ATO Interpretative Decision

ATO ID 2010/2 (Withdrawn)

Income Tax

• This ATO ID is withdrawn as the position stated in this ATO ID is no longer current. The current ATO position on this issue is contained in Taxation Determination TD 2018/D2 Income tax: What constitutes 'use' (and potentially first use) of a mining, quarrying or prospecting right, that is a depreciating asset, for the purposes of subsection 40-80(1) of the Income Tax Assessment Act 1997?
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Issue

Did the taxpayer start to hold a mining, quarrying or prospecting right under item 5 of the table in section 40-40 of the Income Tax Assessment Act 1997 (ITAA 1997) from the date it executed the purchase agreement?

Decision

Yes. The taxpayer started to hold the mining, quarrying or prospecting right under item 5 of the table in section 40-40 of the ITAA 1997 from the date it executed the purchase agreement because the taxpayer exercised the subject matter of the right; it had the right to become the mining, quarrying or prospecting right's legal owner; and it was reasonable to expect that the taxpayer would become the legal owner of the right from that date.

Facts

All legislative references are to the ITAA 1997 unless otherwise stated.

A production licence was granted by the relevant State Authority to an entity (the seller). The seller decided to sell a percentage interest in the production licence to the taxpayer and retain the balance of the interest in the production licence.

After conducting due diligence and obtaining its Board's approval, the taxpayer contracted with the seller to acquire the percentage interest in the production licence (the taxpayer's interest) under a purchase agreement (the purchase agreement).

The taxpayer's interest in the production licence is a mining, quarrying or prospecting right within the meaning of that term in subsection 995-1(1). The mining, quarrying or prospecting right is an intangible asset that is a depreciating asset under subsection 40-30(2).

The purchase agreement contained a clause stating that title to, and the risk relating to and arising from, the taxpayer's interest in the production licence will be deemed to have passed to the taxpayer on the effective date. The effective date was stipulated in the purchase agreement to be a date that was prior to the date the purchase agreement was executed by the seller and the taxpayer.

The taxpayer and the seller entered into a joint venture agreement at the same time the purchase agreement was executed. Pursuant to the terms of the joint venture agreement, the taxpayer appointed the seller as the operator of the taxpayer's interest in the production licence from the effective date.

As the operator, the seller was required to explore for petroleum and appraise, develop and exploit discoveries of an accumulation of petroleum in relation to its retained interest in the production licence and on behalf of the taxpayer, in relation to the taxpayer's interest in the production licence. The seller was also required to ensure that all other relevant State Government legal obligations attached to the taxpayer's interest in the production licence were met. The taxpayer was liable for operational costs incurred by the seller pursuant to the joint venture agreement in respect of the taxpayer's interest in the production licence.

The purchase agreement contained conditions precedent to performance of the agreement. The purchase agreement was completed.

Reasons for Decision

Division 40 provides a deduction for the decline in value of a depreciating asset a taxpayer holds to the extent the asset is used for a taxable purpose (section 40-25).

The table in section 40-40 identifies the holder of a depreciating asset. The first nine items in the table apply to depreciating assets in different circumstances. Item 10 of the table in section 40-40 applies to any depreciating asset. Because the specific items of the table apply in preference to the general item, item 10 applies as a default rule.

Item 10 of the table in section 40-40 provides that a taxpayer holds a depreciating asset if they are the owner of the asset, or the legal owner, if there is both a legal and equitable owner. However, there are other items in the table which identify a holder in various other circumstances even though they are not the asset's owner. For example, an economic owner of an asset which is not the legal owner of that asset will be the holder of the depreciating asset that is a right under item 5 of the table in section 40-40. As the more specific item of the table, item 5 will apply in preference to item 10 of that table to displace the legal owner from holding the depreciating asset.

Item 5 of the table in section 40-40

Item 5 of the table in section 40-40 provides that the economic owner, and not the legal owner, is the holder of an intangible depreciating asset that is a right, if the following four requirements are satisfied:

1. There is an intangible depreciating asset which is a right that an entity legally owns (the legal owner)

The intangible depreciating asset is the taxpayer's interest in the production licence which is a mining, quarrying or prosecting right that is legally owned by the seller.

2. Another entity (the economic owner) exercises the right, or has a right to exercise it immediately

The second requirement of item 5 of the table in section 40-40 is discussed in paragraph 1.35 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM), which introduced Division 40. Paragraph 1.35 of the EM provides that another entity must exercise the 'subject matter' of the right, or have the right to exercise it immediately.

When determining in what circumstances another entity exercises the subject matter of the right for the purposes of item 5 of the table in section 40-40, it is considered that item 5 contemplates this 'exercise' happening in anticipation of and prior to that entity becoming the legal owner of the right.

It follows that when interpreted in the context of item 10 of the table in section 40-40, the exercise of the subject matter of the right by an entity under item 5 of the table in section 40-40 has to be something less than what is required for legal ownership of the right to exist under item 10. Ordinarily, this would require that the entity has done things which would put them in the position of an economic owner of the right and with the expectation that they would, at some later time, become the legal owner of the right.

