House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 5 Mining expenditure

Outline of chapter

5.1 This chapter explains when a miner's expenditure on mining operations will be taken into account in working out the miner's mining profit for a mining project interest.

5.2 All legislative references throughout this chapter are to the Minerals Resource Rent Tax Bill 2011 (MRRT Bill) unless otherwise indicated.

Summary of new law

5.3 A miner's mining expenditure for a mining project interest includes expenditure necessarily incurred in carrying on mining operations upstream of the valuation point. However, such expenditure is specifically excluded if it is:

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a cost of acquiring an interest in a mining project interest;

•

a royalty (other than some private mining royalties);

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a cost of finance;

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a payment under a hire purchase agreement;

•

capital expenditure on non-adjacent land or buildings for administrative or accounting activities;

•

hedging or currency losses;

•

a rehabilitation bond or trust payment

•

a payment of income tax or goods and services tax; or

•

a unit shortfall charge.

Detailed explanation of new law

Mining expenditure

5.4 Mining expenditure is a fundamental concept because it feeds directly into the calculation of a miner's mining profit for a mining project interest in respect of a Minerals Resource Rent Tax (MRRT) year and therefore its total MRRT liability for an MRRT year. [Sections 10-1 and 25-5]

5.5 The mining expenditure for a mining project interest is the sum of all the amounts that are included as mining expenditure for the interest for an MRRT year. [Subsection 35-5(1)]

5.6 An amount is only included in mining expenditure once, under the most appropriate provision. [Section 35-25]

5.7 Some expenditure is specifically excluded. [Subsection 35-5(2) and Subdivision 35-B]

General test for mining expenditure

5.8 A miner's mining expenditure for a mining project interest includes expenditure to the extent that it is necessarily incurred by the miner in carrying on upstream mining operations in respect of that mining project interest. [Section 35-10]

5.9 Unlike income tax, it does not matter whether the expenditure is of a revenue or a capital nature. All expenditure that satisfies the nexus to upstream mining operations is deductible as mining expenditure when incurred. This approach is consistent with the 'cash flow' nature of rent taxes. [Subsection 35-10(2)]

Expenditure

5.10 'Expenditure' is a word with several meanings. In the MRRT context, 'expenditure' refers to disbursement of an amount of money (except where the non-cash benefit rules apply). The term is often coupled with a timing rule, such as 'incurred'. In these cases, the expenditure would occur when the timing rule is satisfied.

5.11 'Expenditure' does not include the consumption of assets, which is another possible meaning of the word. An asset that has been consumed or lost will already have led to an amount of mining expenditure at the time it was purchased for use in upstream mining operations.

5.12 For example, if explosives are included in mining expenditure at the time of purchase, then the value of those explosives is not included in mining expenditure when they are used because that would double count the miner's costs.

5.13 In addition, because miners get an upfront deduction for capital expenditure, there is no depreciation (except in the case of starting base assets). Indeed, if miners were to depreciate their assets, the expenditure would be counted twice - once at the time of purchase, and again over the life of the asset.

Necessarily incurred ... in carrying on

5.14 The words 'necessarily incurred ... in carrying on' are familiar to business taxpayers as they are integral to the general income tax test for deductibility (see section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)). These words are judicially well tested and therefore provide a high degree of certainty regarding the deductibility of expenses. The words have been consciously chosen in preference to the approach to deductibility that is a feature of the Petroleum Resource Rent Tax (PRRT) regime and which has given rise to disputes about whether expenses are deductible or not.

5.15 The approach adopted by the courts in interpreting and applying these words in the income tax context is appropriate for MRRT purposes. This means that, if expenditure is reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of upstream mining operations, it is mining expenditure.

5.16 While there must be a nexus between an expense and upstream mining operations in order for the expense to be mining expenditure, the requirement for expenditure to be necessarily incurred does not impose a narrow test or a test of logical or inescapable necessity. The Courts have developed a pragmatic approach to interpreting these words.

Example 5.35 : Approach to deductibility

Wildfire Coal, a UK resident, has Australian mining operations. After negotiation with a local authority, Wildfire pays for the construction and ongoing maintenance of a community aquatic centre at a township established to provide housing and community facilities for the workforce for its mine. While the aquatic centre is for the use of the whole community, it is primarily for use by the miner's employees. The expenditure on the construction and maintenance of the aquatic centre is an important part of ensuring that it has the workforce that it requires to carry on its operations. The expenditure is incurred as a matter of practical operational necessity and so is mining expenditure to the extent that it is for employees engaged in upstream mining operations.

5.17 However, this does not mean that all expenditure necessarily incurred in carrying on a business that includes the production of a taxable resource is deductible. This is a resource rent tax, not an income tax - not all revenue is assessable, and not all expenditure is deductible. Expenditure must be sufficiently connected to upstream mining operations and not the business more generally. Only expenditure that has the necessary relationship with upstream mining operations is included in mining expenditure.

