House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Reduction in 2009-10 PAYG instalments

Schedule 1 to this Bill amends section 45-405 of Schedule 1 to the Taxation Administration Act 1953 to set the GDP adjustment (GDP refers to gross domestic product) for the 2009-10 income year at 2 per cent.

Date of effect : This measure applies in relation to pay as you go (PAYG) instalment amounts for the 2009-10 income year that become due on or after the date of commencement.

Proposal announced : This measure was announced jointly by the Treasurer and the Minister for Small Business, Independent Contractors and the Service Economy in Media Release No. 030 of 28 March 2009.

Financial impact : This measure will have the following revenue implications:

Compliance cost impact : Low. This measure will not require increased compliance activity on behalf of eligible taxpayers. There is no ongoing compliance cost impact and a minimal transitional impact.

Annual PAYG instalments when voluntarily registered for the goods and services tax

Schedule 2 to this Bill amends Division 45 of Schedule 1 to the Taxation Administration Act 1953 to allow taxpayers who are voluntarily registered for the goods and services tax (GST) and who choose to remit GST annually to choose to make their pay as you go (PAYG) instalments annually if they satisfy the other eligibility tests for annual PAYG instalments. In some cases these taxpayers are currently prevented from making PAYG instalments annually solely due to their voluntary GST registration. The alignment of these annual obligations will reduce compliance costs for eligible taxpayers.

Date of effect : This measure applies from the 2009-10 income year.

Proposal announced : This measure was announced jointly by the Treasurer and Assistant Treasurer and Minister for Competition Policy and Consumer Affairs in Media Release No. 053 of 13 May 2008.

Financial impact : This measure will have the following revenue implications:

Compliance cost impact : Low. This measure will affect only a small proportion of individuals and businesses. There is no ongoing compliance cost impact and a minimal transitional impact, reflecting the need for some taxpayers to be aware of the amendment.

Petroleum resource rent tax: minor changes

Schedule 3 to this Bill amends the Petroleum Resource Rent Tax Assessment Act 1987 by:

•

introducing a functional currency rule into the petroleum resource rent tax (PRRT), along similar lines to the functional currency rule in the Income Tax Assessment Act 1997;

•

introducing a modified 'look-back' rule for exploration expenditure related to a production licence derived from an exploration permit and a retention lease;

•

introducing internal petroleum provisions (similar to the external petroleum provisions) to deal with the case where project petroleum is processed for a tolling fee, or acquired for processing, by a person who has an interest in the project for (if processed), or from (if acquired), another person who has an interest in the same project; and

•

extending the offshore exploration incentive for designated frontier areas by one year so it applies to the 2009 annual offshore acreage release.

Date of effect : 1 July 2008. The commencement date of 1 July 2008 has no adverse implications for PRRT taxpayers.

Proposal announced : The first three measures mentioned above were announced jointly by the Treasurer and the Assistant Treasurer and Minister for Competition Policy and Consumer Affairs in Media Release No. 053 of 13 May 2008. The fourth measure mentioned above was announced jointly by the Treasurer and the Minister for Resources and Energy on 12 May 2009.

Financial impact : The first three measures mentioned above have no fiscal cost over the forward estimates period. The fourth measure mentioned above has no fiscal cost in 2009-10 and 2010-11 and a small but unquantifiable fiscal cost in 2011-12 and 2012-13.

Compliance cost impact : The measures introducing a functional currency rule into the PRRT and the internal petroleum provisions are expected to reduce compliance costs, while the measure introducing a modified 'look-back' rule for exploration expenditure related to a production licence derived from an exploration permit and a retention lease has no impact on compliance costs. The measure extending the offshore exploration incentive by one year has no implications for compliance costs.

Deductible gift recipients

Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 to update the list of deductible gift recipients (DGRs) to include three new organisations.

Tax deductions are provided to donors to organisations that are endorsed as DGRs, subject to certain conditions. Organisations which do not fall under the general DGR categories may seek specific listing in the income tax law.

Date of effect : The date of effect for each of the organisations is listed in Table 4.1.

Proposal announced : The addition of these three organisations has not been announced.

Financial impact : This measure will have the following revenue implications:

Compliance cost impact : Negligible.

Chapter 1 Reduction in 2009-10 PAYG instalments

Outline of chapter

1.1 Schedule 1 to this Bill amends section 45-405 of Schedule 1 to the Taxation Administration Act 1953 to set the GDP adjustment (GDP adjustment factor) for the 2009-10 income year at 2 per cent (GDP refers to gross domestic product).

1.2 All of the legislative references in this chapter are made to Schedule 1 to the Taxation Administration Act 1953 unless otherwise specified.

Context of amendments

1.3 Under the pay as you go (PAYG) instalments system, taxpayers earning business or investment income pay instalments during the year towards their final tax liability for that income year. Taxpayers may pay their PAYG instalments on the basis of GDP-adjusted notional tax (GDP adjustment method) or on the basis of instalment income. Under either method taxpayers can choose to vary their instalment amounts to more accurately reflect their expected tax liability for the income year.

1.4 The GDP adjustment method is available to the classes of taxpayers listed in section 45-130. These taxpayers are individuals, multi-rate trustees, eligible small business entities and full self-assessment taxpayers with $2 million or less of instalment income for the previous income year or more than $2 million of instalment income for the previous income year and are eligible to pay an annual PAYG instalment but have chosen not to.

1.5 Taxpayers who pay PAYG instalments on the basis of the GDP adjustment method are generally quarterly payers who pay four instalments annually. However, section 45-134 allows primary production businesses and special professionals to pay two instalments a year under the GDP adjustment method.

1.6 A quarterly payer who pays instalments on the basis of the GDP adjustment method will pay the instalment amount determined and advised by the Commissioner of Taxation (Commissioner). The Commissioner works out the amount of the instalments taxpayers pay in accordance with Subdivision 45-L.

1.7 The amount of the instalments payable depends on the taxpayer's GDP-adjusted notional tax which is worked out by the Commissioner under section 45-405. Broadly, the GDP-adjusted notional tax amount is worked out by increasing the taxpayer's adjusted taxable income in the previous year by the GDP adjustment factor, which is generally a ratio representing the rate of nominal GDP growth between the previous two full calendar years.

1.8 The GDP adjustment factor can be unrepresentative of expected profit growth in income years where economic and business conditions change quickly and the expected income of taxpayers changes accordingly. This can cause taxpayers to be required to pay PAYG instalments which are too high compared with their actual income, with the overpaid tax being credited to them after the end of the income year when their final tax liability is assessed.

1.9 For the 2009-10 income year, the GDP adjustment factor calculated under the current law will be around 9 per cent. The amendments will set the GDP adjustment factor at 2 per cent for the 2009-10 income year to align it with the expected increase in the Consumer Price Index for the 2009-10 income year, as forecast in the February 2009 Updated Economic and Fiscal Outlook.

1.10 While taxpayers may vary their instalment amounts calculated and notified by the Commissioner themselves, many are reluctant to do so, as significant underpayments can trigger the general interest charge.

Summary of new law

1.11 The GDP adjustment factor to be used by the Commissioner to work out the GDP-adjusted notional tax amount under section 45-405 will be set at 2 per cent for the 2009-10 income year.

Comparison of key features of new law and current law

Detailed explanation of new law

1.12 Taxpayers who pay quarterly PAYG instalments on the basis of the GDP adjustment method are required to pay a percentage of their GDP-adjusted notional tax each quarter as worked out under either section 45-400 or section 45-402.

1.13 GDP-adjusted notional tax is calculated by the Commissioner under section 45-405. Broadly, a taxpayer's GDP-adjusted notional tax is calculated by increasing the taxpayer's adjusted taxable income in the previous income year by the GDP adjustment factor to give the adjusted taxable income for the purposes of calculating their notional tax for the current income year.

1.14 The GDP adjustment factor is calculated using the formula in subsection 45-405(3). This formula produces a ratio which generally represents the rate of nominal GDP growth between the previous two full calendar years. Using this formula to calculate the GDP adjustment factor in the 2009-10 income year would produce a GDP adjustment factor of around 9 per cent.

1.15 The amendments will set the GDP adjustment factor to be used by the Commissioner in calculating PAYG instalments for taxpayers who pay quarterly instalments on the basis of the GDP adjustment method at 2 per cent for the 2009-10 income year. The GDP adjustment factor for income years after 2009-10 is to be based on the current methodology. [ Schedule 1, Part 1, items 1 and 2, definition of ' GDP adjustment' in subsection 45-405(3 ), subsection 45-405(6 )]

Example 1.1

Aaron pays quarterly PAYG instalments on business and investment income he earns on the basis of the GDP adjustment method.

In the 2008-09 income year Aaron has business and investment adjusted taxable income of $50,000. If the current GDP adjustment factor of 9 per cent is used, then Aaron's PAYG instalments will be calculated using the adjusted taxable income of $54,500 for the 2009-10 income year.

However, applying the GDP adjustment factor of 2 per cent will mean that the adjusted taxable income for the 2009-10 income year will be only $51,000 and Aaron's PAYG instalments will be calculated on this lower amount.

