Decision impact statement

Esso Australia Resources Pty Ltd v Commissioner of Taxation

Venue: Federal Court of Australia
Venue Reference No: VID 480-493 of 2011; VID 536-554 of 2011; VID 560-569 of 2011
Judge Name: Keane CJ, Edmonds and Perram JJ
Judgment date: 6 December 2011
Appeals on foot: No
Decision Outcome: Partly Favourable

Impacted Advice

Relevant Rulings/Determinations:

• N/A

Subject References:
petroleum resource rent tax
assessable petroleum receipts
marketable petroleum commodity
sales gas
liquefied petroleum gas
excluded commodity
petroleum project
taxing point
text of provision
content and scheme of Act
legislative history
extrinsic materials
importance of definitions in context
expert evidence
take or pay amounts

Précis

Outlines the ATO's response to this case which concerns 'marketable petroleum commodities' that became 'excluded commodities' and whether receipts were 'assessable petroleum receipts' under the Petroleum Resource Rent Tax Assessment Act 1987 ('PRRTA Act').

Brief summary of facts

Esso Australia Resources Pty Ltd ('Esso') and BHP Billiton Petroleum (Bass Strait) Pty Ltd ('BHPBP') (together 'the taxpayers') are co-venturers in off-shore petroleum recovery operations in Bass Strait and associated onshore processing and storage facilities at Longford and Long Island Point.

'Taxing point' issues

Esso, as operator of the joint venture, recovers petroleum from wells on a series of offshore platforms in the Bass Strait. The platforms are connected by pipelines to the Longford Gas Processing and Crude Stabilisation Plant ('Longford'), which is connected by pipelines to the Long Island Point Fractionation Plant ('LIP').

Esso produces five commercial products from petroleum recovered from Bass Strait: sales gas, commercial ethane, commercial propane, commercial butane and stabilised crude oil.

In summary, the petroleum project involves an integrated production process as follows:

1.

The wells on the Bass Strait platforms are used to recover liquid and gaseous raw petroleum from the petroleum pools;

2.

Some separation of the recovered petroleum occurs on the platform into substantially liquid and substantially gaseous streams, which (sometimes in recombined form) is then piped to shore;

3.

Further separation and filtering of the substantially gaseous stream occurs at Longford to produce the commercial product 'sales gas' and a raw LPG stream comprised of propane, butane and ethane. The sales gas is sold at the exit of the Longford plant;

4.

Further separation and filtering of the substantially liquid petroleum stream occurs at Longford to produce the commercial product 'stabilised crude oil' and to remove the raw LPG and gas that is piped across to the gas plants;

5.

The raw LPG and stabilised crude oil is piped to LIP. The stabilised crude oil is stored at the plant for sale while the raw LPG stream is further separated into the commercial products ethane, propane and butane for sale. Propane and butane are sold at LIP. Ethane is not sold at LIP but is piped to Altona where it is sold.

Not all of the sales gas produced at Longford is sold. Some is used by Esso to generate electricity for use at Longford. Surplus electricity is sold into the Victorian power grid.

Take or pay issue

Esso and Hematite Petroleum Proprietary Ltd (which assigned its rights to BHPBP) ('Sellers') entered into a natural gas sales agreement with the State Electricity Commission of Victoria ('SECV') on 1 January 1981 ('SECV agreement'). Under the SECV agreement, the Sellers agreed to supply natural gas to the SECV.

Under the SECV agreement, if the amount otherwise payable by the SECV to the Sellers for gas in any year was less than a Minimum Annual Payment ('MAP'), the SECV was required to pay the difference to the Sellers ('shortfall payment').

Under the SECV agreement, if the amount of gas taken by the SECV in any year was less than Minimum Annual Quantity ('MAQ') for that year, the SECV had the right to take the difference, being Make Up Gas ('MUG'), over the next four years (provided that in any year in which MUG is taken, the SECV has taken the MAQ for that year). MUG, when taken by the SECV, generally did not require further payment.

Generation Victoria ('GenVic') (the successor to the SECV) made a shortfall payment of $11,753,357.87 to Esso in respect of the 1996 calendar year ('1997 shortfall payment'). Esso did not return the 1997 shortfall payment as an assessable petroleum receipt. The relevant Part of the SECV agreement (allowing MUG) expired on 31 December 1996. As a result, no MUG could be taken by GenVic in the following years.

SECV or GenVic also made shortfall payments in respect of the 1987, 1988, 1991 and 1993 calendar years. Esso returned these shortfall payments as assessable petroleum receipts in the year of tax in which SECV or GenVic took the relevant MUG (i.e. years of tax ended 30 June 1991, 1993, 1995 and 1996).