Example 5.36 : Expenses incurred in carrying on a business

Continuing the previous example, Wildfire Coal decides to list on the ASX and incurs costs associated with listing. While these costs may have a connection with Wildfire Coal's business, they do not have the appropriate connection with upstream mining operations and so are not mining expenditure.

5.18 Importantly, the words 'necessarily incurred ... in carrying on' have proven flexible over time. They are capable of dealing with new situations.

Example 5.37 : Expenses incurred in meeting environmental obligations

Craig Mining Co owns and operates an iron ore mine in the Pilbara. During the 2013-2014 MRRT year, it emits 20,000 tonnes of Co2 in carrying on its upstream mining operations. It is therefore required to purchase and surrender 20,000 emission units to meet its obligations under the Clean Energy legislation. The expenditure is necessarily incurred in carrying on upstream mining operations and so is included in mining expenditure.

Upstream mining operations

5.19 Upstream mining operations are mining operations to the extent that they relate directly to finding and extracting a taxable resource from the mining project area for the mining project interest. Any activity or operation directed at doing anything to, or with, the taxable resource after it reaches the valuation point is not an upstream mining operation. [Section 35-15]

5.20 Extracting the taxable resource incorporates all those activities necessary to free the taxable resource from its in situ location, and so would include recovering resources from the surface of the land, excavating an open cut pit, and digging a traditional underground mine.

5.21 Also included are activities that are preliminary to extraction, such as exploration, and activities undertaken as a consequence of extraction, such as getting taxable resources to their valuation point. This would include any initial crushing to make it possible to move the resources to the valuation point, building the road that links the miner to the run-of-mine stockpile, and buying and maintaining the trucks used for the transport.

5.22 Some particular things that could qualify as upstream mining operations are:

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negotiations with native title holders as part of the process of obtaining a production right over the project area;

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exploring for taxable resources in the project area;

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crushing and weighing taxable resources before they reach their valuation point;

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head office activities, to the extent that they contribute to getting taxable resources to their valuation point;

•

planning and constructing facilities, and acquiring and maintaining plant and equipment, for use in processing taxable resources before they reach their valuation point;

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upgrading computer software used in processing taxable resources before they reach their valuation point; and

•

rehabilitating a project area from damage caused by exploring, extracting and moving taxable resources to their valuation point.

5.23 Some activities may be carried on outside the mining project area.

Example 5.38 : Activities remote from the mine site

Wildfire Coal has automated some activities for producing and handling taxable resources before the valuation point. These are electronically controlled by operators working in a dedicated operations facility located away from the project area in a capital city. The provision and operation of the facilities are upstream mining operations.

Example 5.39 : Training upstream staff

Wildfire Coal employs staff at its head office in a capital city whose duties include the initial induction and training of all new mine site employees. These activities may be carried out at the mine or in the capital city. The activities are upstream mining operations to the extent that they relate to the capacity of personnel to carry on upstream mining operations.

Example 5.40 : Mine planning in a capital city

Wildfire Coal employs staff at its head office in a capital city whose duties include life-of-mine planning. These activities are carried out in the capital city, but in liaison with personnel at the mine site. The mine planning activities are upstream mining operations as they are activities integral to undertaking the mining activities.

Example 5.41 : Consultants researching new extraction processes

Wildfire Coal has engaged consultants to examine and evaluate new extraction processes for use in the planned expansion of production volumes of its taxable resources in relation to its mining project interest. The research takes place in various locations around the world as well as on the site of the mine concerned. The research is an upstream mining activity as it is preliminary and integral to extracting the taxable resources. Upstream mining operations may be carried out before or after the taxable resource reaches the valuation point so long as they otherwise have the required relationship to the extraction of the resource and getting it to the valuation point.

If Wildfire has several mining project interests, or some mines not subject to the MRRT, the costs of research that was relevant to all of them would have to be apportioned.

5.24 Activities directed at preparing the mine site are upstream mining operations.

Example 5.42 : Preparatory activities

Wildfire Coal holds a production licence and will be conducting activities to produce taxable resources from the project area. In developing the mine, it decides to prepare part of the project area for use as a run-of-mine stockpile. This includes earthworks to level and provide access to the run-of-mine stockpile site and drainage work to ensure that any run-off from the run-of-mine stockpile does not contaminate local waterways. These activities are upstream mining operations.

5.25 Activities directed at expanding a mine are upstream mining operations. For example, exploration may be undertaken within the area of a production right in order to define and clarify the exact location and extent of a taxable resource within a mining project area. As this informs decisions made about the operation of the mine in order to extract the taxable resource, it is an upstream mining operation.

Example 5.43 : Exploration within a project area

Wildfire Coal produces taxable resources from an established mine and wants to expand production from the mining project area. It undertakes drilling to clearly establish the boundaries of the existing ore body within the project area. The drilling is an upstream mining operation.

