Explanatory Memorandum
(Circulated by the authority of the Treasurerthe Hon John Dawkins, M.P.)This Memorandum takes account of amendments made by the House of Representatives to the Bill as introduced.Chapter 3 AMENDMENTS TO THE PETROLEUM MINING PROVISIONS
Overview
A. 1 This Bill proposes to amend the income tax provisions that provide deductions for exploration and development expenditure incurred in petroleum mining activities. The amendments will prevent deductions for expenditure incurred for the purpose of deriving exempt income
[Clause 14] .
Summary of the amendments
3.2 Division 10AA authorises deductions for capital expenditure incurred in exploring for petroleum and in developing and operating a petroleum field.
3.3 The intention of these petroleum mining provisions is to allow deductions only if the expenditure is incurred for the purposes of producing assessable income. However, amendments to the provisions that commenced 21 August 1990 have created a loophole which enables deductions to be claimed for expenditure incurred for the purpose of producing exempt income.
3.4 Generally, all income derived by resident taxpayers is assessable, whether derived in Australia or elsewhere. One exception relates to income derived by resident companies in carrying on a business in "listed" countries (broadly, countries with comparable rates of tax to Australia's).
3.5 Under the loophole, Australian petroleum mining companies are able to claim deductions for exploration and development expenditure incurred in petroleum mining activities conducted in a listed country, even though the income derived from those activities is exempt. These deductions can then be used to reduce tax on assessable income derived from other sources.
3.6 Accordingly, the petroleum mining provisions are to be amended so that deductions are allowable only if expenditure is incurred for the purpose of producing assessable income.
3.7 Date of Effect: The amendments apply to expenditure incurred after 7-30pm (by standard time in the ACT) on 21 August 1990, the commencement time of the amendments that gave rise to the technical defect.
Background to the legislation
3.8 The petroleum mining provisions [Division 10AA] provide the basis of deduction of expenditure on exploration or prospecting activities and capital expenditure on developing and operating a petroleum field.
3.9 Broadly, exploration and prospecting expenditure is deductible in full in the year it is incurred [section 124AH]. Capital expenditure incurred in developing and operating a petroleum field ("allowable capital expenditure") is evenly deductible over the lesser of the number of years in the life of the field or 10 years [section 124ADG].
3.10 Until 21 August 1990, deductions were restricted to expenditure incurred in respect of activities conducted in Australia. A similar restriction applied under a number of other capital allowances that provide deductions for capital expenditure, including the general mining and quarrying provisions (which operate similarly to the petroleum mining provisions).
3.11 These restrictions were removed because it was no longer considered appropriate to discriminate between domestic and foreign source income; that is, foreign sourced income was to be taxed on the same basis as income derived from domestic sources.
3.12 In removing the restrictions, it was always intended that the deductions would be available only if expenditure was incurred for the purpose of producing assessable. This intention was clearly stated in the 1990-91 Budget announcement of the removal of the restrictions, and in both the Second Reading Speech and the Explanatory Memorandum on Taxation Laws Amendment Act (No.6) 1990 , which introduced the amendments removing the restriction. Relevant extracts from these documents are at the Appendix to this chapter.
3.13 Nevertheless, this assessable income requirement was inadvertently not included in the amendments as they applied to the petroleum mining provisions. Unlike the general mining provisions, there has never been such a requirement in the petroleum mining provisions. The historical reason for this is that income from carrying on petroleum mining operations in Australia has never been tax-exempt. By comparison, the requirement was necessary for the general mining provisions because of the former exemption for income from mining gold in Australia.
3.14 Not all income derived by resident taxpayers is assessable. In particular, income derived by Australian companies in carrying on a business in certain "listed" countries is exempt from tax [section 23AH]. Broadly, listed countries are those that have comparable rates of tax to Australia's. There are some 60 listed countries. Australian petroleum mining companies have been quite active in some, including: Canada, China, Malaysia, New Zealand, the Philippines, Papua New Guinea and the United States of America.