1.16 Taxpayers may still vary their quarterly instalments under section 45-112 if they consider their income is expected to be lower or higher than the amount determined by the Commissioner using the 2 per cent GDP adjustment factor.

1.17 In order to avoid inoperative provisions in the tax laws, the provisions that give effect to a 2 per cent GDP adjustment factor for the 2009-10 income year will be automatically repealed on 1 July 2014. [ Schedule 1, Part 2, items 3 to 5 ]

Application and transitional provisions

1.18 The amendments in Part 1 of Schedule 1 commence on the day after the Bill receives Royal Assent and apply for the purposes of working out the amount of an instalment that becomes due on or after the date of commencement. [ Schedule 1, Part 3, item 6 ]

1.19 Instalments for the 2009-10 income year that are due before commencement would be calculated in accordance with the existing law, which would mean a GDP adjustment factor of around 9 per cent would have applied. However, under section 45-400 each instalment amount payable in the income year is worked out based on a set percentage of a taxpayer's GDP-adjusted notional tax reduced by the instalment amounts for the earlier quarters in that income year. This will mean that aggregate instalment amounts payable for the 2009-10 income year will reflect the 2 per cent adjustment calculation.

Chapter 2 Annual PAYG instalments when voluntarily registered for the goods and services tax

Outline of chapter

2.1 Schedule 2 to this Bill amends Division 45 of Schedule 1 to the Taxation Administration Act 1953 to allow taxpayers who are voluntarily registered for the goods and services tax (GST) and who choose to remit GST annually to choose to make their pay as you go (PAYG) instalments annually if they satisfy the other eligibility tests for annual PAYG instalments.

2.2 All of the legislative references in this chapter are made to Schedule 1 to the Taxation Administration Act 1953 unless otherwise specified.

Context of amendments

2.3 As part of the 2008-09 Budget the Government announced that it would introduce measures to align the PAYG instalments and GST payment and reporting requirements for taxpayers who are voluntarily registered for GST. However, the Government decided to defer the commencement of the measure until 1 July 2009.

2.4 Under the PAYG instalments system taxpayers earning business or investment income pay instalments during the year towards their final tax liability for that income year. Taxpayers generally make these instalment payments on a quarterly basis, however, provided a taxpayer meets certain conditions they may instead choose to make PAYG instalments annually.

2.5 The eligibility requirements that a taxpayer must meet in order to make PAYG instalments annually are set out in Subdivision 45-E. Under the current law a taxpayer can choose to make PAYG instalments annually if:

•

they are neither registered, nor required to be registered, under Part 2-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act);

•

they are not a partner in a partnership that is registered, or required to be registered, under Part 2-5 of the GST Act;

•

their most recent notional tax notified by the Commissioner of Taxation (Commissioner) is less than $8,000; and

•

in the case of a company, the company is not a participant in a GST joint venture under Division 51 of the GST Act or part of an instalment group.

2.6 If a taxpayer meets these conditions at the end of a starting instalment quarter and chooses to make their PAYG instalments annually, they must then notify the Commissioner of their choice, in the approved form, on or before the day on which their PAYG instalment would otherwise have been due.

2.7 The current condition that a taxpayer must not be registered or required to be registered for GST is an original feature of the PAYG instalment system and was introduced when GST was payable at least quarterly. However, in 2004 the option of paying GST on an annual basis was introduced for taxpayers who are voluntarily registered for GST.

2.8 Under the GST Act a taxpayer may now be eligible to pay GST annually if they are voluntarily registered for GST and make an annual tax period election under Division 151 of the GST Act.

2.9 The introduction of annual GST payments in 2004 without changing the annual PAYG instalment conditions at that time has created a misalignment between the PAYG and GST systems. This misalignment in some cases prevents taxpayers from making PAYG instalments annually solely due to their voluntary GST registration, even where they may be remitting GST annually. This imposes unnecessary compliance costs on these taxpayers.

2.10 These amendments will allow taxpayers to choose to make PAYG instalments annually where they are voluntarily registered for GST and meet the other eligibility tests for annual PAYG instalments. This will reduce compliance costs for eligible taxpayers.

Summary of new law

2.11 These amendments will allow taxpayers who are voluntarily registered for GST and who choose to remit GST annually to also choose to make their PAYG instalments annually if they satisfy the other relevant eligibility tests for annual PAYG instalments.

Comparison of key features of new law and current law

Detailed explanation of new law

Taxpayers that are voluntarily registered for GST and have made an annual tax period election

2.12 Section 45-140 currently does not allow taxpayers that are registered, or required to be registered under Part 2-5 of the GST Act to choose to make PAYG instalments annually.

2.13 Under these amendments taxpayers that are voluntarily registered for GST and have made an annual tax period election under Division 151 of the GST Act will be able to choose to make PAYG instalments annually if they satisfy the other relevant eligibility tests for annual payment.

[ Schedule 2, item 3, subsection 45-140(1A )]

Example 2.1

Michael is a taxpayer who is voluntarily registered for GST and has made an annual tax period election under Division 151 of the GST Act for the 2009-10 income year. He is a partner in a partnership that is neither registered, nor required to be registered for GST and his most recent notional tax notified by the Commissioner is less than $8,000.

Michael made quarterly PAYG instalments for the 2008-09 income year but would like to choose to make PAYG instalments annually for the 2009-10 income year.

Michael is eligible to choose to make PAYG instalments annually for the 2009-10 income year as he meets the requirements set out in subsection 45-140(1A).

Partners in partnerships that have made an annual tax period election

2.14 Under these amendments a partner in a partnership that is voluntarily registered for GST and has made an annual tax period election under Division 151 of the GST Act will be able to choose to make PAYG instalments annually where they satisfy the other relevant eligibility tests for annual payment.

2.15 A taxpayer who is a partner in multiple partnerships that are registered under Part 2-5 of the GST Act will also be able to choose to make PAYG instalments annually so long as the registered partnerships in which they are a partner have made valid annual tax period elections and the taxpayer satisfies the other relevant eligibility tests for annual payment.

Example 2.2

Rebecca is a partner in three different partnerships. Two of the partnerships in which she is a partner are voluntarily registered for GST and have also made annual tax period elections under Division 151 of the GST Act for the 2009-10 income year. The third partnership is not registered for GST.

Rebecca made quarterly PAYG instalments for the 2008-09 income year but would like to choose to make PAYG instalments annually for the 2009-10 income year.

Rebecca will be eligible to make PAYG instalments annually if she meets the other eligibility tests in paragraphs 45-140(1A)(c) to (f), as she meets the requirements set out in paragraphs 45-140(1A)(a) and (b).

When must a taxpayer satisfy the eligibility tests

2.16 In order to satisfy the eligibility tests introduced by these amendments a taxpayer must meet the relevant eligibility tests set out in subsection 45-140(1A).

2.17 Taxpayers must satisfy the conditions in paragraphs 45-140(1A)(c) to (f) by the end of the relevant starting instalment quarter. This reflects the existing requirements under the current law.

2.18 Taxpayers must also satisfy the eligibility tests set out in paragraphs 45-140(1A)(a) or (b) at the time they make their choice to make PAYG instalments annually. The current law requires taxpayers to make this choice by notifying the Commissioner, in the approved form, on or before the day on which that instalment would otherwise be due.

2.19 Allowing taxpayers to satisfy the eligibility requirements in paragraphs 45-140(1A)(a) or (b) at this time will avoid significant confusion. If taxpayers were required to meet these requirements at the end of the relevant starting instalment quarter, taxpayers that made a valid annual tax period election after this time would not be eligible to choose to make PAYG instalments annually.

[ Schedule 2, item 3, subsection 45-140(1A )]

Example 2.3

Mark is a partner in a partnership that is voluntarily registered for GST. He made quarterly PAYG instalments for the 2008-09 income year but would like to choose to make PAYG instalments annually for the 2009-10 income year. He is not registered for GST.

At the end of the starting instalment quarter, which for Mark is 30 September 2009, Mark is not a partner in a partnership that is required to be registered under Part 2-5 of the GST Act and his most recent notional tax notified by the Commissioner is less than $8,000.

The partnership, in which Mark is a partner, however, has not made an annual tax period election under Division 151 of the GST Act by 30 September 2009.

Mark speaks with Geoff, the other partner in the partnership, and they make an annual tax period election for the partnership for the 2009-10 income year on 10 October 2009.

Mark is now able to choose to make PAYG instalments annually for the 2009-10 income year by notifying the Commissioner of his choice, in the approved form, by the day on which his PAYG instalment would otherwise have been due.

Cessation of eligibility to pay an annual PAYG instalment

2.20 The current law specifies when a taxpayer who has chosen to make PAYG instalments annually stops being an annual PAYG instalment payer. Taxpayers that choose to make PAYG instalments annually under the eligibility tests introduced by subsection 45-140(1A) will also be subject to these rules.