5.26 Some activities that take place after a mine stops producing taxable resources are upstream mining operations.

Example 5.44 : Mine site rehabilitation and restoration

Wildfire Coal carries out rehabilitation activities on an area from which taxable resources have been recovered by open cut mining. These activities are a consequence of extracting the taxable resources and so are related to extracting those resources. Therefore, the activities are upstream mining operations.

Example 5.45 : Mine site rehabilitation and restoration

Wildfire Coal operates a tailings pond to contain water drained from the coal mine it operates and for which it has a mining project interest. The water is removed from the mine to allow for the extraction of the coal and to maintain mine safety. After the mine closes, Wildfire Coal drains and backfills the tailings pond to restore the site. These restoration activities are upstream mining operations.

Example 5.46 : Mine site rehabilitation and restoration

When restoring its mine site, Wildfire Coal removes conveyor belt systems used to transport coal from the coal face to the run-of-mine stockpile. This is an upstream mining operation.

Mining operations

5.27 The MRRT defines mining operations to include all activities or operations that are 'preliminary or integral to, or consequential upon' extracting or producing taxable resources, or producing something else using those taxable resources. [Paragraph 35-20(1)(a)]

5.28 However, mining operations do not include doing anything to, or with, taxable resources after they reach the form and location they are in when a mining revenue event happens to them, or they are first applied to producing something in relation to which a mining revenue event happens. [Paragraph 35-20(1)(b)]

5.29 Mining operations therefore include those things that are directly involved in production, as well as those things that the miner does before the commencement, and after the cessation, of those operations. Things done as a matter of practical need to facilitate or enable that production are also included.

5.30 Some activities and operations are specifically identified as mining operations for a mining project interest for the purposes of clarifying the scope of the general definition and removing doubt in some cases of particular concern. This does not limit what is included under the general definition. [Subsection 35-20(2)]

5.31 The specific activities are:

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exploration or prospecting for taxable resources in the project area for the mining project interest;

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extracting taxable resources from the project area;

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doing anything to, or with, taxable resources recovered from the project area before they reach the form they are in when a mining revenue event happens to them;

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obtaining access to the project area for mining operations;

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acquiring, constructing or maintaining anything to be used in the above activities;

•

rehabilitating the project area affected by any of the above activities;

•

closing down any of the above activities; and

•

activities done in furtherance of these activities.

[Subsection 35-20(2)]

5.32 An activity is an activity done in 'furtherance' of the other activities specified if it is, from a practical and business point of view, directed at facilitating or enabling those activities to be carried on. However, the idea of an activity done in furtherance of another activity does not extend to activities that have only a remote or temporal connection with a listed activity. For instance, obtaining an ASX listing, while an activity that, in a remote sense, furthers the mining activities, would be too remote a connection to be part of the upstream mining operations.

5.33 The definition of 'exploration or prospecting' comes from section 40-730 of the ITAA 1997 and therefore includes activities such as geological mapping, geophysical surveys, systematic searching for areas containing minerals, and searching by drilling within those areas. It includes searching for ore within, or near, an ore-body by drives, shafts, cross-cuts, winzes, rises and drilling. It further includes conducting feasibility studies to evaluate the economic feasibility of mining minerals once they have been discovered, and obtaining mining or prospecting information associated with the search for, and evaluation of, areas containing minerals. [Section 300-1, definition of 'exploration or prospecting']

Example 5.47 : Exploring and prospecting

Pick and Shovel Co holds a mining project interest in Western Australia from which it extracts iron ore. Pick and Shovel conducts a search for additional iron ore near the ore body and within the project area. The search is part of the mining operations for the mining project interest.

Incurring mining expenditure

5.34 The MRRT operates on an accruals basis. Mining expenditure is therefore deductible in the year that it is incurred. This aligns with the treatment of deductible expenditure under the ITAA 1997 and under the PRRT.

Example 5.48 : Contractor performing services

Wildfire Coal engages Upstream Coal Services (Upstream) in June 2013 to perform activities that would be upstream mining operations. Under the agreement, Wildfire is to pay Upstream after the work is done and invoiced. Upstream performs its contractual obligations in July 2013 and immediately issues a tax invoice. Wildfire incurs this expense in the 2013-2014 MRRT year and can therefore include the amount charged for Upstream's services in its mining expenditure for that year.

Example 5.49 : Joint venture funds

Pick & Shovel Co is the operator of an iron ore mine on behalf of joint venturers, SingCo, SangCo, and SongCo. At the start of each month, Pick & Shovel provides an estimate of expenditure for the following month, and makes a cash call to the joint venturers for their share of the estimated monthly expenditure. The cash call simply puts Pick & Shovel in funds. It does not procure the carrying on of any operations. Any pecuniary liabilities incurred by Pick & Shovel as joint venture operator, so far as they relate to the other joint venturers' shares, are mining expenditure for each of SingCo, SangCo, and SongCo because Pick & Shovel is acting as their agent.

