Decision impact statement

ZZGN and Commissioner of Taxation

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Court citation:
[2013] AATA 351
(2013) 95 ATR 831

Venue: Administrative Appeals Tribunal
Venue Reference No: 2010/4354
Judge Name: President D Kerr & Senior Member C R Walsh
Judgment date: 5 April 2013
Appeals on foot: No
Decision Outcome: Partly Favourable

Impacted Advice

Relevant Rulings/Determinations:

• Taxation Ruling TR 98/23

Subject References:
Deductible expenditure
Excluded expenditure
Exploration expenditure
Feasibility or environmental study
General project expenditure
'operations and facilities involved in or in connection with exploration for petroleum'
Transferable exploration expenditure
Transfer of unused exploration expenditure between group companies
Payments liable to be made
Petroleum Resource Rent Tax
Procuring the carrying on of operations by others

Précis

Outlines the ATO's response to this case on whether various expenditure was 'exploration expenditure' within the meaning of paragraph 37(1)(a) of the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA)

Brief summary of facts

ZZGN (the taxpayer) made a taxable profit in the year ended 30 June 2005 in respect of its participation in a petroleum joint venture within the area of a production licence. This was a petroleum project under the PRRTAA [the Pear Project].

Company A was a participant in a petroleum joint venture in respect of the area of an exploration permit [the Apple Joint Venture] in the years ended 30 June 2002 to 30 June 2005. Company A incurred expenditure, but did not derive a taxable profit, from its participation in the Apple Joint Venture in these years.

ZZGN and Company A were wholly owned subsidiaries of Company B and were 'group companies' in relation to each other, in terms of sections 2B^[1] and 45B, in the year ended 30 June 2005.

For the year ended 30 June 2005, Company A transferred an amount of its unused transferable exploration expenditure to ZZGN under section 45B. The unused transferable exploration expenditure was incurred by Company A in the years ended 30 June 2002 to 30 June 2005 and related to the Apple Joint Venture.

As Company A was a 'loss company' in terms of section 45B it was required by that section to transfer to a group company (which was not a loss company - ZZGN in this case) as much of its unused transferable exploration expenditure as could be transferred in terms of the PRRTAA. Unused transferable exploration expenditure is determined having regard to what is exploration expenditure in terms of section 37.

Later, ZZGN requested that the Commissioner amend its assessment for the year ended 30 June 2005 to reflect a further transfer of unused transferable exploration expenditure from Company A to the Pear Project under section 45B. The additional expenditure was said to have been incurred by Company A in connection with the Apple Joint Venture in the year ended 30 June 2005.

The result of this amendment request and the determination of a subsequent objection was that the Commissioner accepted that only part of the expenditure was able to be transferred under section 45B. He concluded that the balance of the expenditure was not transferrable as it was not incurred by Company A in or in connection with exploration for petroleum for the purposes of paragraph 37(1)(a).

ZZGN applied to the Administrative Appeals Tribunal (Tribunal) for a review of the objection decision.

The expenditure in dispute before the Tribunal was referable to Company A's participation in the Apple Joint Venture and was in three broad categories:

1.

Amounts charged to Company A under the Apple Joint Venture agreement by Company C (the Operator) of the Apple Joint Venture (Company C Billed Expenditure).

2.

Amounts incurred by Company A itself in relation to the Apple Joint Venture (Company A Direct Expenditure).

3.

Amounts charged to Company A by the taxpayer in relation to the Apple Joint Venture (Allocated Expenditure).

The Commissioner accepted at the hearing that if any of the disputed expenditure was found by the Tribunal to be exploration expenditure, it was transferable under section 45B.

Issues Decided by the Tribunal

The central issue to be determined by the Tribunal was what amount (if any) of the disputed expenditure was exploration expenditure in terms of subsection 37(1) [18].

In addressing this issue the Tribunal considered the following questions [19 & 20]:

1.

What is meant by the phrase, in paragraph 37(1)(a), 'payments liable to be made by the person ... in carrying on or providing operations and facilities involved in or in connection with exploration for petroleum in the eligible exploration or recovery area in relation to the project', and

2.

For the disputed Company A Direct Expenditure and Allocated Expenditure, does section 41 apply to deem payments made by Company A to group companies to be a liability incurred by it for the purpose of claiming a deduction, and

3.