2.21 Taxpayers will stop being annual payers if:

•

they become required to be registered under Part 2-5 of the GST Act;

•

they become a partner in a partnership that is required to be registered under Part 2-5 of the GST Act;

•

the partnership in which they are a partner becomes required to be registered under Part 2-5 of the GST Act;

•

the Commissioner notifies them that their notional tax is more than $8,000;

•

the annual tax period election that applies to them or to a partnership in which they are a partner ceases to have effect; or

•

in the case of a company, the company becomes a participant in a GST joint venture, part of an instalment group or Subdivision 45-Q starts to apply to the company as the head company of a consolidated group.

2.22 The amendments to sections 45-150, 45-155 and 45-160 reflect the introduction of the eligibility tests to allow taxpayers that are voluntarily registered for GST and have made annual tax period elections to make PAYG instalments annually.

Example 2.4

Sharon is an individual who is voluntarily registered for GST and has made an annual tax period election for the 2009-10 income year under Division 151 of the GST Act.

On 17 November 2010 she is informed by the Commissioner that her turnover is above the GST registration turnover threshold. The Commissioner accordingly disallows her annual tax period election.

Under the GST Act Sharon's annual tax period will cease to have effect from 30 June 2011.

As Sharon's annual tax period election will cease to have effect from 30 June 2011 she will also cease to be an annual PAYG instalment payer for the 2011-12 income year.

2.23 Amendments to paragraphs 45-150(3)(a), 45-155(4)(a) and 45-160(3)(a) reflect the fact that taxpayers may again become annual PAYG payers only if they satisfy the conditions in either subsection 45-140(1) or (1A).

2.24 The amendments to give effect to this change in paragraph 45-155(4)(a) reflect the fact that the section relates to circumstances at the start of the first instalment quarter in an income year rather than any instalment quarter. [ Schedule 2, item 11, paragraph 45-155(4)(a )]

Application

2.25 The amendments made by this Schedule apply in relation to instalments for income years starting after 30 June 2009. [ Schedule 2, item 15 ]

Chapter 3 Petroleum resource rent tax: minor changes

Outline of chapter

3.1 Schedule 3 to this Bill amends the Petroleum Resource Rent Tax Assessment Act 1987 (PRRT Act) by:

•

introducing a functional currency rule into the petroleum resource rent tax (PRRT), along similar lines to the functional currency rule in the Income Tax Assessment Act 1997;

•

introducing a modified 'look-back' rule for exploration expenditure related to a production licence derived from an exploration permit and a retention lease;

•

introducing internal petroleum provisions (similar to the external petroleum provisions) to deal with the case where project petroleum is processed for a tolling fee, or acquired for processing, by a person who has an interest in the project for (if processed), or from (if acquired), another person who has an interest in the same project; and

•

extending the offshore exploration incentive for designated frontier areas by one year so it applies to the 2009 annual offshore acreage release.

3.2 All references in this chapter are to the PRRT Act.

Context of amendments

Petroleum resource rent tax

3.3 The PRRT is a tax on profits generated by petroleum projects located offshore with the exception of the North West Shelf project area. The PRRT 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 assessable receipts after recovery of project deductible 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 the first production licence) to be available as a deduction against project receipts in future years. Limited transfer of deductible expenditure to other PRRT projects of the taxpayer, or of PRRT projects of other companies in the same group, applies.

Functional currency rule

3.4 Section 10 of the PRRT Act requires that for the purposes of the PRRT Act all amounts and values shall be expressed in terms of Australian dollars. Based on this section, the Australian Taxation Office currently administers the PRRT Act on the basis that when a receipt is derived or a payment is incurred in a foreign currency, the foreign currency amount is to be immediately converted to Australian dollars for PRRT purposes. This approach applies for each individual transaction. This enables PRRT taxpayers to work out their PRRT liability in Australian dollar terms. The measure in the Bill allows PRRT taxpayers or company groups to elect to work out their PRRT liability in the relevant functional currency (for example, US dollars).

Exploration expenditure derived from an exploration permit or a retention lease

3.5 Section 5 of the PRRT Act is an interpretative provision which essentially describes what is meant by the exploration for petroleum in, or the recovery of petroleum from:

•

an exploration permit (which provides the right to someone to explore for petroleum in a particular area);

•

a retention lease (which provides someone the right to a petroleum discovery that is not currently commercially viable to be developed but may become commercially viable to develop sometime in the future); or

•

a production licence (which provides someone the right to produce petroleum).

3.6 A key outcome of section 5 of the PRRT Act is that in the case where a retention lease is derived from an exploration permit and then a production licence is derived from the retention lease area, exploration expenditure incurred within the retention lease area is attached to the production licence and is a deductible expense in working out any PRRT liability arising from that production licence area. However, exploration expenditure incurred outside the retention lease area but inside the exploration permit area is not attached presently to the production licence derived from the retention lease area. Consequently, certain exploration expenditure may not be connected to a relevant area and if so remains undeductible for PRRT purposes. The measure in the Bill ensures that all exploration expenditure is deductible for PRRT purposes against the appropriate area's production licence.

Internal petroleum

3.7 The PRRT Act already addresses the circumstance where a petroleum project sources petroleum for processing from another petroleum project. This is known as external petroleum. The petroleum project may process this petroleum either for a tolling fee or purchase this petroleum. For the petroleum project sourcing petroleum from outside this project, any tolling fee paid to it for processing this petroleum is an assessable receipt, and the costs of processing this external petroleum are deductible expenditure. Further, the cost to a petroleum project of purchasing any external petroleum for processing from another project is a deductible expense. For the petroleum project providing the external petroleum to another project, any tolling fee it pays is deductible expenditure. Further, the proceeds from selling petroleum for further processing to another project are an assessable receipt for the selling project. Any external petroleum acquired counts as petroleum of the acquiring project and so gives rise to assessable receipts of the acquiring project. The new measure addresses the circumstance where petroleum is sourced from within the petroleum project (such as by one participant in the project from another participant in the same project). This is known as internal petroleum.

Offshore exploration incentive

3.8 The offshore exploration incentive in the PRRT allows an immediate 150 per cent uplift on PRRT deductions for exploration expenditure incurred in designated offshore frontier areas. Designated offshore frontier areas are designated by the Minister administering the Offshore Petroleum Act 2006 (presently the Minister for Resources and Energy) and may constitute up to 20 per cent of exploration permit areas released in a year. They must be located more than 100 kilometres from an existing commercialised oil discovery, and they must not be adjacent to an area designated in the previous year's acreage release. This measure applied to the annual offshore acreage releases for 2004 to 2008.

3.9 The measure in the Bill extends the offshore exploration incentive by one year. This will enable this incentive to apply to the 2009 annual offshore acreage release. Any assistance provided beyond 2009 will be considered in light of the final report of the Australia's Future Tax System review and the Energy White Paper, which are both scheduled to be completed by the end of 2009.

Summary of new law

3.10 Schedule 3 to this Bill implements the following four measures.

•

The first measure allows PRRT taxpayers to work out their PRRT tax liability in their applicable functional currency (for example, US dollars) instead of Australian dollars. The functional currency rules for PRRT are similar to the functional currency rules for income tax purposes (with some differences to accommodate the different features of PRRT). A key feature is that PRRT taxpayers (or those PRRT taxpayers who are members of a company group) can elect to work out their PRRT liability in the applicable functional currency. This measure reduces compliance costs for PRRT taxpayers who elect to use a functional currency.

•

The second measure deals with exploration expenditure related to a production licence derived from an exploration permit or a retention lease. This measure ensures that all exploration expenditure in a permit area or lease area is deductible for PPRT purposes against the appropriate area's production licence. In effect, the measure relates exploration expenditure in an exploration permit area to the first subsequent retention lease area or production licence area, and relates exploration expenditure in a retention lease area to the first subsequent production licence area.

•

The third measure introduces internal petroleum provisions (similar to the external petroleum provisions) to deal with the case where project petroleum is processed for a tolling fee, or acquired for processing, by a person who has an interest in the project for (if processed), or from (if acquired), another person who has an interest in the same project.

•

The fourth measure extends the offshore exploration incentive by one year. This will enable this incentive to apply to the 2009 annual offshore acreage release.

Comparison of key features of new law and current law

Detailed explanation of new law

Functional currency

Translation rule from a foreign currency to Australia dollars

3.11 The current section 10 of the PRRT Act indicates that for the purposes of the PRRT Act all amounts and values shall be expressed in terms of Australian dollars. This Bill replaces the current section 10 with a new section 10. The effect of this amendment is to add clarity to this central concept.

3.12 The first clarification is that an amount in a foreign currency needs to be translated into Australian dollars [ Schedule 3, item 17, subsection 10(1 )]. The rule applies to amounts generally, and is intended to be interpreted broadly. Examples of an 'amount' include, without limitation:

•

an amount of an expense;

•

an amount of an obligation;

•

an amount of a liability;

•

an amount of a receipt;

•

an amount of a payment;

•

an amount of consideration; and

•

a value.

[ Schedule 3, item 17, subsection 10(2 )]

3.13 The second clarification is that if a PRRT taxpayer derives an assessable receipt in relation to a petroleum project, this assessable receipt is to be translated into Australian dollars for PRRT purposes at the time the receipt is derived for PRRT purposes [ Schedule 3, item 17, subsection 10(3 )]. The term 'assessable receipts' derived by a PRRT taxpayer in relation to a petroleum project is defined in section 23 of the PRRT Act.