Therefore, the joint venturers only incur mining expenditure when Pick & Shovel actually incurs a pecuniary liability that bears the necessary relationship to upstream mining operations.

Apportioning mining expenditure

5.35 An asset can be used both in upstream and downstream mining operations and staff can perform functions that are relevant to both upstream and downstream mining operations. Costs may also relate to more than one mining project interest, or to taxable resources and non-taxable resources. Only the part of the expenditure incurred in the upstream operations related to taxable resources is mining expenditure and deductible against mining revenue. Expenditure that also serves other purposes must be apportioned. Expenditure that is for multiple mining project interests must be apportioned between them. [Subsection 35-10(1)]

5.36 The words 'to the extent', which are also familiar to taxpayers through their frequent use in income tax law, support the apportionment of costs. [Subsection 35-10(1)]

Example 5.50 : Activities partly for upstream mining operations

Wildfire Coal uses a loader to maintain the run-of-mine stockpile and to load ore onto vehicles for transport to the next stage of processing. The use of the loader will be an upstream mining operation to the extent that it is used to maintain the stockpile. Its use will not be an upstream mining operation to the extent that it is used to load the ore for transport away from the stockpile. Therefore, its cost and the costs of operating and maintaining it must be apportioned between its upstream and downstream roles.

Example 5.51 : Expenditure incurred in growing forests to generate carbon emission units

Pinder & Sons owns and operates a coal mine in the Illawarra region of New South Wales. Both its upstream and downstream mining operations emit significant amounts of Co2.

Pinder & Co acquires 1,000 hectares of land in Tasmania at a cost of $1 million to grow forests and generate emission units to meet its emission liabilities. Based on initial estimates, Pinder & Co will only need 300 hectares of the forest to offset the emissions generated by the upstream operations of its coal mine. Therefore, Pinder & Co will include $300,000 in its mining expenditure.

5.37 Apportionment of mining expenditure must be on a fair and reasonable basis. What will be fair and reasonable is essentially a question of fact to be determined in each case and could include using a proxy, such as revenue, production volumes, direct costs, labour costs, or head counts.

Example 5.52 : Apportioning between taxable and non-taxable resources

Wildfire Coal operates a coal mine in north Queensland. The mine can only be accessed for six months of the year due to the wet season. The company also operates a copper mine in southern Queensland. Wildfire purchases a fleet of 10 dump trucks for use in its coal mine, to transport coal to the valuation point. When the wet season comes, they move the dump trucks south to work in the copper mine.

The trucks spend 50 per cent of their time in the coal mine and 50 per cent of their time in the copper mine. The total cost of the dump trucks was $5,000,000. The miner must apportion this expenditure between its coal operation and its copper operation. The miner may only claim $2.5 million as mining expenditure.

Example 5.53 : Apportioning head office costs

Wildfire Coal operates two coal mines and one nickel mine in Queensland. It does not engage in any other commercial activities.

During the year, Wildfire receives $200 million revenue from each of its coal mines and $70 million from its nickel mine. The operating expenditure for each of the coal mines is $80 million, of which $20 million is upstream of the respective valuation points. The total operating expenditure for the nickel mine is $160 million.

Wildfire also incurs $37 million of costs at its Head Office in Brisbane. These costs relate to:

ASX Listing	$1 million
Interest	$4 million
Private royalties	$5 million
Business development	$5 million
Political donations	$1 million
Investor Relations	$1 million
Human Resources	$10 million
Management	$5 million
Office lease	$5 million

The ASX listing fee, investor relations and political donation costs would not qualify as mining expenditure as they do not have the necessary connection with the coal operations. To the extent to which the interest and private royalties relate to the coal operations, they would be excluded expenditure. The business development costs relate to researching potential acquisition targets of coal and other mining projects in and out of Australia. These costs would not be deductible for MRRT purposes on the basis that they were not incurred in respect of a mining project interest or pre-mining project interest and therefore do not have the necessary connection with the coal operations.

The remaining $20 million of human resources, office lease and management expenditure has the necessary connection with the mining operations but needs to be apportioned using a two-step process: firstly across the three mining operations, and secondly between upstream and downstream, each on a fair and reasonable basis.

Step 1

One basis for undertaking the first step of allocating the human resources, office lease and management expenditure to each of the three mines may be to use a reasonable estimate of the headcount of employees at each of the mines. A split based on total costs of each of the three mines could also be appropriate.

Another may be to allocate the expenditure to each of the three mines based on the proportion that the operating costs of each of the coal mines ($80 million each) bears to the total operating costs of the three mines ($320 million). In this case, that would result in the coal mines each being allocated 25 per cent of the costs (or $5 million each). The $10 million that relates to the nickel mine would never be MRRT expenditure, as nickel is not a taxable resource.

