Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello MP)Chapter 2 - Corporate restructuring and transferable exploration expenditure
Outline of chapter
2.1 Schedule 2 to this Bill amends the Petroleum Resource Rent Tax Assessment Act 1987 (PRRT Act) to allow internal corporate restructuring within groups to occur without losing the ability to transfer exploration expenditure between petroleum projects of group members. This change was announced by the Treasurer and Minister for Industry, Tourism and Resources in a joint press release dated 10 May 2005.
Context of amendments
Background
2.2 The Petroleum Resource Rent Tax (PRRT) is a tax on profits from petroleum projects. It is assessed on a project basis and the liability to pay PRRT is imposed on a taxpayer in relation to its interest in the project. This liability is based on the project's receipts less project expenditures. Deductible expenditure not offset against project receipts in a financial year is compounded at varying rates (depending on the type of expenditure and time between the expenditure being incurred and deducted) to be available as a deduction against project receipts in future years.
2.3 A regime allowing the transfer of unused (or undeducted) exploration expenditure between petroleum projects was introduced on 1 July 1990. This regime allows and requires exploration expenditure actually incurred on a particular petroleum project which is not absorbed against assessable receipts from this project (ie, a project not generating a PRRT liability) to be transferred to the extent it can be offset against assessable receipts of another petroleum project (ie, a project generating a PRRT liability). The ability to transfer exploration expenditure between projects in this way is dependent on meeting the common ownership test. These rules are contained in the Schedule to the PRRT Act. Transfers are, in priority, to other projects in which the same taxpayer has a qualifying interest and any remaining amounts are transferred to other projects in which a company that is a member of a common wholly-owned group has a qualifying interest.
Implications of current law
2.4 The amendment allowing company restructures to occur without losing the ability to transfer exploration expenditure applies where members of a common company group have an interest in the project incurring the exploration expenditure and in the project generating the PRRT liability. In particular, section 45B of the PRRT Act requires that if a company with unused exploration expenditure (the loss company) is part of a company group and there is another company in that group with a petroleum project with a notional taxable profit (ie, taxable profit excluding group company transfers), then the loss company must transfer the unused transferable exploration expenditure to the profitable project to the extent that it can in accordance with the rules set out in Part 6 of the Schedule to the PRRT Act (in particular, meeting the common ownership test). Unused exploration expenditure eligible for transfer is subject to ordering rules. Under section 2B of the PRRT Act, a company is a group company in relation to another company and a period if one of the companies is a subsidiary of the other company, or each company is the subsidiary of the same company, for the period.
2.5 Part 6 of the Schedule to the PRRT Act outlines the rules relating to transfer of exploration expenditure between group companies. Clause 28 establishes the situations in which Part 6 may apply. This clause also defines the loss company as the group company with unused transferable expenditure and a profit company as each of the other companies within the company group involved in the transfer. Clause 29 identifies the project (in which the loss company holds an interest) from which unused exploration expenditure is transferred as the transferring project, and the project in relation to which the expenditure is being transferred as the receiving project (in which the profit company holds an interest).
2.6 These terms are applied in clause 31 of the Schedule to the PRRT Act, which essentially tests continuity of ownership between the loss company and the profit company (ie, the common ownership test). In particular, this rule specifies that, in order to be able to transfer exploration expenditure, the loss company must have held an interest in the transferring project, the profit company must have held an interest in the receiving project and both companies must have been group companies in relation to each other, for the whole period from the start of the financial year in which the exploration expenditure was incurred to the end of the year in which the transfer takes place.
2.7 An effect of clause 31 is to prevent transfers of exploration expenditure where the company with an interest in either the transferring or receiving project has changed since the exploration expenditure was incurred, even if both the interests have remained at all times within a common company group. That is, it does not allow internal corporate restructures to occur without losing the ability to transfer exploration expenditure sometime in the future.