3.14 The third clarification is that if a PRRT taxpayer incurs deductible expenditure in relation to a petroleum project, this deductible expenditure is to be translated into Australian dollars for PRRT purposes at the time the deductible expenditure is incurred for PRRT purposes [ Schedule 3, item 17, subsection 10(4 )]. The term 'deductible expenditure' incurred by a PRRT taxpayer in relation to a petroleum project is defined in section 32 of the PRRT Act.

3.15 The fourth clarification covers the circumstances arising from transfers subject to sections 48 or 48A of the PRRT Act. This is because amounts may arise in respect of a PRRT taxpayer acquiring the whole interest in a petroleum project, or part of an interest in a petroleum project. In particular, sections 48 and 48A of the PRRT Act contain rules for the treatment of parties when there is a transfer of an interest in assessable receipts in relation to a petroleum project from one party (the vendor) to another (the purchaser). The effect of these two sections is to place the purchaser in the same position in relation to the petroleum project as the vendor (although not in the same position in relation to wider deductibility (transfer) of past project exploration expenditure). They treat the purchaser as if they had derived the assessable receipts, incurred the deductible expenditure and paid the tax instalments of the vendor in relation to that share of the vendor's interest in the assessable receipts in relation to the petroleum project up to the time of the transaction, and treats the vendor as not having done so. Section 48 deals with the case where the PRRT taxpayer acquires the whole interest of the vendor in a petroleum project while section 48A deals with the case where the PRRT taxpayer acquires only part of the vendor's interest in the assessable receipts in relation to the petroleum project.

3.16 The same rule applies in the case where a purchaser acquires the whole of a vendor's interest in assessable receipts in relation to a petroleum project (which is covered in section 48 of the PRRT Act), and the case where the purchaser acquires part of a vendor's interest in assessable receipts in relation to a petroleum project (which is covered in section 48A of the PRRT Act). This rule addresses the case where there is an amount in the functional currency (that is, a foreign currency) of the vendor arising because of the operation of the functional currency rules which needs to be translated into Australian dollars in relation to the purchaser. In this case, there are two scenarios.

3.17 The first scenario is where an assessable receipt is actually derived, or deductible expenditure is actually incurred, during the year of tax in which the transfer time occurs for the purposes of section 48 and 48A of the PRRT Act. The applicable exchange rate to translate an amount in a functional currency (that is, a foreign currency) to Australian dollars in this scenario is the exchange rate at the transfer time (that is, not the time the expenditure was originally incurred). [ Schedule 3, item 17, subsections 10(5) and (6 )]

3.18 The second scenario is where the amount is incurred in a year of tax before the year of tax the transfer time occurs. The applicable exchange rate to translate the relevant amount in a functional currency (that is, a foreign currency) to Australian dollars in this scenario is also the exchange rate at the transfer time (that is, not the time the expenditure was originally incurred). The relevant amount of class 1 augmented bond rate general expenditure, class 1 augmented bond rate exploration expenditure and class 2 augmented bond rate general expenditure is the amount taken to have been incurred at the start of the year of tax the transfer time occurs. The relevant amount of class 2 augmented bond rate exploration expenditure will arise later from the amount taken to have incurred for the purposes of subparagraph 48(1)(a)(ia) and paragraph 48A(5)(c) (these amounts being those in relation to which exploration expenditure actually incurred on or after 1 July 1990 will later be taken to be incurred so far as it can be used up in a particular tax year). [ Schedule 3, item 17, subsections 10(5) and (6 )]

3.19 These clarifications do not exclude or affect the operation of the provisions dealing with a taxpayer using a functional currency as set out below. [ Schedule 3, item 17, subsection 10(7 )]

Election to use the functional currency rules

3.20 A person may elect to be bound by the functional currency rules for the purposes of the PRRT Act. This election has effect for the year of tax beginning on 1 July 2009 if the election is made within 30 days after Royal Assent of the Bill. For the 20010-11 year of tax and later years of tax, the election needs to be made before the commencement of the relevant year of tax from which the taxpayer wishes the functional currency rules to apply. The election must be in writing and continues in effect until a withdrawal of the election takes effect. [ Schedule 3, item 19, subsections 58B(1) to (3 )]

3.21 The general rule above applies where a person has an interest in assessable receipts in relation to a petroleum project or projects and there are no other members of the same company group with interests in assessable receipts in relation to a petroleum project or projects. In such a case, the same functional currency (whether the Australian dollar or another currency for which the taxpayer has elected) will apply for PRRT purposes in relation to every petroleum project interest of the taxpayer, and any transfers between projects of that taxpayer will therefore be worked out according to that same currency.

3.22 The other possibility is where several members of a group of companies each have an interest in assessable receipts in relation to a petroleum project or projects. The policy principle is that there is one election (if any) applying to all the company members of a company group which have an interest in a petroleum project for the year of tax (called the 'designated company group'), and this election is made by the relevant head company of the designated company group which applies to all the members of the designated company group the functional currency of that head company. The rationale behind this principle is that different members of a company group holding an interest in a number of petroleum projects cannot operate in a number of different currencies for PRRT purposes given the possibility of transferring exploration expenditure between petroleum projects of different members of the group of amounts that would be subject to variations produced by the differences between currencies.

3.23 This principle is given effect by rules based on concepts in new subsections 2B(1A), (2), (4A) and (4B) and in new section 2BA which defines a designated company group, combined with definitions of various terms including a 'group company' at a point in time, a 'subsidiary company' of another company at a point in time, a 'basic company group' and an 'overall company group'. The method to identify the designated company group, and the head company of this group, is set out in a number of steps.

3.24 The first step is to identify the overall company group [ Schedule 3, item 16, subsection 2BA(2 )]. The followings terms are used in defining an overall company group.

•

Group company: A company is a group company in relation to another company at a particular time if one of the companies is a subsidiary of the other company, or each of the companies is a subsidiary of the same company, at the time [ Schedule 3, item 12, subsection 2B(1A )].

•

Subsidiary: A subsidiary of a company at a particular point in time is where the company beneficially owns all the shares in the subsidiary (directly, or wholly or partly through other subsidiaries) and there is no agreement, arrangement or understanding in force with any person that affects those ownership rights of the company or of the other subsidiaries through which the shares of the subsidiary are beneficially owned. In effect, a company group comprises a company and all its subsidiary companies that are 100 per cent owned within the group [ Schedule 3, item 13, subsection 2B(2 )].

•

Basic company group: A basic company group is a group of companies, where each company in the group is a group company in relation to each other company in the group [ Schedule 3, item 15, subsection 2B(4A )].

3.25 An overall company group is a basic company group that is not a subset of any other basic company group [ Schedule 3, item 15, subsection 2B(4B )]. In essence, the overall company group is the parent company - the ultimate holding company - of the group and all its subsidiary companies that are 100 per cent owned within the group.

3.26 The second step is to identify the provisional designated company group. This comprises all the members of the overall company group that are entitled to derive assessable receipts in relation to a petroleum project [ Schedule 3, item 16, subsection 2BA(3 )]. In essence, the provisional designated company group is all the companies within the overall company group which have an interest in a petroleum project. This includes the companies between PRRT projects of which transfer of expenditure for PRRT purposes could be required.

3.27 The third step is to identify the designated company group and the head company of this group. There are two possibilities in this context:

•

The first possibility is where the head company of the designated company group is entitled to derive assessable receipts in relation to a petroleum project. This happens if there is a member of the provisional designated company group of which every other member of that group is a subsidiary. Then the provisional designated company group is the designated company group, and that member is the head company of the designated company group. [ Schedule 3, item 16, subsection 2BA(4 )]

•

The second possibility is where the head company of the designated company group is not itself entitled to derive assessable receipts in relation to a petroleum project. This happens if there is no member of the provisional designated company group of which every other member of that group is a subsidiary. Because the provisional designated company group is selected from within an overall company group, these members must have at least one company of which they are all subsidiaries. One of them is the head company of the designated company group. [ Schedule 3, item 16, subsection 2BA(5 )]

3.28 In respect of the second possibility, it is necessary to ensure that the head company of a designated company group is the company at the lowest possible level within the overall company group of which all the members of the provisional designated company group are subsidiaries. If a designated company group is identified under subsection 2BA(5) in which the head company of the designated company group is a subsidiary of another company (that is, a higher-tier company), and the higher-tier company is not a member of the provisional designated company group, then the high-tier company is taken to be not a member of a designated company group. In effect, the head company for PRRT purposes, which makes and withdraws functional currency elections binding the other members of the designated company group, either is entitled itself to assessable receipts in relation to a petroleum project or is at the lowest possible level within the overall company group. [ Schedule 3, item 16, subsections 2BA(6) and (7 )].

3.29 The reason for identifying the lowest possible level head company of the designated company group is so that if there is a sale of the designated company group this need have no implications in applying the functional currency rules. It is also consistent with other aspects of the PRRT in that if there is a sale of a company group, this does not impact on the transfer of exploration expenditure between members of this company group, nor do sections 48 and 48A apply in respect of a transfer of an entitlement to assessable receipts of a petroleum project.