On the facts of this case, an allocation of the human resources, office lease and management expenditure to the three mines based on the proportion that the revenue or profits from each of the coal mines bears to the total mining revenue of the mines may not be reasonable. That is because Wildfire's revenue and profit margin from its coal mines is disproportionately large compared to its profit margin from its nickel mine. Revenues and profits may not therefore be an accurate proxy for working out the purpose for which the expenditure was incurred.

Step 2

Once the cost allocation has been made to each of the mine sites, it still needs to be split between upstream and downstream. This could be done using the proportion of upstream/downstream costs as a proportion of total costs at each mine. On this basis, the $5 million allocated to each coal mine above would then be split $1.25 million to upstream and $3.75 million to downstream, as 25 per cent of each coal mine's costs are upstream in this example. Upstream costs of the two mines would be MRRT expenditure and the downstream costs may be taken into account in determining the MRRT revenue.

Other amounts of mining expenditure

5.38 Amounts may be included in mining expenditure when there is an adjustment to the use of an asset used in upstream mining operations. For example, if half the cost of an asset was mining expenditure when acquired, based on an expected 50 per cent use each in the upstream and downstream operations of a mining project interest, a later decision to use it fully in the interest's upstream mining operations would lead to a further amount of mining expenditure. This is discussed in Chapter 13. [Division 160]

Excluded expenditure

5.39 Certain expenditure is specifically excluded from mining expenditure because of the general design of the MRRT while others are excluded because of the way the MRRT is intended to interact with various claims to the resource right. These are:

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costs of acquiring rights and interests in projects;

•

royalties;

•

financing costs;

•

hire purchase payments;

•

costs of non-adjacent land and buildings used in administrative or accounting activities;

•

hedging losses and foreign exchange losses;

•

rehabilitation bond and trust payments;

•

payments of income tax or GST; and

•

unit shortfall charge.

[Subsection 35-5(2) and Subdivision 35-B]

Cost of acquiring rights and interests in a project

5.40 An amount of expenditure is excluded expenditure to the extent it relates to:

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acquiring an interest in a production right covering an area, unless the expenditure is in relation to the grant of the production right [subsection 35-35(1)] ;

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acquiring a mining project interest [subsection 35-35(2)] ; or

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acquiring an interest in profits, receipts or expenditures of, or relating to, a mining project interest [subsection 35-35(3)] .

5.41 Deductions for expenditure incurred in acquiring rights or interests in projects are excluded for reasons of tax symmetry.

5.42 If a miner sells its right or interest in a project it is not required to include the sale proceeds in its mining revenue (if it were, tax would be imposed on the capitalised value of the future profits). Accordingly, the acquirer of the right is not entitled to a deduction for any consideration paid to acquire the right (or any costs associated therewith).

5.43 However, the same issue does not arise with respect to expenditure incurred in association with the initial grant of a right. Hence, expenditures such as government fees and legal expenses paid in relation to the grant of a right are deductible.

When something is granted

5.44 Something is 'granted' when it is bestowed or conferred. The word 'grant' has historically been used to refer to situations in which governments bestow property rights upon citizens (and other entities). It has not generally been used to describe the transfer of rights. It has been used here because the types of situations envisaged involve governments granting exploration and production rights. Generally, such rights can only be granted once. After they have been granted, they may be sold, but not granted again.

5.45 However, more than one right could be granted over the same area. For example, an exploration right may lapse and a government may grant a new right. It is appropriate that expenditure associated with such a subsequent grant be included in mining expenditure; it is not a transfer of an existing mining right.

Royalties

5.46 Mining royalties, private mining royalties, and payments that give rise to royalty credits are excluded expenditure. [Subsection 35-40(1)]

5.47 Mining royalties are discussed in detail in Chapter 6, which is about allowances.

Private mining royalties

5.48 A private mining royalty is a payment in the nature of a royalty to another person not made under a Commonwealth, State or Territory law. It could be a payment in kind rather than in cash. Private mining royalties are usually calculated by reference to a percentage or share of the gross or net value of the taxable resource, or by reference to a quantity of taxable resource (or of some product form or component of it) [subsection 35-45(2)] . Examples of private mining royalties include:

•

payments to a party other than under a Commonwealth, State or Territory law for access to the land (sometimes called 'private override royalties'); and

•

payments under resource profit sharing arrangements.

5.49 Private mining royalty arrangements differ from government imposed royalties in that they are, in substance, profit sharing agreements in respect of the exploitation of a resource, rather than a price the owner earns for selling the resource.

5.50 Private mining royalties are excluded in order to avoid the need to assess individual royalty recipients against their share of a project's proceeds, which would be necessary if such payments were deductible.