MLMDQ payments issue

The Sellers entered into a natural gas sales agreement with the Gas and Fuel Corporation of Victoria ('GFC') on 1 January 1975 ('GFC agreement'). The GFC agreement provided for a specified volume of natural gas, sourced from dedicated gas fields, to be sold to GFC. Further, the Sellers were only required to deliver the quantity of gas required by GFC each day up to an agreed amount (the Maximum Daily Quantity ('MDQ')).

Under the GFC agreement, GFC was required to inform the Sellers of the MDQ to be set for the contract year five years in advance. The MDQ had to be less than or equal to the Sellers' maximum daily supply capacity (the Maximum Limit to the Maximum Daily Quantity ('MLMDQ')). The GFC agreement specified the MLMDQ from 1980 to 1989. Thereafter, the Sellers were required to nominate their MLMDQ 10 years in advance. In 1990, the Sellers made their MLMDQ nominations for the years 1990 to 2000.

In August 1990, GFC approached the Sellers about increasing the MLMDQ so that it could access a higher MDQ in the 1995-2000 years if required. The parties reached agreement ('MLMDQ agreement') in mid-1991 and the MLMDQ was actually increased for the 1995-2000 years.

The increased level of MLMDQ did not increase the amount of gas to be sold. It merely increased the range in which GFC could nominate the maximum quantity of gas to be delivered on a given day.

GFC agreed to make monthly payments to the Sellers from July 1991 to December 2000 ('MLMDQ payments'). The payments consisted of a fixed and a variable component.

The terms of the MLMDQ agreement were subsequently incorporated into a new Gas Sales Agreement between the taxpayers and Gascor (the successor to GFC) dated 20 November 1996.

Decision at First Instance (Esso Australia Resources Pty Ltd v Commissioner of Taxation [2011] FCA 360)

The decision addressed thirteen separate questions concerning the taxing point, take or pay, MLMDQ payment and sale of surplus electricity issues. Middleton J found for the Commissioner on the principal taxing point issues, but held that the sale of surplus electricity into the Victorian electricity grid did not give rise to assessable petroleum receipts. His Honour also found for the Commissioner on the take or pay issues, but held that the MLMDQ payments were not assessable petroleum receipts.

The taxpayers appealed from the decision on the principal taxing point and take or pay issues and the Commissioner cross-appealed on the MLMDQ payments issue. The Commissioner did not appeal from the decision on the sale of surplus electricity issue.

Issues decided by the court

The issues decided by the Court must be viewed against the background of the legislative scheme underlying the PRRT. Broadly, under that scheme, tax is imposed at a rate of 40% in respect of the taxable profit of a person of a year of tax in relation to a petroleum project. Taxable profit is defined (in section 22) as assessable receipts derived by a person to the extent they exceed deductible expenditure and certain other amounts.

'Assessable receipts' are defined in section 23 to mean, inter alia, assessable petroleum receipts. Broadly, in terms of section 24, assessable petroleum receipts comprise the sale consideration less sale expenses of marketable petroleum commodities ('MPCs') which have become 'excluded commodities' by virtue of being sold. In addition, if the MPC becomes an excluded commodity by virtue of some other manner specified under the Act (e.g. if it is moved away from the place of its production before being sold) then notional receipts are used (e.g. the market value of the commodity just before it became an excluded commodity). There is also provision in section 24 to assess the sale of petroleum which has not reached the MPC stage.

An MPC is defined in terms of various products produced from petroleum including stabilised crude oil, sales gas, condensate, and LPG. An excluded commodity is defined in section 2 as an MPC that has been sold or otherwise processed, treated or dealt with in a particular way.

Because of the way the legislation operates, and particularly for the operation of section 24, it is necessary to determine if an MPC exists and, if so, the manner in which it becomes an excluded commodity. This affects, for example, whether actual sale consideration or notional receipts are used.

'Taxing point' issues

The Court agreed with the conclusions of Middleton J on the taxing point issues:

1.

Sales gas, as an MPC, '...was not produced until the point of sale at Longford...' [59]. Middleton J observed that the sales gas product was produced by Esso when the petroleum recovered from the various wellheads on the offshore platforms completed the final processing at Longford [250]. At [249] Middleton J observed that by the act of sale of the sales gas, it became an excluded commodity and that section 24(c) of the PRRTA Act was not applicable. It necessarily follows that Middleton J concluded, and the Full Court agreed, that there was no point prior to the sale at which the sales gas (as an MPC) became an excluded commodity.

2.

LPG (propane and butane), as an MPC, was produced by Esso upon completion of the processing at LIP. Propane and butane each became an excluded commodity by way of the sales at LIP [67]. Ethane became an excluded commodity by virtue of its being moved away from its place of production at LIP to Altona [70].