3.30 Subsection 58B(4) indicates that if a head company of a designated company group makes an election to be bound by the functional currency rules, and this head company is the head company of a designated company group at the start of the year of tax for which the election is in effect and at the end of that year of tax, then each company that is a member of this designated company group at the end of that year of tax is taken to have made an election to use the functional currency rules that is in effect for that year. Further, this deemed election is taken to have effect for the year of tax and supersedes any other election made by any other member of the designated company group that would otherwise be in effect. [ Schedule 3, item 19, subsection 58B(4 )]

3.31 The implication of this subsection is that once the head company of a designated company group makes an election to be bound by functional currency rules, this election applies to all the members of the designated company group of which it is the head company at the end of the year of tax for which the election applies. Another implication is that when a company leaves a designated company group and joins another designated company group without changing the head company of that group, then that company is subject to the position of the designated company group it joins for the whole of the year of the change and thereafter. When a company with an interest in assessable receipts in relation to a petroleum project becomes another subsidiary of the head company of a designated company group, then this company is subject to the election applicable to the acquiring designated company group.

3.32 Subsection 58B(5) addresses the possibility of the head company of a designated company group who has made an election to be bound by functional currency rules is replaced by another head company of the designated company group during the year of tax. For example, this could arise because of an internal restructure which causes a change in the head company of the designated company group during a year of tax, or because the head company of a designated company group which made an election to be bound by functional currency rules leaves the overall company group during a year of tax. The effect of subsection 58B(5) is to deem the replacement head company of the designated company group to have made the election to be bound by functional currency rules. Similar to subsection 58B(4), subsection 58B(5) indicates that if a head company of a designated company group is deemed to have made an election to be bound by the functional currency rules, then each company that is a member of this designated company group at the end of that year of tax is taken to have made an election to use the functional currency rules that is in effect for that year. Further, this deemed election is taken to have effect for the year of tax and supersedes any other election made by any other member of the designated company group that would otherwise be in effect. [ Schedule 3, item 19, subsection 58B(5 )]

3.33 Subsection 58B(6) indicates that if the head company (or deemed head company) of a designated company group at the end of a year of tax has not made an election to be bound by the functional currency rules that is effective for all the members of the group (directly or by application of subsection 58B(5)), and it or any other member of the designated company group has made an election, then this election is taken to have been withdrawn. The implication of this subsection is that only a head company of a designated company group can make an effective election for the group to use the functional currency rules in relation to a year of tax. Further, if the head company has not made an effective election, no valid election will apply to any member of the group. No election can apply to only some of the members of a designated company group in any year of tax. This is because transfer of exploration expenditure must be made between projects of a taxpayer and between projects of other taxpayers in the same company group according to the same currency, preventing currency conversion having any effect on such transfer. [ Schedule 3, item 19, subsection 58B(6 )]

Applicable functional currency

3.34 The applicable functional currency depends on the factual circumstances of the PRRT taxpayer (or of the head company of their designated company group). The person's applicable functional currency is the sole or predominant foreign currency the person's financial accounts are kept in. (If there is no such foreign currency, then there is no applicable functional currency for which election can be made and no election will be effective to permit or require accounts to be kept for PRRT purposes other than in Australian currency.) If the person is the head company (or deemed head company) of a designated company group, it is the currency of the head company's (or deemed head company's) accounts immediately before the end of the year of tax for which the election applies. If the person is not a member of a designated company group, it is the sole or predominant foreign currency of the person's accounts at the time the election is made. This aligns the commercial rationale for accounting in a foreign currency with the election to use that currency for PRRT purposes. [ Schedule 3, item 19, subsection 58C(1 )]

3.35 If the person is a member of a designated company group (to which the head company's election applies), then the person's applicable functional currency for the year of tax is the sole or predominant foreign currency in which the financial accounts of the head company (or deemed head company) of the designated company group are kept immediately before the end of the year of tax for which the election applies. This rule ensures that all members of a designated company group use the same functional currency in the same year, and that the currency is that of the head company at the close of the year, if an election to use it applies. [ Schedule 3, item 19, subsection 58C(2 )]

3.36 The term 'accounts' includes ledgers, journals, statements of financial performance, profit and loss accounts, balance sheets and statements of financial position and includes statements, reports and notes attached to, intended to be read, with such items. This definition is used to help identify the accounts for which the sole or predominant currency actually used (if not the Australian dollar), taking account of all accounts actually kept and the currency used for each of them, is the functional currency which can be chosen. [ Schedule 3, item 1, definition of ' accounts' in section 2 ]

Translation rules when operating in a functional currency to work out taxable profit

3.37 The translation rules for working out taxable profit in a functional currency are set out in section 58D. These rules include:

•

translating amounts not specified in the functional currency into the functional currency;

•

changing the normal foreign currency rules so that the functional currency is no longer treated as a foreign currency whereas Australian currency is treated as a foreign currency; and

•

translating taxable profit in relation to a petroleum project worked out in the functional currency into Australian currency. (This has the effect that all provisions relating to the amount of tax, its recovery and collection and any penalties, continue to operate in Australian currency despite the use of the functional currency.)

[ Schedule 3, item 19, paragraphs 58D(1)(a) to (d )]

3.38 The functional currency translation rule provides for the translation of 'an amount' into the applicable functional currency. Similar to section 10, the rule applies to amounts generally, and is intended to be interpreted broadly. Examples of an 'amount' include (without limitation):

•

an amount of an expense;

•

an amount of an obligation;

•

an amount of a liability;

•

an amount of a receipt;

•

an amount of a payment;

•

an amount of consideration; and

•

a value.

[ Schedule 3, item 19, subsection 58D(2 )]

3.39 In the case of assessable receipts and deductible expenditure arising or transferred to the taxpayer after the election to use a functional currency takes effect, the exchange rate for translating amounts not specified in the functional currency into the functional currency is set out in sections 58E to 58H. This applies to assessable receipts derived and deductible expenditure incurred in relation to a petroleum project, as well as assessable receipts derived and deductible expenditure incurred in relation to acquiring the whole interest in a petroleum project or part of an interest in a petroleum project. These rules correspond exactly to the same rules as in subsections 10(3) to (6) which deal with the case of translating foreign currency amounts into Australian dollars. [ Schedule 3, item 17, section 10, item 19, sections 58E to 58H ]

3.40 The applicable conversion rates can be summarised briefly:

•

For assessable receipts actually derived by the taxpayer, conversion is at the exchange rate applicable when the receipt is derived for PRRT purposes (subsection 10(3) and section 58E).

•

For deductible expenditure actually incurred by the taxpayer, conversion is at the exchange rate applicable when the expenditure is incurred (subsection 10(4) and section 58F).

•

For assessable receipts and deductible expenditure taken to be incurred because of a transfer of a part or of the whole of a vendor's entitlement to assessable receipts in relation to a project, and requiring conversion to the currency used by the purchaser:

-

if these are receipts derived or expenditure incurred during the transfer year, conversion is at the exchange rate applicable at the transfer time;

-

if they are expenditure taken to be incurred on the first day of the transfer year, conversion is at the exchange rate applicable at the transfer time; and

-

if they are the amounts in relation to which transferable exploration expenditure may later be taken to have been incurred, conversion is at the exchange rate applicable at the transfer time (subsections 10(5) and (6) and sections 58G and 58H).

3.41 There may be amounts in relation to which transferable exploration expenditure may later be taken to have been incurred, when and to the extent that the resulting compounded amount can be used up in relation to a particular project and a particular year of tax. For these amounts, the conversion will be at the exchange rate applicable at the transfer time. The conversion will not be made then, but only when and to the extent that transferable exploration expenditure is later taken to be incurred. The conversion will be made using the exchange rate at the transfer time, and compounding will then be worked out for the converted amount from the point in time when the actual expenditure was actually incurred. Using the exchange rate of the transfer time provides certainty of the applicable exchange rate to a taxpayer acquiring the potential expenditure as a consequence of acquiring all or part of a vendor's entitlement to assessable receipts of a petroleum project.

Events that happen before an election (or withdrawal) takes effect

3.42 Deductible expenditure may have been incurred in a year of tax before the start of the year of tax the election to use a particular functional currency takes effect (or before the withdrawal of an election takes effect). In the case of such expenditure, the exchange rate for translating amounts not specified in the relevant functional currency into the relevant functional currency is set out in section 58K. For amounts not specified in Australian currency incurred before the withdrawal of an election, so that the amount must be translated into Australian currency, the exchange rate is set out in section 58M.