5.51 This approach is consistent with the treatment of private royalties under the PRRT.

5.52 However, a private mining royalty payment is not excluded expenditure if:

•

it is given to a contractor for services that form part of upstream mining operations for a mining project interest and does not represent a share of the miner's profits [subsection 35-40(2)] . Such expenditure is more appropriately described as a fee for services, rather than as a private mining royalty;

•

it is paid to an entity under an agreement entered into with the entity before 2 May 2010 and at a time when the entity is a State or Territory body (other than an 'excluded STB' within the meaning of section 24AT of the Income Tax Assessment Act 1936 , which would include a municipal corporation, public educational institution, public hospital, or superannuation fund) [subsection 35-40(3)] . Where these arrangements were entered into prior to 2 May 2010, the miner would not have had the opportunity to take into account the MRRT in striking the relevant agreement; or

•

it is made, by way of consideration for the carrying on of mining operations in the project area, to native title holders, registered native title claimants, or a person that holds rights arising under an Australian law dealing with the rights of Aboriginal persons or Torres Strait Islanders in relation to land or waters that relate to the project area [subsection 35-40(4)] .

Example 5.54 : Royalties paid to State or Territory bodies

Voltage Power Co (a State body) operates a coal-fired electricity generation plant. It holds a mineral development licence over an area of land with significant coal deposits. Prior to 2 May 2010, it enters into an agreement with Ready, Willing & Able Co, a mining company, to develop part of the coal deposits, with a view to having some of the coal supplied to Voltage Power Co's electricity plant, and the balance sold into export markets. Voltage Power Co consents to Ready, Willing & Able Co applying for a mining lease over the relevant part of Voltage Power Co's licence area, in consideration of Ready, Willing & Able Co entering a contract to supply coal at fixed prices to Voltage Power Co, and also paying a royalty on the export coal sales.

The payments are mining expenditure for Ready, Willing & Able Co because they are the price of obtaining access to the coal deposits, and hence necessarily incurred in carrying on upstream mining operations for the mining project interest. Although the payments of a share of mining revenues are private mining royalties, and therefore would normally be excluded expenditure, they are not excluded expenditure here because they are paid to Voltage Power Co, a State or Territory body, under an agreement entered into before 2 May 2010.

Example 5.55 : Private mining royalties and native title holders

Wildfire Coal negotiates an Indigenous Land Use Agreement (the Agreement) with a native title group under the Native Title Act 1993 . The Agreement is registered. In accordance with the Agreement, the native title group agrees to the granting of mining tenure over a part of their land, and to allow Wildfire Coal to access and mine that land. Wildfire Coal agrees to provide a benefits package that includes a lump sum payment, a share of mining revenues, scholarship and apprenticeship programs, payments relating to heritage protection and environmental management, and the provision of community infrastructure.

These payments by Wildfire Coal in accordance with the Agreement are necessarily incurred in carrying on upstream mining operations and so are mining expenditure. Although the payments of a share of mining revenues are private mining royalties, they are not excluded expenditure because they are paid to a native title holder in consideration for carrying on mining operations on its land.

5.53 Private mining royalties paid to a State or Territory body, or to a native title holder or claimant, that are not excluded expenditures, will be deductible if they satisfy the general expenditure test and irrespective of whether they are paid to acquire an interest in production right or a mining project interest. [Subsection 35-40(5)]

Financing costs

5.54 Financing costs and associated payments are not deductible under the MRRT. Broadly, the types of costs excluded include the principal and interest on a loan, borrowing costs, dividends, capital returns, trust and partnership distributions, and the costs of issuing membership interests in entities. This is consistent with the treatment under the PRRT. [Section 35-50]

5.55 Financing costs are excluded because the purpose of the MRRT is to tax profits arising from the non-renewable resource that is extracted and those profits should not depend on the way in which a miner chooses to finance its operations.

5.56 Capital invested in upstream operations is instead recognised through immediate deductibility and an 'uplift' allowance to maintain the value of losses for activities upstream of the valuation point. Downstream operations are effectively recognised through the process of attributing the revenue to the resource at the valuation point.

5.57 Allowing a deduction for financing costs would therefore amount to a double deduction for the cost of capital unless financiers were also subject to the MRRT on their returns from their financing activities. It would also distort investment and production decisions, creating a bias towards debt financing instead of equity financing.

5.58 Three types of financing costs are excluded.

Financial arrangement

5.59 Expenditure incurred in relation to an arrangement that gives rise to a financial arrangement is excluded expenditure. 'Arrangement' and 'financial arrangement' take their meaning from the ITAA 1997 (see subsection 995-1(1) of the ITAA 1997). For these purposes a 'financial arrangement' is defined to mean an arrangement under which an entity has a legal or equitable right to provide and/or receive a financial benefit that is cash settlable. [Paragraph 35-50(a)]

Equity interest

5.60 Expenditure incurred in relation to an 'equity interest' that is a financial arrangement is also excluded expenditure, as is expenditure incurred in relation to is a scheme that gives rise to an equity interest issued by the miner. [Paragraphs 35-50(b) and (c)] .