3.

Stabilised crude oil, as an MPC, was produced by Esso following the further separation and filtering at Longford. It became an excluded commodity by virtue of its being moved away from its place of production to the 'tank farm' at LIP [70].

In reaching their decision, their Honours had regard to various textual and contextual indications [107].

Their Honours observed that the language of the PRRTA Act made it clear that the receipts with which the Act is concerned are receipts which have been derived in relation to the petroleum project [97].

The PRRTA Act contained no suggestion that the relevant relationship between a receipt and the petroleum project is to be sought by imagining the project as if it were segmented into a series of steps - none of which could sensibly be described as 'the project' - and then fixing upon a notional receipt for a 'product' which may, in only a technical sense, answer the description of one of the specified MPC's at that segment of the project.

Their Honours thought that the focus upon the definition of 'excluded commodity' lead to a skewed view of the concept of 'petroleum project' which sees it as consistent with points in the production process rather than a concept which involves the derivation of profit from the indentified products of that process.

While their Honours thought it was impermissible to have regard to the ordinary meaning of 'marketable' in deciding what the definition meant, their Honours noted that the language of the PRRTA Act, considered as a whole, indicated that the expression 'marketable petroleum commodities' did not apply to commodities which are not yet products capable of being marketed [107].

To become an 'excluded commodity', an MPC must have been separated from the process of production and capable of being sold or moved or stored as a finished product [94]. The PRRTA Act imposes a tax on profits from the project, not upon MPC's which, though discernible as such as a matter of chemical formulae and physical properties, have not emerged from the production process as marketable finished products [99]. The review of the extrinsic material served to confirm this view [111].

Their Honours noted that the outcome would be the same whether or not the questions were determined in accordance with the amended definition of MPC provided for in Tax Laws Amendment (2011 Measures No. 8) Act 2011 (which received Royal Assent after the hearing but before this decision) [206]. The amendment applied from 1 July 1990.

Take or pay issue

The Court held that in the context of the SECV agreement a shortfall payment was consideration for the gas supplied in that year. The shortfall payment merely complemented what was otherwise the consideration for the gas taken in a particular year. The MAP was a minimum annual payment for the gas supplied in that year [161]. The entitlement to MUG arose not out of making a shortfall payment, but as a result of the SECV failing to take the MAQ for that year [162]. Hence, the shortfall payment in any year could never be consideration for MUG taken in a subsequent year [167].

Accordingly, the 1997 shortfall payment was an assessable petroleum receipt for the taxpayers in the year of tax ended 30 June 1997. The shortfall payments relating to the 1991 and 1993 calendar years were assessable petroleum receipts in the years of tax ended 30 June 1992 and 1994 respectively.

On the same reasoning, their Honours considered that the shortfall payments relating to the 1987 and 1988 calendar years were not consideration received in respect of petroleum recovered on or after 1 July 1990, as contemplated by subsection 33(4) of the PRRLA Act, and thus were not assessable petroleum receipts [167]. The extrinsic materials leading to the enactment of that Act did not alter this conclusion [169].

MLMDQ payments issue

The Court held that the MLMDQ payments were not made as consideration for the sale of gas but as consideration for the Sellers agreeing to revise the MLMDQ previously advised to GFC over the period 1991-2000 [194]. The MLMDQ payment was not a quid pro quo for the delivery of gas. Rather it was a payment for an agreement to an enhancement of the buyer's rights as to the timing of the delivery of the same quantity of gas [198]. According to their Honours, the focus of paragraph 24(b) is 'explicitly upon the consideration receivable by the seller in order to entitle the buyer to a transfer of the agreed quantity of the commodity' [200].

Accordingly, the MLMDQ payments were not assessable petroleum receipts for the taxpayers.

ATO view of Decision

'Taxing point' issues

The Court's decision is consistent with the Commissioner's views on the operation of section 24 of the PRRTA Act and the meaning of a 'marketable petroleum commodity'.

The amendment to the definition of 'marketable petroleum commodity' in section 2E of the PRRTA Act with retrospective effect from 1 July 1990, enacted after the hearing, but prior to the publishing of the Court's reasons for judgment, is consistent with the Court's decision.

Take or pay issue

The Court's characterisation of the 1997 shortfall payment is consistent with the Commissioner's contentions both at first instance and on appeal. Similarly, the Commissioner agreed that the shortfall payments for the 1991 and 1993 calendar years were assessable petroleum receipts in the years of tax ended 30 June 1992 and 1994 respectively.

The Commissioner did not seek special leave to appeal from the decision of the Court in relation to the shortfall payments for the 1987 and 1988 calendar years. The Commissioner respectfully agrees with the Court's finding that the language of subsection 33(4) of the PRRLA Act was not apt to modify the operation of the SECV agreement.