3.43 There are two possible scenarios in moving to a functional currency for which the same rule applies. The first is where an election is made to move from Australian dollars into a functional currency. The second is where an election is made to move from a currency other than Australian dollars to another currency other than Australian dollars. (This will be because the sole or predominant currency in which the accounts are kept is different to that at the time applicable to the election now withdrawn.) In either case, the applicable exchange rate to translate to the newly chosen functional currency is the exchange rate at the start of the year of tax the election takes effect. This is so whether the amount is taken to have been incurred on the first day of the year of the new election, or whether it is expenditure actually incurred before the election took effect and in relation to which the amount of transferable exploration expenditure taken to be incurred will be worked out in later years. The relevant amount of class 1 augmented bond rate general expenditure, class 1 augmented bond rate exploration expenditure and class 2 augmented bond rate general expenditure to be converted is then the amount taken to have been incurred at the start of the year the election to use a functional currency takes effect. The relevant amount in the case of class 2 augmented bond rate exploration expenditure, class 2 GDP factor expenditure, and transferable exploration expenditure is the amount actually incurred on the basis of which transferable exploration expenditure may be later taken to be incurred. [ Schedule 3, item 19, subsections 58K(1) and (2 )]

3.44 Where an election is withdrawn and no fresh election with effect from the start of the next year of tax is made, any prior year expenditures must be converted into Australian currency. In this case, the applicable exchange rate to translate the relevant amount from the functional currency to Australian dollars is the exchange rate at the start of the year of tax for which the withdrawal of the election takes effect. The relevant amount of class 1 augmented bond rate general expenditure, class 1 augmented bond rate exploration expenditure and class 2 augmented bond rate general expenditure to be converted is then the amount taken to have been incurred at the start of the year the withdrawal of the election to use a functional currency takes effect. The relevant amount in the case of class 2 augmented bond rate exploration expenditure, class 2 gross domestic product factor expenditure, and transferable exploration expenditure is the amount actually incurred on the basis of which transferable exploration expenditure may be later taken to be incurred. [ Schedule 3, item 19, subsections 58M(1) and (2 )]

Treatment of closing-down expenditure

3.45 Under section 46 of the PRRT Act, a person is entitled to a tax credit in relation to a petroleum project where, in the year of tax, the sum of closing-down expenditure and other deductible expenditures incurred by the person exceeds the assessable receipts derived by the person in that year of tax. That credit will refund 40 per cent of the excess closing-down expenditure, up to the total PRRT previously paid by the person in relation to that petroleum project.

3.46 The current subsection 46(1) of the PRRT Act is replaced with a new subsection. The only change is to introduce the term excess closing-down expenditure to improve the clarity of the provision. This term is defined as the amount by which the sum of closing down expenditure and other deductible expenditure incurred by the person on a petroleum project in a year of tax exceeds assessable receipts derived by the person in the year of tax in relation to that project up to the closing-down expenditure in that year of tax on that project. The tax credit is:

•

40 per cent of so much of the excess closing-down expenditure for the year of tax; but limited by

•

the total amount of any tax paid by the person in respect of the project in previous years, reduced by the total amount of any credits previously allowable in relation to the project.

That is, the total of tax credits for closing-down expenditure cannot exceed the total PRRT paid by the person in respect of the petroleum project.

[ Schedule 3, item 18, subsection 46(1 )]

3.47 This term 'excess closing-down expenditure' is used in the context of working out the tax credit if the PRRT taxpayer is operating in a functional currency. In particular, if the PRRT taxpayer is operating in a functional currency, then all the amounts comprising excess closing-down expenditure in a year of tax are denominated in the functional currency. The amount of excess closing down expenditure is worked out in the functional currency, and translated from the functional currency to Australian dollars. The credit is then worked out in Australian dollars, in which all PRRT was previously worked out and paid by the person in respect of the project. A PRRT taxpayer's operation in a functional currency will not hinder working out the credit in Australian dollars. [ Schedule 3, item 19, paragraph 58D(1)(e )]

Translation of taxable profit and excess closing-down expenditure from a functional currency to Australian dollars

3.48 Once taxable profit or excess closing-down expenditure in relation to a petroleum project has been worked out in a functional currency, a methodology needs to be determined to translate these amounts from the functional currency to Australian dollars. The PRRT due, or the tax credit payable in respect of closing down expenditure, will then be worked out in Australian dollars from these amounts. The person may elect to use either the average exchange rate during the year of tax or the exchange rate on the last day of the year of tax [ Schedule 3, item 19, subsection 58J(1 )]. This election must be in writing and is irrevocable [ Schedule 3, item 19, subsection 58J(2 )]. Further, this election is deemed to take effect in each year of tax for which an applicable functional currency election made under section 58B continues [ Schedule 3, item 19, subsections 58J(4) and (5 )]. If the person has not made an election, then they are taken to have elected for the average exchange rate during each year of tax [ Schedule 3, item 19, subsection 58J(3 )].

3.49 Subsections 58J(6) and (9) indicate that if a head company of a designated company group makes an election to use a particular methodology to translate taxable profit and excess closing-down expenditure from a functional currency to Australian dollars, and this head company is the head company of a designated company group when it made the election and at the end of a year of tax, then each company that is a member of the designated company group at the end of the year of tax is taken to have made this election. Further, this deemed election of each member company takes effect for the year of tax and supersedes any other election made by any other member who is not the head company of the designated company group. In other words, the election taken to have been made by the designated company group supersedes any election actually made or otherwise taken to have been made by any member of the group. [ Schedule 3, item 19, subsections 58J(6) and (9 )]

3.50 The implication of these subsections is that once the head company of a designated company group has made an election to use a particular methodology to translate taxable profit or excess closing down expenditure from a functional currency to Australian dollars, all the members of that group during a year of tax are bound by this election. Another implication is that if a company joins a designated company group without a change of that group's head company, then the company is subject from that year to the position of the designated company group it joins. This is so whether the joining company was previously a member of another designated company group or not.

3.51 Subsections 58J(7) and 58J(10) address the possibility of the head company of a designated company group which has made an election to use a particular translation methodology for taxable profit and excess closing-down expenditure is replaced by another head company of the designed company group during the year of tax. For example, this could arise because of an internal restructure which causes a change in the head company of the designated company group during a year of tax, or because the head company of a designated company group which has made an election to be bound by functional currency rules leaves the overall company group during a year of tax. The effect of subsections 58J(7) and 58J(10) are to deem the replacement head company of the designated company group to have made the same election in respect of the translation methodology for taxable profit and excess closing-down expenditure as the head company that made the actual election. [ Schedule 3, item 19, subsections 58J(7) and (10 )]

3.52 Similar to subsections 58J(6) and (9), subsections 58J(7) and 58(J)(10) indicate that if a head company of a designated company group is taken to have made an election to use a particular methodology to translate taxable profit and excess closing-down expenditure from a functional currency to Australian dollars, and this deemed head company is the head company of a designated company group when it made the election and at the end of a year of tax, then each company that is a member of the designated company group at the end of the year of tax is taken to have made this election. Further, this deemed election of each member company takes effect for the year of tax and supersedes any other election made by any other member company that is not the deemed head company of the designated company group. In other words, the election taken to have been made by the designated company group supersedes any election actually made or otherwise taken to have been made by any member of the group. [ Schedule 3, item 19, subsections 58J(7) and (10 )]

3.53 Subsection 58J(8) indicates that if the head company (or deemed head company) of a designated company group has not made (or deemed to have been made) an election effective for the whole group to use average exchange rate methodology to translate taxable profit and excess closing-down expenditure from a functional currency to Australian dollars effective for a particular year of tax, and any other member of the designated company group has made such an election, then this election is taken as from the start of the year of tax not to have been in effect. All members of the designated company group, including the head company and the deemed head company (if any), will then be taken to have made the default election for the average exchange rate methodology under subsection 58J(3). [ Schedule 3, item 19, subsection 58J(8 )]

3.54 Subsection 58J(11) applies where a head company (or deemed head company) of a designated company group has not made (or deemed to have been made) an election effective for the whole group to use end-of-year exchange rate methodology to translate taxable profit and excess closing-down expenditure from a functional currency to Australian dollars effective for a particular year of tax. Where any other member of the designated company group has made such an election, then this election is taken as from the start of the year of tax not to have been in effect. All members of the designated company group, including the head company and the deemed head company (if any), will then be taken to have made the default election for average exchange rate methodology under subsection 58J(3). [ Schedule 3, item 19, subsection 58J(11 )]

Withdrawal of the functional currency election

3.55 A person may withdraw an election to be bound by the functional currency rules for the purposes of the PRRT Act. However, a person may only withdraw this election if the person's applicable functional currency has ceased to be the sole or predominant currency in which the person keeps their account in. For members of a designated company group, only the head company (or deemed head company) can withdraw an election. This withdrawal of an election to be bound by the functional currency rules has effect for the year of tax immediately after the end of the year of tax the withdrawal is made [ Schedule 3, item 19, subsection 58L(1 )]. The withdrawal must be in writing and does not prevent the person making a new election to be bound by the functional currency rules [ Schedule 3, item 19, subsections 58L(2) and (3 )].