5.61 'Equity interest' is defined in the ITAA 1997 (see subsection 995-1(1) of the ITAA). Broadly, an entity holds an equity interest if the return on the interest is linked to the economic performance of the entity in which the interest is held.

Hire purchase agreements

5.62 Hire purchase agreements are treated as if they are debt funded property purchases. Therefore, any payment made in relation to a hire purchase agreement is excluded expenditure. [Subsection 35-55(1)]

5.63 A miner who enters into a hire purchase arrangement for property with an arm's length party will be taken to have acquired the property for the amount shown in the agreement as the cost or value of the property. [Paragraph 35-55(3)(a)]

5.64 If the parties are not dealing at arm's length, or if the agreement does not specify a cost or value for the property, the miner will be taken to have acquired the property for the amount that could reasonably be expected to have been paid by the miner for the purchase of the property had the hirer actually sold the property to the miner at the start of the agreement, and the parties had dealt with each other at arm's length. [Paragraph 35-55(3)(b)]

5.65 The cost of the property is taken to have been incurred, and the asset is deemed acquired, when the property is supplied to the miner. [Subsection 35-55(2)]

5.66 The result is that the deemed acquisition cost could be mining expenditure, in the same way as it could be if the miner had actually bought the property, but the actual payments made under the hire purchase agreement are excluded expenditure.

5.67 It is important to note that these rules apply to hire purchase agreements entered into before 1 July 2012 [Schedule 4 to the Minerals Resource Rent Tax (Consequential Amendments and Transitional Provisions) Bill 2011 (MRRT (CA & TP) Bill), item 5] . If an asset is deemed to have been acquired, and an amount deemed to have been incurred, prior to 1 July 2012 the interim expenditure rules will apply (see Chapter 7).

Non-adjacent land and buildings used in connection with administrative or accounting activities.

5.68 Capital expenditure is excluded expenditure to the extent that it relates to land or buildings that are not adjacent to the project area for a mining project interest and are used in connection with administrative or accounting activities. [Section 35-60]

5.69 The reason for this approach is that land or buildings that are at or adjacent to upstream mining operations are likely to take their value from the production right itself and their treatment recognises that investment in such assets is a risk associated with the project. However, the value of non-adjacent land and buildings does not reflect this risk and is likely to appreciate over time. Therefore, capital payments in relation to these assets are excluded expenditure.

5.70 However, to the extent that a building used for accounting and administrative functions is also used for upstream mining operations, the expenditure referable to the upstream mining operations is deductible. This is consistent with the idea that it does not matter where upstream mining operations occur, the expenditure associated with those operations, is deductible.

Capital expenditure

5.71 While the distinction between revenue and capital expenditure is generally not relevant for MRRT purposes, it is here. Put simply, an expense is of a capital nature if it is directed at the business entity, structure or organisation so that the business can operate; an expense is of a revenue nature if it is directed at the operation of the business (per Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd v FC of T (1938) 61 CLR 337). The purchase of land on which a head office is constructed is an example of a capital expense, as too would be the construction of the head office.

Adjacent

5.72 Adjacent to the project area should be taken to mean the nearest practicable location that is consistent with this principle. Whether a place is the nearest practicable location will vary in different circumstances and may take into account factors such as mine operation, safety, and remoteness.

Example 5.56 : Adjacent land and buildings

Wildfire Coal operates an underground coal mine in relation to a production right that it holds. Due to the remoteness of the coal mine, employees engaged in operations on the mine site live in a regional centre located 50 kilometres away. All administration for the coal mine is carried on at the administration building in this regional centre. The company incurs capital expenditure in respect of that administration building. The expenditure is not excluded expenditure as the building is 'adjacent' to the project area - the nearest practical location for land or buildings where administrative or accounting activities can be carried out for the operations of the coal mine.

Example 5.57 : Non-adjacent land and buildings

South & Co Mines operates an iron ore mine in the Pilbara region. It incurs capital expenditure on a building in Perth from which it conducts the administration associated with the mine. The capital expenditure for the building is excluded expenditure because the building is not adjacent to the Pilbara mines.

Example 5.58 : Administrative building used for more than one mine

Pick & Shovel operates a coal mine in Queensland and an iron ore mine in Western Australia. It has a building adjacent to its iron ore mine in Western Australia, from which it carries out administrative functions that support its iron ore mine, as well as its coal mine in Queensland. To the extent that the capital expenditure incurred on the building is referrable to its West Australian iron ore mine, Pick & Shovel can claim a deduction. However, the capital expenditure related to Queensland coal mining operations is excluded expenditure because the building is not adjacent to the coal mine.