Example 2.1: Operation of current law
Company A and Company B are members of a group where Company A has an interest in Project 1 and Company B has an interest in Project 2 and these interests remain unchanged over the entire period since the time Project 1 commenced. Company A has incurred exploration expenditure in relation to Project 1. However, as it proves to be an uncommercial project (ie, never enters production) the exploration expenditure remains unused. Project 2 generates a PRRT liability for Company B against which Project 1 exploration expenditure can be deducted. In this case, the common ownership test is satisfied and the current law operates satisfactorily.
However, an internal company restructuring occurs where it is decided to close Company A and transfer its interest in Project 1 to Company C. This restructure is assumed to take place sometime between when the exploration expenditure was incurred and the end of the transfer year. Both Company A and Company C are within the same company group for PRRT purposes. If this restructure occurred, the company group would breach paragraph 31(1)(a) and the exploration expenditure would be forever tied to Project 1. Consequently, this exploration expenditure would only be deductible against a PRRT liability arising from Project 1. This is because Company C (the company that now has the interest in Project 1), which is also now the loss company, has not had an interest in Project 1 for the whole period from the beginning of the financial year that the expenditure was incurred.
Similarly, if Project 1 were to remain with Company A, but Company B's interest in Project 2 is transferred to Company C, then transferring exploration expenditure from Project 1 to Project 2 would be prohibited under paragraph 31(1)(b). This is because Company C (the company that now has the interest in Project 2), which is now the profit company, has not had an interest in Project 1 for the whole period since the expenditure was incurred. In this case, the exploration expenditure would still be able to be transferred to other projects of the group, subject to satisfying clause 31.
Also, if the interest in both projects were brought for a time into the one company within the company group, transferring unused exploration expenditure between the two projects would not be possible again under the current rules, even once the projects were again held by different companies in a common group.
Conclusion
2.8 In summary, the current rules result in company groups maintaining inactive companies and projects in order to protect their ability to transfer unused exploration expenditure sometime in the future. This places an undue compliance and administrative burden on those companies, and prevents efficient corporate structuring over time.
Summary of new law
2.9 These amendments will allow unused exploration expenditure to be available for transfer between projects within the group company where there is continuity of group ownership of the transferring and receiving projects. That is, both the loss interest and the receiving interest need to have been held by companies which are group companies in relation to each other (or are the same company) during the entire period between the expenditure being actually incurred and the expenditure being transferred to the other project and used. The amendments are designed to allow internal corporate restructuring of a wholly-owned group to occur without losing the ability to transfer unused exploration expenditure.
Comparison of key features of new law and current law
| New law | Current law |
|---|---|
| The new clause 31 of the Schedule to the PRRT Act specifies (inter alia) that both the receiving interest and the loss interest need to be held by companies which are group companies in relation to each other during the entire period between the start of the year in which the amount of exploration expenditure is actually incurred and the end of the year in which this amount of unused exploration expenditure is transferred to the receiving interest and used. This rule allows internal corporate restructures to occur without losing the ability to transfer exploration expenditure between petroleum projects with common ownership sometime in the future. | The current clause 31 of the Schedule to the PRRT Act specifies (inter alia) that, in order to be able to transfer exploration expenditure, the loss company must have held an interest in the transferring project, the profit company must have held an interest in the receiving project and both companies must have been group companies in relation to each other, for the whole period from the start of the financial year in which the exploration expenditure was incurred to the end of the year in which the transfer takes place. This rule does not allow internal corporate restructures to occur without losing the ability to transfer exploration expenditure between petroleum projects with common ownership sometime in the future. |
Detailed explanation of new law
2.10 These amendments recast the continuity of ownership test in clause 31 of the Schedule to the PRRT Act. This clause sets out the common ownership test that needs to be met in order to be able to transfer an amount of exploration expenditure from one project to another project where both projects are held within a company group.