Does any of the disputed expenditure constitute exploration expenditure for the purposes of paragraph 37(1)(a)?

Question 1

The Tribunal looked at the construction of section 37, including the meaning of 'exploration' and operations and facilities 'involved in or in connection with' exploration for petroleum in paragraph 37(1)(a). Section 37 was to be considered and interpreted in 'light of the rich legislative history of the section and the statute, to ascertain its purpose' [378].

Meaning of 'exploration' in paragraph 37(1)(a)

The Tribunal considered that the word 'exploration' in its context in the PRRTAA must be read according to its ordinary everyday meaning [312, 314]. 'Exploration' is not to be read 'as a term of art or as having a particular technical meaning' in the context of the PRRTAA [313].

The Tribunal found, as a matter of fact, that in the context of subsection 37(1), the ordinary meaning of 'exploration' contemplates the use of any range of survey techniques to identify prospective oil or gas fields [322]. A number of survey techniques are listed by the Tribunal by way of examples. Any scientific or technical analysis necessarily associated with evaluating the survey results would come within the ordinary meaning of 'exploration' (for example, technical analytical work to evaluate the scale of discoveries [317]). The drilling of appraisal wells to provide a more accurate indication of the potential size and quality of the oil or gas reserves are also included in 'exploration'.

The Tribunal also said that the ordinary meaning of 'exploration' does not include 'feasibility studies of the field for future development and production' [322].

Meaning of operations and facilities 'in connection with' exploration for petroleum

The deductibility of much of the disputed Company C Billed Expenditure depended on the meaning of 'in connection with' exploration [323].

The Tribunal noted that the phrase 'in connection with' is of potentially wide import and those words were intended to expand the activities for which a deduction could be claimed beyond that which is directly 'involved in' exploration [384].

The Tribunal said the relevant 'connection' is a 'matter of judgment requiring a consideration of the subject matter, legislative history and facts of a case' [378]. However, the words 'in connection with' in subsection 37(1) cannot be given such a wide scope that it would allow the provision to apply to all project expenditure incurred up to the time of a final and irrevocable decision to proceed to production as it would run counter to the text, context and purpose of the PRRTAA [389].

The Tribunal concluded that the phrase 'in connection with' in the context of paragraph 37(1)(a) requires that there be 'shown to be a reasonably direct relationship between the 'operations' for which expenditure has been incurred and 'exploration'' [390]. Remote and indirect connections are not sufficient.

Question 2

For the purpose of this question, the Tribunal described the purpose and effect of section 41 [413] and referred to the views expressed by the majority of the Full Court of the Federal Court (Keane CJ and Edmonds J) in Esso Australia Resources Pty Ltd v Federal Commissioner of Taxation (2012) 200 FCR 100 (Esso) on the operation of section 41 [414].

When applying these views the Tribunal noted that the facts it was considering were materially different to those before the Full Federal Court in Esso. For example, most of the service agreements relating to the services in this case were not of the same nature as those in Esso, and invoices were issued in this case.

The Tribunal observed that the Full Court in Esso was 'not seeking to exclude [from potential deductibility] normal commercial arrangements where properly invoiced accounts distinguishing expenditure between projects could be provided' [450].

It seems that the Tribunal accepted that all of the disputed Company A Direct Expenditure and Allocated Expenditure satisfied section 41, and the Tribunal went on to consider if the work done relating to this expenditure was relevantly 'connected with' exploration for the purposes of subsection 37(1) [453, 471 & 472].

Question 3

The Tribunal applied its views outlined at Question 1 to the facts relating to the disputed expenditure and concluded that some of the expenditure was 'in connection with' exploration for petroleum in terms of subsection 37(1) and as a result deductible to the taxpayer as 'transferable exploration expenditure' for section 45B purposes [405, 408, 411, 453].

ATO view of decision

Meaning of 'exploration' and 'in connection with exploration for petroleum'

The Commissioner has incorporated the views of the Tribunal on the ordinary meaning of 'exploration' and the term 'in connection with exploration for petroleum' in paragraph 37(1)(a) into Taxation Ruling TR 2014/9 Petroleum resource rent tax: what does 'involved in or in connection with exploration for petroleum' mean? which issued on 17 December 2014.