3.56 If the person withdrawing the election to be bound by the functional currency rules is a head company (or deemed head company) of a designated group, then each other company in a designated company group is also taken to have withdrawn this election. This deemed withdrawal of an election to be bound by the functional currency rules has effect for the year of tax immediately after the end of the year of tax the withdrawal is made. [ Schedule 3, item 19, subsection 58L(4 )]

Exploration permit and retention lease derived production licences

3.57 Section 5 of the PRRT Act is an interpretative provision which essentially describes what is meant by the exploration for petroleum in or the recovery of petroleum from particular areas in relation to a petroleum project. The areas can be the area of:

•

an exploration permit (which provides the right to someone to explore for petroleum in a particular area);

•

a retention lease (which provides someone the right to a petroleum discovery in a particular area that is currently not commercially viable to be developed but may become commercially viable to develop sometime in the future); or

•

a production licence (which provides someone the right to produce petroleum from a particular area).

3.58 The Bill recasts current section 5 of the PRRT Act so that it will apply in amended terms to a petroleum project where the earliest applicable production licence comes into force after 30 June 2008. As a result, the Bill inserts subsections 5(5) and (6) into the PRRT Act applicable to such projects. The current section 5 continues to apply to petroleum projects where any production licence comes into force before 1 July 2008. As a result, the current subsections 5(1) to (4) are retained but limited to those projects; and projects with applicable production licences pre-1 July 2008 are distinguished from those with only post-30 June 2008 production licences [ Schedule 3, items 21 and 22, section 2, item 23, subsection 5(1 ), item 24, subsection 5(2 )]. Given that it takes a number of years to construct a new petroleum project, the measure impacts on PRRT liability of taxpayers in future years (no PRRT taxpayers are expected to be affected in the 2008-09 year of tax).

3.59 Subsection 5(5) indicates in relation to post-30 June 2008 petroleum projects a reference in the PRRT Act to exploration in or recovery from the area of a production licence, an exploration permit or a retention lease means exploration or recovery from this area while the relevant licence, permit or lease is or was in force. This is equivalent to the current section 5(1) which will now apply only to pre-1 July 2008 petroleum projects. [ Schedule 3, item 25, subsection 5(1 )]

3.60 For post-30 June 2008 petroleum projects, the case where a production licence is derived from an exploration permit is addressed in paragraph 5(6)(a). In this case, there are two scenarios. The first scenario is where a production licence is derived from an exploration permit and no other production licences or retention leases have been derived from this exploration permit. Under this scenario, the eligible exploration or recovery area in relation to the petroleum project is the whole of the exploration permit area from which the production licence is derived, for exploration or recovery that occurs before the production licence comes into force. In other words, this means that exploration in the exploration permit area, and recovery of petroleum from the exploration permit area, before the production licence derived from this exploration permit area comes into force is treated as expenditure that relates to the petroleum project for this production licence. [ Schedule 3, item 25, paragraph 5(6)(a )]

3.61 The second scenario is where a production licence is derived from an exploration permit and a production licence or retention lease has been derived previously from this exploration permit. Under this scenario, the eligible exploration or recovery area in relation to the petroleum project is the whole of the exploration permit area from which the production licence is derived, for exploration or recovery that occurs before the production licence comes into force but after the most recent of any production licence or retention lease previously derived from the exploration permit came into force. In other words, this means that exploration in the exploration permit area, and recovery of petroleum from the exploration permit area, before the most recent production licence derived from this exploration permit area came into force and after any previous production licence or retention lease derived from this exploration permit came into force, relates to the petroleum project for this most recent production licence. (Earlier expenditure will relate only to projects related to the earlier production licences or related to the earlier retention leases.) [ Schedule 3, item 25, paragraph 5(6)(a )]

3.62 The case where a production licence is derived from a retention lease is addressed in paragraphs 5(6)(b) and (c). There are a number of scenarios. The first scenario is where a production licence is derived from a retention lease and expenditure on exploration or production occurs in the retention lease area. Under this scenario, the eligible exploration or recovery area in relation to the petroleum project is the whole of the retention lease area from which the production licence is derived, provided that exploration or recovery occurs before the production licence comes into force. In other words, this means that exploration in the retention lease area, and recovery of petroleum from the retention lease area, before the production licence derived from this retention lease area comes into force relates to the petroleum project for this production licence. (As a practical matter, the case where another production licence has previously been derived from the retention lease is not addressed because this is expected never to occur.) [ Schedule 3, item 25, paragraph 5(6)(b )]

3.63 The second scenario is where a production licence is derived from a retention lease that was derived from an exploration permit, and expenditure on exploration or production occurs in the exploration permit area outside the retention lease area. No other production licence or retention lease has come into effect derived from that exploration permit. Under this scenario, the eligible exploration or recovery area in relation to the petroleum project includes the whole of the exploration permit area from which the retention lease production licence was derived, provided that exploration or recovery occurs before the retention lease comes into force. In other words, this means that exploration in the exploration permit area, and recovery of petroleum from the exploration permit area, before the retention lease derived from this exploration permit area comes into force relates to the petroleum project for the production licence derived from this retention lease. [ Schedule 3, item 25, paragraph 5(6)(c )]

3.64 The third scenario is where a production licence is derived from a retention lease and the retention lease is derived from an exploration permit. Further, in this scenario, a production licence or retention lease has been derived previously from the same exploration permit. Under this scenario, the eligible exploration or recovery area in relation to the petroleum project is the whole of the exploration permit area from which the retention lease is derived from, provided that exploration or recovery occurs before the retention lease comes into force and after any previous production licence or retention lease derived from this exploration permit comes into force. In other words, this means that exploration in the exploration permit area, and recovery of petroleum from the exploration permit area, before the most recent retention lease derived from this exploration permit area comes into force and after any previous production licence or retention lease is derived from this exploration permit, relates to the petroleum project for this production licence. (Earlier expenditure will relate only to the projects related to the earlier production licences or related to the earlier retention leases.) [ Schedule 3, item 25, paragraph 5(6)(c )]

3.65 There is the possibility under the second and third scenarios of a number of retention leases being issued at the same point in time. If a petroleum project is derived from one or more retention leases, these retention leases as well as other retention leases (if any) come into force at the same point in time, and these retention leases are derived from a single exploration permit, then the relevant exploration expenditure relating to the petroleum project is shared equally between the retention leases issued at the one point in time. [ Schedule 3, item 25, subsection 5(7 )]

3.66 Paragraph 5(6)(d) includes in the eligible exploration or recovery area of a petroleum project the whole of the project's production licence area or areas while the relevant licence is in force. This paragraph is equivalent to paragraph 5(2)(c). In other words, this means that exploration in the production licence area, and recovery of petroleum from the production licence area, relate to the petroleum project for this production licence. [ Schedule 3, item 25, paragraph 5(6)(d )]

Processing of internal petroleum

Meaning of internal petroleum

3.67 The term internal petroleum in relation to a petroleum project is defined as petroleum (or any constituent of petroleum) recovered from the production licence area or areas relating to this project where:

•

the petroleum is recovered or processed by a person entitled to derive assessable receipts in relation to the project, and this recovery or processing is undertaken for or on behalf of another person who is entitled to derive assessable receipts in relation to the project; or

•

the petroleum is sold by a person entitled to derive assessable receipts in relation to the project, and this sale is to another person who is entitled to derive assessable receipts in relation to the project.

[ Schedule 3, item 26, definition of ' internal petroleum' in section 2 ]

3.68 In other words, internal petroleum covers the scenario where a person who has an interest in a petroleum project processes petroleum (or any constituent) on behalf of another person who also has an interest in the same project, and the scenario where a person who has an interest in a petroleum project sells their share of petroleum (or any constituent) produced by the project to another person who has an interest in the same project. This is similar to the case with external petroleum. These scenarios are illustrated in the following two examples.

Example 3.1

Assume that Company A and Company B form an unincorporated joint venture with each company having a 50 per cent interest in production of a petroleum project. Assume that this project produces natural gas, each company is entitled to 50 per cent of annual production, Company A processes for a tolling fee Company B's share of this natural gas by removing impurities so it can be sold into the domestic market, and Company B derives assessable receipts from its share of this natural gas. The natural gas processed by Company A on behalf of Company B for a tolling fee is internal petroleum under the first limb of the definition of internal petroleum.

Example 3.2

Assume that Company A and Company B form an unincorporated joint venture with each company having a 50 per cent interest in production of a petroleum project. Assume that this project produces natural gas, each company is entitled to 50 per cent of annual production, Company A buys Company B's share of this natural gas, processes this natural gas by removing impurities so it can be sold into the domestic market, and sells this natural gas into the domestic market. The natural gas acquired by Company A (and sold by Company B) is internal petroleum under the second limb of the definition of internal petroleum.

3.69 The term processing of internal petroleum is defined as including the stabilisation, transportation, storage or recovery of internal petroleum in relation to the project. This is the same as the definition of external petroleum. [ Schedule 3, item 28, definition of ' processing of internal petroleum' in section 2 ]

3.70 Under the new subsection 19(2C), the scope of a petroleum project is broadened to encompass internal petroleum provided that the project's own operations and facilities are wholly or partly used to process that petroleum [ Schedule 3, item 29, subsection 19(2C )]. This is the same approach as used for external petroleum. (This is less cumbersome than the alternative approach of providing parallel provisions to those of subsection 19(4) for application to internal petroleum.) As a consequential change, the definition of a petroleum project is amended by adding a reference to the new subsection 19(2C) [ Schedule 3, item 27, section 2 ].