Main rule
2.11 The main rule specifies that both the receiving interest and the loss interest need to be held by companies which are group companies in relation to each other during the entire period between the start of the year in which the amount of exploration expenditure is actually incurred and the end of the year in which this amount of unused exploration expenditure is transferred to the receiving interest and used. In general terms, the main rule allows company restructuring to occur without losing the ability to transfer unused transferable exploration expenditure to a PRRT paying project. [Schedule 2, item 2, subparagraph 31(1)(a)(i)]
Example 2.2: Operation of main rule
In Example 2.1, where the interest in Project 1 (which incurred the unused transferable exploration expenditure) is transferred from Company A to Company C as part of a company restructuring, the unused transferable exploration expenditure associated with Project 1 and now held by Company C can be transferred to Project 2 held by Company B. This is because at the time of the restructuring, Companies A, B and C are group companies in relation to each other. That is, before the restructuring, Companies A and B were group companies in relation to each other and after the restructuring Companies B and C were group companies in relation to each other.
Similarly, in Example 2.1 where the interest in Project 2 (which is generating a PRRT liability) is transferred from Company B to Company C as part of a company restructuring, the unused exploration transferable expenditure associated with Project 1 and held by Company A can be transferred to Project 2 now held by Company C. Again, this is because at the time of the restructuring, Companies A, B and C are group companies in relation to each other. That is, before the restructuring Companies A and B were group companies in relation to each other, and after the restructuring Companies B and C were group companies in relation to each other.
2.12 The main rule also allows for the possibility that both the loss interest and the receiving interest are held by the same company for some part of the time once the exploration expenditure is actually incurred and before the time that the amount of expenditure is transferred to the receiving interest. The loss interest and the receiving interest cannot be held by the same company when the amount of expenditure is transferred, as the transfer would then not be between members of a common group and would not be made under this rule. That is, where the transfer is between project interests of the same taxpayer, the transfer is subject to clause 22 of the Schedule to the PRRT Act. [Schedule 2, item 2, subparagraph 31(1)(a)(ii)]
2.13 These amendments define the terms 'loss interest' and the 'receiving interest'. The loss interest means an interest held in the transferring entity (a petroleum project for PRRT purposes) by the loss company at either the end of the transfer year or immediately before the start of the finishing day (the end of the petroleum project) if the finishing day for the transferring entity is before the end of the transfer year. Similarly, the receiving interest means an interest held in the receiving project (a petroleum project for PRRT purposes) by the profit company at either the end of the transfer year or immediately before the start of the finishing day if the finishing day for the receiving project is before the end of the transfer year. This is because, until the end of the year in which the amount of expenditure is transferred, it cannot be ascertained finally whether the amount of expenditure is available for transfer (as unused in relation to the transferring entity) or can be utilised by the receiving project (as an offset to what would otherwise be taxable profit in the year of tax) [Schedule 2, item 2, subclause 31(4)] . The definitions of 'loss company', 'profit company', 'transferring entity', 'receiving project' and 'group company' remain unchanged.
Other requirements and qualifications
2.14 The main rule specifies the company that must have actually incurred the exploration expenditure for PRRT purposes. This company is the holder of the loss interest at that time, and is either the company that actually incurred the exploration expenditure or the company taken to have incurred the exploration expenditure because of the operation of paragraph 41(1)(b). The effect of paragraph 41(1)(b) is to ensure that where a third party (such as a contractor) actually incurs the exploration expenditure, this expenditure is taken for PRRT purposes to have been incurred by the PRRT taxpayer who is liable to pay the third party. The operation of paragraph 31(1)(b) does not limit the number of internal corporate restructures that can occur without losing the ability to transfer exploration expenditure sometime in the future. [Schedule 2, item 2, paragraph 31(1)(b)]