Example 5.59 : Building used for administrative and technical functions

Remote Controlled Mining operates three iron ore mines in the Pilbara. It has a building in Perth from which it performs administrative functions. A number of operating, technical, and geological services integral to upstream mining operations are also performed from this building.

To the extent that the capital costs of the building relate to upstream operating, technical, and geological services, they can be included in mining expenditure.

Hedging or foreign exchange expenditure

5.73 Expenditure is excluded to the extent that it relates to hedging or foreign exchange arrangements. [Section 35-65]

5.74 Hedging and foreign exchange arrangements are pure financial transactions which, while they impact on the ultimate profitability of a business, do not affect the value of the resource. While it is doubtful that such expenditure would ever bear a sufficient relationship to upstream mining operations in order to satisfy the general expenditure test, this provision removes all doubt.

Hedging arrangements

5.75 Excluded expenditure includes expenditure that relates to a 'derivative financial arrangement' (see subsection 995-1(1) of the ITAA 1997) [paragraph 35-65(a)] . Basically, this is a financial arrangement that changes in value in response to a variable, and in respect of which there is no requirement for a net investment.

Foreign exchange arrangements

5.76 Excluded expenditure also includes expenditure that relates to a 'foreign currency hedge' (see subsection 995-1(1) of the ITAA 1997) [paragraph 35-65(b)] . Put simply, this is a financial arrangement that hedges a risk in relation to movements in currency exchange rates.

Example 5.60

KF Iron Exports has entered a contract with a major overseas industrial group to provide a substantial amount of iron ore over an extended period for a set amount per tonne. As the currency of the country in which the industrial group operates is volatile, KF Iron enters into a hedging contract with a third party (unrelated to the sales contract) to cover the possibility that the value of the currency falls during the term of the contract. Any expenditure relating to the foreign currency hedge is excluded expenditure for MRRT purposes.

5.77 To the extent to which a hedging or foreign exchange arrangement forms part of a sales contract, any expenditure on the hedge would be included in mining expenditure. That is because the sales contract, as a non-cash settlable arrangement, would not be a 'derivative financial arrangement' or a 'foreign currency hedge'.

Rehabilitation bonds and trust payments

5.78 Amounts provided as security for rehabilitation of the project area for a mining project interest are excluded expenditure for the MRRT. [Subsection 35-70(1)]

5.79 To ensure that money put aside for rehabilitation is secure, rehabilitation bonds and trust payments are generally placed in low-risk investments. Therefore, it is not appropriate that the MRRT uplift rate (which is intended to reflect the higher risk associated with a resource project) apply to such payments.

5.80 However, if an amount held as security is paid out by a trustee or bondholder, then that amount will be included in the miner's mining expenditure to the extent that it is for rehabilitation of a project area for the mining project interest the miner has at the time the amount is incurred by the trustee or bondholder. If more than one miner has a mining project interest in relation to the project area, the miner may include in its expenditure the amount that reasonably relates to its mining project. Such amounts are considered expenditure of the miner at the time the trustee or bondholder incurs the amount. [Subsection 35-70(2)]

5.81 The trustee must provide the miner with a notice containing the information the miner needs to determine the extent to which the amount is mining expenditure for the miner. [Schedule 1 to the MRRT (CA & TP) Bill, item 8, section 121-12 of Schedule 1 to the Taxation Administration Act 1953] .

Payments of income tax or GST

5.82 Income tax payments under the ITAA 1997 or the ITAA 1936 are excluded expenditure and cannot be deducted against mining revenue. [Paragraph 35-75(a)]

5.83 Payments of GST, input tax credits and decreasing adjustments are also excluded expenditure. As with mining revenue, all mining expenditure is deducted on a GST-exclusive basis. [Paragraphs 35-75(b) and (c)]

5.84 All payments of penalties or interest under tax laws are excluded expenditure. [Paragraph 35-75(d)]

Unit shortfall charge under the Clean Energy Bill 2011

5.85 The amendments make unit shortfall charges incurred by an entity in relation to its obligations under the Clean Energy Bill 2011 excluded expenditure. [Schedule 3, item 92 of the MRRT (CA & TP) Bill, section 35-80 of the MRRT Bill )

5.86 A unit shortfall occurs when an entity has not surrendered enough emission units to meet its emissions liability. Entities liable for a shortfall charge will pay a premium above the value of the unit.

5.87 The unit shortfall charge is excluded expenditure for MRRT purposes to ensure that the entity liable to the charge bears its full cost and does not have an incentive to defer its emissions liability.

5.88 The amendment to the MRRT Bill commences at the later of the commencement of the Clean Energy Bill 2011 and the commencement of the MRRT Bill. This ensures that both pieces of legislation are enacted before the amendment occurs. [Clause 2 to the MRRT (CA & TP) Bill, item 8 of the table]