Explanation of the amendments
3.15 The deficiency in the petroleum mining provisions which allows deductions for expenditure incurred for the purposes of deriving exempt income is to be remedied by inserting a requirement that expenditure be incurred for the purpose of gaining or producing assessable income.
3.16 To qualify for deduction, capital expenditure on the development and operation of a petroleum field must be incurred in carrying on prescribed petroleum operations [subsection 124AA(2)].
3.17 Under the existing rules, prescribed petroleum operations are defined as: mining operations for the purpose of obtaining petroleum [subsection 124(1) definition].
3.18 This definition is to be amended by adding a requirement that such mining operations be operations carried on for the purpose of gaining or producing assessable income [Clause 15] .
3.19 Section 124ABA deals with cash bidding payments for exploration permits and production licences granted under the Petroleum (Submerged Lands) Act 1967 (the Petroleum Act) or under a corresponding law of a State or the Northern Territory. These payments are treated as allowable capital expenditure upon the grant of a production licence or, if the expenditure is incurred after the licence has been granted, at the time of the payment.
3.20 As well, payments made to a government of a foreign country can qualify if made under a law of that country that has been prescribed as being equivalent in relevant respects to the Petroleum Act.
3.21 At the moment, there is no requirement that payments covered by section 124ABA be in relation to assessable income producing activities. Accordingly, the subsection 124ABA(6) definitions of "licence cash bidding payment" and "permit cash bidding payment" are to be amended to require that the payments be made either in carrying on prescribed mining operations or for the purpose of exploring or prospecting for petroleum obtainable by prescribed mining operations [Clause 16] .
Exploration and prospecting expenditure
3.22 The existing provisions allow deductions for expenditure incurred on exploration or prospecting for the purpose of discovering petroleum [subsection 124AH(1)].
3.23 Subsection 124AH(1) is to be amended so that deductions are allowable only if expenditure is incurred for the purpose of discovering petroleum obtainable by prescribed petroleum operations [Clause 17] . This amendment will, with the changed meaning of prescribed petroleum operations outlined above, effectively require that expenditure on exploration and prospecting for petroleum be for the purpose of producing assessable income.
3.24 Clause 17 will also make a corresponding amendment to subparagraph 124AH(4C)(b)(i). Subsection 124AH(4C) is a safeguarding measure which denies a taxpayer a deduction for exploration and prospecting expenditure unless the Commissioner of Taxation is satisfied that the taxpayer is, broadly speaking, either a bona fide petroleum miner [paragraph 124AH(4C)(a)] or a bona fide explorer for petroleum [subparagraph 124AH(4C)(b)(i)].
Application of the amendments
3.25 The amendments apply to expenditure incurred after 7-30 p.m., by standard time in the ACT, on 21 August 1990. This is the time from which deductions under the petroleum mining provisions became available for expenditure on operations outside Australia [Clause 18] .
APPENDIX
Amendments to the Petroleum Mining Provisions
Extracts from documents outlining amendments to extend deductions under the petroleum mining provisions to operations conducted outside Australia
"As part of the process of achieving more equality in the treatment of Australian and foreign income producing activities, the Government has decided to allow these deductions against assessable foreign source income for capital expenditures made after 21 August 1990. In particular, the Government has decided to...extend the deductions for mining and petroleum activities in Australia provided by Divisions 10, 10AAA and 10AA of Part III to similar foreign activities that generate assessable income" [Budget Paper No. 1, 1990-91, 4.10] .
Second Reading Speech on the amending Act, Taxation Laws Amendment Act (No.6) 1990:
"Other amendments contained in this Bill will...implement the Budget announcement to extend the deductions for certain capital expenditures of particular activities in Australia to similar offshore activities that generate assessable income" [page 1] ; and
"In particular, the Bill will extend, in relation to foreign activities that generate assessable income... the deductions relating to mining and petroleum activities in Australia" [page 5] .
Explanatory Memorandum to Taxation Laws Amendment Act (No. 6) 1990:
"The amendments proposed in this Bill will extend the scope of this Division to expenditure incurred after 7.30pm EST on 21 August 1990 by Australian residents in relation to operations out of Australia provided the operations are conducted for the purpose of producing assessable income" [page 19] .