will refer to Example 2, where a person had the following transferable exploration expenditure amounts:

Example 2 also stated that there is a receiving project (Project 1) with a notional taxable profit of $60m. Therefore the amount of transferable exploration expenditure, transferred to the receiving project is the amount that, when compounded in accordance with Part 7 of the Schedule, equals $60m. The expenditure set out above has been ranked in relation to the production licence of the receiving project.

Assume again that the production licence of the receiving project (Project 1) came into force during the year ended 30 June 2000.

Compounding of transferred amounts is done as follows:

Step 1

With the expenditures ranked in accordance with Part 5 of the Schedule, apply the compounding rules to expenditure incurred in the earliest ABR expenditure year.[Clause 37]

Step 2

Subclause 37(1) does not apply as the relevant ABR expenditure year (the financial year ended 30 June 1995) was not the financial year immediately before the transfer year (2001). However, if the expenditure was incurred in a financial year immediately before the transfer year, the transferable amount would be multiplied by the augmented bond rate to calculate the compounded amount.

Step 3

Since the ABR expenditure year was an earlier year, the compounding rules under clause 37(2) apply as follows (assuming an augmented bond rate for all years of 1.28):

(Transferred amount) * (augmented bond rate) = (Notional Taxable Profit)


(Transferred amount) * 1.28 = $60m


Now working backwards to the ABR expenditure year that produced the compounded transferred amount:

Step 4

The amount taken to be transferred for the purposes of subsection 45D(2) is $60m. The "transferred amount", the amount of expenditure actually incurred in the relevant ABR expenditure year (the financial year ended 30 June 1995) is $13.6m.