Other matters

After the Tribunal handed down its decision, there were substantial amendments to sections 37 and 41 by Tax Laws Amendment (2013 Measures No. 2) Act 2013 (the June 2013 changes).

The Tribunal's views as to the ordinary meaning of 'exploration' and the term 'in connection with exploration for petroleum' in paragraph 37(1)(a) were not affected by these amendments as this part of the provision was not altered by the June 2013 changes.

However, other aspects of sections 37 and 41 were affected by the June 2013 changes. For example, the terms 'payments liable to be made' in section 37^[2] and 'incurred a liability to make a payment' in section 41 are no longer relevant^[3]. The terms that replaced them are 'payments to the extent that they are made' and 'made a payment wholly or partly'.

As a result, the Commissioner considers that the views expressed by the Tribunal in relation to 'payments liable to be made' and 'incurred a liability to make a payment' are no longer relevant when considering provisions that have been changed from that wording to 'payments to the extent that they are made' and 'made a payment wholly or partly'.

There is one aspect of the Tribunal's reasons on which the Commissioner would like to comment specifically. This relates to 'cash calls' under the terms of the Joint Operating Agreement (JOA) for the Apple Joint Venture. The Tribunal noted that [381]:

•

the Commissioner accepted that Company C operated as agent for the Joint Venturers (including Company A) under the JOA

•

Company C contracted liabilities on behalf of or as Agent for the Joint Venturers under the JOA funding obligations

•

the Commissioner accepted, in relation to the Company C Billed Expenditure, that under the JOA the obligation of Company A to pay 'cash advances' under each Authority for Expenditure created a relevant liability for subsection 37(1) purposes.

The Commissioner notes that the last of the above dot points suggests that he accepted that the relevant liability for subsection 37(1) purposes was established by the obligation to pay 'cash advances' in relation to the Company C Billed Expenditure.

The Commissioner has carefully reviewed his submissions and the representations he made to the Tribunal and, with respect, does not believe that he accepted that the relevant section 37(1) liability was, on the facts of this case, established by the obligation to pay cash advances.

The Commissioner has been of the view for some time that where the joint venture arrangements mean that the operator is an agent of the joint venturers in carrying out relevant project activities, then the joint venturer's liability (for a share) arises when the overall liability arises for the operator, and not when a cash call is made or paid. Cash advance or call mechanisms are not relevant where an agency exists.

As a result, the Commissioner would not accept that in an agency situation a payment that discharges an obligation to pay a cash advance is relevant for subsection 37(1) purposes (or other purposes including for sections 38 and 39).

Administrative Treatment

The Commissioner has issued TR 2014/9 in relation to the meaning of exploration for PRRT purposes. The Ruling is consistent with the views of the Tribunal in its decision. The Ruling applies to expenditure incurred from 21 August 2013 (the date of issue of the Draft Taxation Ruling TR 2013/D4 Petroleum resource rent tax: what does 'involved in or in connection with exploration for petroleum' mean?).

Prior to the issue of TR 2013/D4, the Commissioner had an approach, contrary to the views contained in that Draft Taxation Ruling (and TR 2014/9), of accepting that a wider range of feasibility expenditure fell within the meaning of exploration expenditure in section 37 of the PRRTAA.

The Commissioner will communicate to Industry and affected taxpayers how he will apply compliance resources in relation to expenditure incurred on or before 21 August 2013.

Generally, he will not seek to disturb claims for expenditure incurred on or before 21 August 2013 where taxpayers have self-assessed, or will self-assess on a basis consistent with the approach contained in the letter to be provided to affected taxpayers and reproduced below.

Finalisation of Taxation Ruling TR 2014/9 - Petroleum resource rent tax: what does 'involved in or in connection with exploration for petroleum' mean?

On 17 December 2014 the ATO finalised Taxation Ruling TR 2014/9 Petroleum resource rent tax: what does 'involved in or in connection with exploration for petroleum' mean?.

The ruling applies to expenditure incurred from the date of the issue of Draft Taxation Ruling TR 2013/D4, which was 21 August 2013.

You will find the link to TR 2014/9 on www.law.ato.gov.au/index.htm .

The view in the ruling is supported by a decision of the Administrative Appeals Tribunal in ZZGN and Commissioner of Taxation [2013] AATA 351.