This recognises that the exercise of the subject matter of the right is something less than a legal exercise of the right which distinguishes item 5 of the table in section 40-40 from item 10 of that table. This reflects the policy intent behind item 5.

In this case, in order for the taxpayer to be exercising the subject matter of their interest in the production licence for the purposes of item 5 of the table in section 40-40, the Commissioner considers that the taxpayer must be exploiting the inherent character of that mining, quarrying or prospecting right. Exploitation of the inherent character of a mining, quarrying or prospecting right that is an interest in a production licence would require, at a minimum, that the taxpayer use the right to develop and recover discoveries of petroleum.

Further, in ATO Interpretative Decision ATO ID 2007/116 (Capital Allowances - depreciating asset - use of a mining, quarrying or prospecting right), the Commissioner was of the view that a taxpayer may appoint another entity to exploit the inherent character of a mining, quarrying or prospecting right on the taxpayer's behalf.

In this case, the taxpayer makes their interest in the production licence available to the seller to operate, pursuant to the terms of the joint venture agreement. Under the joint venture agreement, the seller carries out development and exploits discoveries of petroleum on the taxpayer's interest in the production licence. It also meets all other relevant State Government legal obligations attached to the taxpayer's interest in the production licence.

In making their interest in the production licence available to the seller to carry out these activities under the joint venture agreement, the taxpayer is exploiting the inherent character of the mining, quarrying or prospecting right. This is because the seller has performed contractual obligations on behalf of the taxpayer which puts the taxpayer in the position of an economic owner of the right. Accordingly, the taxpayer will be exercising the subject matter of the right for the purposes of item 5 of the table in section 40-40.

3. The economic owner has a right to become the right's legal owner

The purchase agreement gave the taxpayer a right to acquire an interest in the production licence. Notwithstanding that the purchase agreement contained conditions precedent to performance of the agreement, the existence of those conditions will not extinguish the taxpayer's right to become the legal owner of their interest in the production licence until such time as those conditions are not met and the agreement is terminated.

It is therefore considered that the taxpayer has a right to become the right's legal owner, that is, to become the legal owner of the taxpayer's interest in the production licence, from the date the purchase agreement was executed. It is considered that for the purposes of item 5 of the table in section 40-40, the taxpayer will not have a right to become the right's legal owner as from the effective date. This is because as at the effective date, the purchase agreement under which the taxpayer obtained the legal right to acquire its interest in the production licence, had not been executed and therefore, was not a binding contract at that date.

4. It is reasonable to expect that the economic owner will become the legal owner of the right ; or the right will be disposed of at the direction and for the benefit of the economic owner

Taxation Ruling TR 2005/20 (Income tax: the interaction of deemed ownership under Division 240 of the Income Tax Assessment Act 1997 with the 'holding' rules in Division 40) considers the meaning of 'reasonable to expect' in the context of item 6 of the table in section 40-40.

Paragraph 28 of TR 2005/20 states that:

The cases suggest for it to be 'reasonable to expect' something to occur requires a sufficiently reliable prediction that it will occur, or at least an expectation or prediction based on reasonable grounds.

It is the Commissioner's view that the meaning of 'reasonable to expect' in item 6 of the table in section 40-40 will be the same for the purposes of item 5 of the table in section 40-40.

In this case, the taxpayer conducted due diligence and obtained its Board's approval prior to executing the purchase agreement. Upon entering into the purchase agreement, the taxpayer purports to have accepted title to, and the risk relating to and arising from, its interest in the production licence. This included liability for operational costs incurred by the seller pursuant to the joint venture agreement in respect of the taxpayer's interest in the production licence.

In these circumstances, the taxpayer has accepted economic ownership of its interest in the production licence and the risks and benefits that accompany such ownership by committing to these risks and financial obligations. It is considered that the taxpayer would not have entered into the purchase agreement and accepted these risks and financial obligations if it did not have a sufficiently reliable prediction, based on reasonable grounds, that it would become the legal owner of its interest in the production licence.

Accordingly, it is reasonable to expect that the taxpayer will become the legal owner of its interest in the production licence from the date the purchase agreement was executed.

As the taxpayer satisfies all of the requirements of item 5 of the table in section 40-40, it will start to hold the mining, quarrying or prospecting right, being its interest in the production licence, from the date it executed the purchase agreement.

Year of income:  Year ended 31 March 2005

Legislative References:
Income Tax Assessment Act 1997
   subsection 40-25
   subsection 40-30(2)
   section 40-40
   item 5 of the table in section 40-40
   subsection 995-1(1)

Related Public Rulings (including Determinations)
Taxation Ruling TR 2005/20

Related ATO Interpretative Decisions
ATO ID 2007/116
ATO ID 2009/130

Other References:
Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001

Keywords
Deduction for depreciating assets
Economic owner
Hold a depreciating asset
Intangible depreciating assets
Legal owner
Mining, quarrying or prospecting information

Business Line:  Administration, Business and Personal Taxes Centre of Expertise

Date of publication:  8 January 2010

ISSN: 1445-2782