Assessable petroleum receipts

3.71 Section 23 of the PRRT Act specifies that a reference to assessable receipts includes assessable petroleum receipts and assessable tolling receipts. Consequently, assessable petroleum receipts need to include receipts for internal petroleum and assessable tolling receipts need to include tolling fees for processing internal petroleum.

3.72 In respect of assessable petroleum receipts, once the internal petroleum is sold from one project participant to another, all assessable petroleum receipts in relation to internal petroleum are assessable receipts in relation to petroleum from the project. In other words, internal petroleum falls within the meaning of paragraph 24(2)(a) which defines the meaning of petroleum from the project so as to be petroleum that is recovered from the production licence area or areas in relation to the petroleum project. This means that no amendment is required to ensure that what happens to internal petroleum is included in assessable petroleum receipts as for any other project petroleum or project marketable commodities. Similarly, petroleum from the project includes external petroleum in relation to the project, by an extension of the definition of 'petroleum from the project' in subsection 24(2).

3.73 In terms of assessable tolling receipts, the term internal petroleum has been added to section 24A of the PRRT Act. This ensures that tolling fee income in relation to processing internal petroleum is included in assessable tolling receipts. This applies in the same way as for tolling fee income in relation to processing external petroleum. [ Schedule 3, item 30, section 24A ]

Deductible expenditures

3.74 Expenditures incurred in recovering, stabilising, transporting, storing or processing internal petroleum are deductible exploration and general project expenditure in the same way as for other petroleum from the project [ Schedule 3, items 31 to 33, paragraphs 37(1)(c ), 38(1)(c) and (d )]. This expenditure expressly includes payment of a tolling fee to process internal petroleum - that is, in procuring another person to do the relevant things. Further, carrying on or providing the operations, facilities and other things comprising the project includes undertaking these activities in the context of processing internal petroleum [ Schedule 3, item 34, subsection 38(2 )]. In addition, expenditure incurred in purchasing internal petroleum is deductible general project expenditure [ Schedule 3, item 31, paragraph 37(1)(c )]. These are the same outcomes as for external petroleum.

3.75 Similar to processing external petroleum, processing internal petroleum is carved out of section 41 of the PRRT Act. This means that processing internal petroleum by the person paid a tolling fee for processing internal petroleum is not excluded from being included in that person's carrying on or providing of the operations, facilities or other things constituting the petroleum project, and so that part of the cost of doing so remains part of that person's deductible expenditure on the project. [ Schedule 3, item 35, subsection 41(2 )]

3.76 The following examples provide two possible scenarios.

Example 3.3

Assume that Company A and Company B form an unincorporated joint venture with each company having a 50 per cent interest in production from a petroleum project. Assume that this project produces natural gas, each company is entitled to 50 per cent of annual production, Company A processes Company B's share of this natural gas by removing impurities so it can be sold into the domestic market for a fee of $1,000, Company A's expenditure for undertaking this processing is $900, and Company B derives assessable receipts totalling $10,000 from the sale of this natural gas.

The natural gas processed by Company A on behalf of Company B for tolling fee is internal petroleum under the first limb of the definition of internal petroleum. In the case of Company A, it derives assessable tolling receipts relating to the tolling fee of $1,000 under section 24A (and therefore an assessable receipt under paragraph 23(1)(aa)), and incurs deductible general project expenditure of $900 under paragraph 38(1)(d). In the case of Company B, it derives an assessable petroleum receipt of $10,000 under section 24 (and therefore an assessable receipt under paragraph 23(1)(a)), and incurs deductible general project expenditure relating to the tolling fee of $1,000 under paragraph 38(1)(d).

Example 3.4

Assume that Company A and Company B form an unincorporated joint venture with each company having a 50 per cent interest in production from a petroleum project. Assume that this project produces natural gas, each company is entitled to 50 per cent of annual production, Company A buys Company B's share of this natural gas for $5,000, processes this natural gas by removing impurities so it can be sold into the domestic market (which costs $10,000), and sells this natural gas into the domestic market for $20,000.

The natural gas acquired by Company A (and sold by Company B) is internal petroleum under the second limb of the definition of internal petroleum. In the case of Company A, it derives an assessable petroleum receipt of $20,000 under section 24 (and therefore an assessable receipt under paragraph 23(1)(a)). Company A incurs deductible general project expenditure relating to the costs of purchasing the natural gas of $5,000 under paragraph 38(1)(c) and relating to processing the natural gas of $10,000 under paragraph 38(1)(d). In the case of Company B, it derives an assessable petroleum receipt of $5,000 under section 24 (and therefore an assessable receipt under paragraph 23(1)(a)).

Offshore exploration incentive

3.77 The offshore exploration incentive in the PRRT allows an immediate 150 per cent uplift on PRRT deductions for exploration expenditure incurred in designated offshore frontier areas. Designated offshore frontier areas are designated by the Minister administering the Offshore Petroleum Act 2006 (presently the Minister for Resources and Energy) and may constitute up to 20 per cent of exploration permit areas released in a year. They must be located more than 100 kilometres from an existing commercialised oil discovery, and they must not be adjacent to an area designated in the previous year's acreage release. This measure has applied to the annual offshore acreage releases for 2004 to 2008.

3.78 The amendment to subsection 36B(2) replaces '2008' with '2009'. This will allow the Minister to specify designated offshore frontier areas relating to the 2009 annual offshore acreage release. [ Schedule 3, item 37, subsection 36B(2 )]

Application and transitional provisions

Functional currency

3.79 The amendments relating to functional currency apply to instalments and assessments of PRRT for the years that start on or after 1 July 2009. [ Schedule 3, item 20 ]

3.80 As mentioned above, PRRT taxpayers have the option of electing to use the functional currency rules. For the 2009-10 year of tax, taxpayers can make this election within 30 days after the Bill receives Royal Assent (see paragraph 1.21).

Exploration expenditure

3.81 The amendments relating to exploration expenditure apply to every petroleum project, differentiating any post-30 June 2008 petroleum project from any pre-1 July 2008 petroleum project. No specific application or transitional provisions are needed. Given that it takes a number of years to construct a new petroleum project, the measure impacts on PRRT liability of taxpayers only in future years (that is, no PRRT taxpayers will be affected in the 2008-09 year of tax).

Internal petroleum

3.82 The amendments relating to internal petroleum apply to instalments and assessments of PRRT for the years that start on or after 1 July 2008 [ Schedule 3, item 36 ]. No PRRT taxpayers are adversely affected by the retrospective application date because there are no PRRT taxpayers expected to rely on these amendments for the 2008-09 year of tax. It is expected that the amendments will apply to certain petroleum projects in future years.

Offshore exploration incentive

3.83 The amendments relating to the offshore exploration incentive commence on or after 12 May 2009 (which is the day of announcement of the measure).

Chapter 4 Deductible gift recipients

Outline of chapter

4.1 Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 to update the list of deductible gift recipients (DGRs) to include three new entities.

Context of amendments

4.2 The income tax law allows taxpayers who make gifts of $2 or more to DGRs to claim income tax deductions. To be a DGR, an organisation must fall within one of the general categories set out in Division 30 of the Income Tax Assessment Act 1997, or be listed by name under that Division.

4.3 DGR status assists eligible funds and organisations to attract public support for their activities.

Summary of new law

4.4 The amendments add three organisations to the list of specifically listed DGRs. Gifts of $2 or more that are made to organisations that are specifically listed, are tax deductible.

Detailed explanation of new law

4.5 Schedule 4 allows deductions for gifts to the organisations listed in Table 4.1. [ Schedule 4, items 1 to 3 ]

4.6 The Royal Institution of Australia Incorporated is a charitable organisation established to promote science and scientific applications for the advancement of the Australian community. The Royal Institution of Australia Incorporated is the first international affiliate of the Royal Institution of Great Britain.

4.7 Diplomacy Training Program Limited is an independent not-for-profit organisation affiliated with the Faculty of Law at the University of New South Wales. Diplomacy Training Program Limited provides training for representatives of non-government organisations in the Asia-Pacific region. Its training program focuses on human rights, good governance and the rule of law, with the aim of ending poverty, distress, suffering and violations of human rights.

4.8 Leeuwin Ocean Adventure Foundation Limited provides an educational and self-development training program to young people, mainly throughout Western Australia, which stimulates personal development, self reliance, teamwork, confidence, responsibility and community spirit. Leeuwin Ocean Adventure Foundation Limited conducts its program on the STS Leeuwin II, a three-masted barquentine tall ship, maintained as a class 1A passenger ship.

Application and transitional provisions

4.9 The amendments listing the organisations named in Table 4.1 apply from the dates of effect shown in the table.

Consequential amendments

4.10 A number of changes have been made to update the index to include the new entities. [ Schedule 4, items 4 to 6 ]

Index

Schedule 1: Reduction in 2009-10 PAYG instalments

Schedule 2: Choosing annual PAYG instalments if voluntarily registered for GST

Schedule 3: Petroleum resource rent tax

Schedule 4: Deductible gift recipients