The Court's decision on the take or pay issue turned on the particular terms of the SECV agreement (e.g. the Court's finding that the SECV's entitlement to MUG did not arise from making the shortfall payment). Taxation Ruling TR 96/5 discusses the timing of derivation of assessable income under take or pay contracts where the payment gives the buyer the right to receive delivery of the product some time in the future. As such, the decision does not have any implications for the views expressed in Taxation Ruling TR 96/5.

MLMDQ payments issue

The Commissioner did not seek special leave to appeal from the decision of the Court in relation to the characterisation of the MLMDQ payments. The Commissioner respectfully agrees with the Court's finding in the particular circumstances of the case that the MLMDQ payments were for an agreement to enhance the buyer's right as to the timing of the delivery of the same quantity of gas rather than consideration for the sale of gas.

Administrative Treatment

Implications for ATO precedential documents (Public Rulings & Determinations etc)

Taxation Ruling TR 96/5 Income tax: take or pay contracts

Implications on Law Administration Practice Statements

N/A

Court citation:
[2011] FCAFC 154
(2011) 199 FCR 226
86 ATR 525 Related Rulings/Determinations:
Taxation Ruling TR 96/5 Income tax: take or pay contracts

Legislative References:
Acts Interpretation Act 1901
s 15AB

Petroleum Resource Rent Tax Act 1987
The Act

Petroleum Resource Rent Tax Assessment Act 1987
s 2
s 19
s 21
s 22
s 23
s 24
s 38

Petroleum Resource Rent Legislation Amendment Act 1991
s 33(4)

Petroleum Revenue Act 1985
The Act

Petroleum (Submerged Lands) Act 1967
s 5

Taxation Laws Amendment Act (No 6) 2001
Schedule 1

Tax Laws Amendment (2011 Measures No. 8) Act 2011
Schedule 2

Petroleum Resource Rent Tax Assessment Bill 1986


Petroleum Resource Rent Tax Assessment Bill 1987


Petroleum Resource Rent Legislation Amendment Bill 1991

Case References:
Alliance Petroleum Australia NL v Australian Gas Light Co
(unreported, Supreme Court of South Australia, Lander J, 23 December 1994)

Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue
[2009] HCA 41
(2009) 239 CLR 27
(2009) 73 ATR 256
2009 ATC 20-134

Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW)
[1948] HCA 28
(1948) 77 CLR 143

Australian Communications Network Pty Ltd v Australian Competition and Consumer Commission
[2005] FCAFC 221
(2005) 146 FCR 413

Delaney v Staples (trading as De Monfort Recruitment)
[1992] 1 All ER 944

Diamond Shamrock Explorations Co v Hodel
853 F2d 1159 (5th Cir 1988)

Esso Australia Resources Pty Ltd v Commissioner of Taxation
[2009] FCA 272
(2009) 75 ATR 323

Esso Australia Resources Pty Ltd v The Commissioner of Taxation
[2011] FCA 360
(2011) 83 ATR 47

Federal Commissioner of Taxation v Orica Ltd
[1998] HCA 33
(1998) 194 CLR 500
(1998) 39 ATR 66
(1998) 98 ATC 4494

MacDonald (Inspector of Taxes) v Dextra Accessories Ltd
[2005] 4 All ER 107

Oxfordshire County Council v Oxford City Council
(2006) 4 All ER 897
[2006] 2 AC 674

Owners of Shin Kobe Maru v Empire Shipping Co Inc
(1994) 181 CLR 404

PMT Partners Pty Ltd (In liq) v Australian National Parks and Wildlife Service
[1995] HCA 36
(1995) 184 CLR 301

Project Blue Sky Inc & Ors v Australian Broadcasting Authority
[1998] HCA 28
(1998) 194 CLR 355

Richardson v Austin
(1911) 12 CLR 463

Robshaw Brothers Ltd v Mayer
[1957] 1 Ch 125

Simpson v Connelly
[1953] 1 WLR 911

Spencer v The Commonwealth
[2010] HCA 28
(2010) 241 CLR 118

Sun World International Inc v Registrar, Plant Breeders' Rights
(1998) 87 FCR 405

Visa International Service Association v Reserve Bank of Australia
[2003] FCA 977
(2003) 131 FCR 300

Wacal Developments Pty Ltd v Realty Developments Pty Ltd
(1978) 140 CLR 503

Woodside Energy Ltd v Federal Commissioner of Taxation
[2009] FCAFC 12
(2009) 174 FCR 91
(2009) 74 ATR 922

Woodside Energy Ltd v Federal Commissioner of Taxation (No 2)
[2007] FCA 1961
(2007) 69 ATR 465