2.15 The main rule is qualified to deal with the circumstances where the starting day (the start of the particular petroleum project) of the transferring entity or of the receiving project is after the start of the financial year the transferred amount of exploration expenditure is incurred, and also the circumstances where the finishing day (the end of the particular petroleum project) of the transferring entity or of the receiving project occurs before the end of the transfer year (for which the amount of exploration expenditure is transferred and used). In such circumstances, the company holding the transferring entity at its starting day and the company holding the receiving project at its starting day are deemed to have held that interest from the start of the financial year until the starting day. Correspondingly, the loss company holding the loss interest on the finishing day and the profit company holding the receiving interest on the finishing day are deemed to have held that interest from the finishing day until the end of the transfer year. This allows the transfer rules to apply appropriately although technically there may be no project from which, or to which, to transfer the amount of exploration expenditure because the relevant petroleum project started after the start of the year, or ended before the end of the year. These are the points as at which the transfer rules can be applied (because then it can be known that no other events in the year can operate to affect the transfer). [Schedule 2, item 2, subclause 31(2)]
2.16 Finally, the amendments deal with the circumstance where the starting day for the receiving project is a later financial year than the financial year the exploration expenditure is incurred. In this circumstance, the loss company may transfer exploration expenditure only if the company which held the receiving interest at the start of the starting day was the company which had been granted an exploration permit by reference to which the starting day is determined. This rule needs to be satisfied in addition to the main rule discussed in paragraphs 2.11 to 2.13. In effect, therefore, it is not possible for a group to take up an interest in a new project so as to absorb prior-year exploration expenditure of another project, unless the group is granted the relevant exploration permit for the new project. The operation of subclause 31(3) does not limit the number of internal corporate restructures that can occur without losing the ability to transfer exploration expenditure sometime in the future. [Schedule 2, item 2, subclause 31(3)]
2.17 The existing comparable provision to the proposed new subclause 31(3) under the current PRRT Act is subclause 31(4). This existing provision identifies the starting point for applying the provision as the starting day for the transferring entity. The year in which the receiving project has its starting day is then a later financial year than that of the starting point. In contrast, the substituted provision identifies the starting point as the point when the exploration expenditure is incurred. This change more accurately reflects the original policy intention behind this provision. A consequential change is made to subclause 22(4), applying the same concept in relation to transfers of amounts of expenditure between projects of the same taxpayer, so as to maintain consistency between the concept as expressed in subclause 22(4) and as expressed in the proposed new subclause 31(3). [Schedule 2, item 1, subclause 22(4)]
Application and transitional provisions
2.18 These amendments will apply to instalments and assessments of PRRT for financial years beginning on or after 1 July 2006. [Schedule 2, item 3
2.19 However, in the case where the transferable exploration expenditure was actually incurred before 1 July 2006, this expenditure may only be transferred from the loss company to the profit company provided certain conditions are met [Schedule 2, item 4, subsection 4(1)] . The first condition is that if the new clause 31 (inserted in the PRRT Act by this Bill) prevents the transfer, this expenditure cannot be transferred [Schedule 2, item 4, subsection 4(2)] .
2.20 The second condition applies in the circumstance where the starting day for the receiving project was before 1 July 2006. In this circumstance, the expenditure cannot be transferred if old clause 31 (ie, clause 31 of the Schedule to the PRRT Act in force immediately before 1 July 2006) would have prevented the transfer of the expenditure, in relation to the transfer year starting on 1 July 2005, from the company that actually incurred the expenditure to the company that held the receiving interest at the end of that year. [Schedule 2, item 4, subsection 4(3)]
2.21 The third condition applies in the circumstance where the starting day for the receiving project was on or after 1 July 2006. In this circumstance, the expenditure cannot be transferred if paragraph 31(1)(a) of the old clause 31, subject to subclauses (2), (2AA), (2AB) and (2A) of that clause, did not, in relation to the transfer year starting on 1 July 2005, apply to the company that actually incurred the expenditure. [Schedule 2, item 4, subsection 4(4)]
2.22 For the purposes of the second and third conditions, the company is taken to have incurred the exploration expenditure because of the operation of paragraph 41(1)(b). The effect of paragraph 41(1)(b) is to ensure that where a third party (such as a contractor) actually incurs the exploration expenditure, this expenditure is taken for PRRT purposes to have been incurred by the PRRT taxpayer who is liable to pay the third party. [Schedule 2, item 4, subsection 4(5)]
2.23 The effect of the second and third conditions is to prevent the transfer of exploration expenditure incurred before 1 July 2006 if a corporate restructuring occurred in the period before 1 July 2006 resulting in failure to meet the conditions set out in old clause 31.