Exploration expenditure incurred on or before 21 August 2013

The ATO acknowledges that prior to the issue of TR 2013/D4, the Commissioner had an

approach, contrary to the views contained in TR 2014/9 (and TR 2013/D4), of accepting that a wider range of feasibility expenditure fell within the meaning of exploration expenditure in section 37 of the PRRTAA.

In relation to expenditure incurred on or before 21 August 2013, the ATO will not seek to disturb claims for expenditure (whether the claim is made in either prior or future years)where taxpayers have self-assessed or will self-assess on the basis that exploration for petroleum includes:

•

Expenditure falling within the ordinary meaning of 'exploration for petroleum' which is limited to the discovery and identification of the existence, extent and nature of petroleum. This includes searching in order to discover the resource, as well as the process of ascertaining the size of the discovery and appraising its physical characteristics. Appraisal of the physical extent and nature of a find may be a considerable exercise and can involve recovery of some of the resource in the course of exploration - for example, drilling an appraisal well.

•

Expenditure on operations and facilities 'in connection with' exploration; 'In connection with' ensures the inclusion of expenditure on all operations and facilities which exhibit a reasonably direct relationship (that is, other than one that is remote or indirect) with exploration for petroleum (for example, with the activities of searching for, and identifying, petroleum).

•

Expenditure which is directed at making a full assessment or evaluation of the commercial or economic viability of an entire project to develop a petroleum pool, including how best to develop the pool as part of that assessment or evaluation. This would include a range of feasibility studies (both technical and economic/commercial), and relevant environmental or heritage studies.

•

It would also include expenditure on engineering and design work that is required in order to specify the project to a point where cost and project schedule can be estimated with sufficient definition for project shareholders to assess the economic or commercial feasibility of the project. This is in contrast to detailed engineering and design which is directed to development or construction of the project itself.

The ATO observes that there is no 'bright line' test to the effect that all expenditure incurred before a final decision to develop or mine (often the Final Investment Decision (FID)) is treated as exploration, and there is also no principle that exploration expenditure cannot be incurred after that point.

While, in general, expenditure incurred up to FID will qualify as exploration for petroleum, certain types of development and other expenditure that may be incurred will not be included, such as the following:

•

Early development or early execution costs that anticipate a decision to proceed with the project and which may become regret costs if the project does not ultimately proceed. Early development activities go beyond ascertaining economic or commercial feasibility. Such activities could include detailed development engineering and design work (as opposed to engineering and design work for feasibility) execution planning, preliminary site works, or mobilizing supply bases.

•

The cost of certain project assets that have long-lead times (long-lead assets) which are ordered while commercial feasibility is still being assessed but in anticipation of a decision to proceed. These costs may become regret costs if the project does not proceed.

For taxpayers with assessments for the PRRT tax years ending 30 June 2011, 30 June 2012 and 30 June 2013, we will give you until 2 March 2015 to review your affairs and consider the need to make any amendments to your assessments. For entities who will not have PRRT assessments until future years, the ATO expects you to review your affairs in line with this letter prior to filing your first PRRT return that includes a claim for expenditures covered by this letter.

Risk reviews and audits

Taxpayers whose PRRT affairs are currently being examined will be given the same opportunity to review their affairs and consider the need for any self-assessments.

Implications for impacted ATO precedential documents (Public Rulings & Determinations etc)

On 28 October 2015, the Commissioner withdrew TR 98/23 and replaced it with Taxation Ruling TR 2015/D4 to clarify his view on deductions for mining and petroleum exploration expenditure. While it is anticipated that the views in the replacement ruling will provide a more favourable outcome to taxpayers, a process has been put in place to address situations where taxpayers have applied TR 98/23 in full to arrangements, before its withdrawal, and believe the outcome is more favourable than would otherwise be the case applying the views in the final Ruling.

Implications for impacted Law Administration Practice Statements

None.

Amendment history

Related Rulings/Determinations:

• Taxation Ruling TR 2014/9
• Draft Taxation Ruling TR 2015/D4
• Taxation Ruling TR 98/23 (withdrawn on 28 October 2015 - replaced by TR 2015/D4)

Taxation Ruling TR 2014/9
Draft Taxation Ruling TR 2015/D4
Taxation Ruling TR 98/23 (withdrawn on 28 October 2015 - replaced by TR 2015/D4)

Legislative References:
Customs Act 1901 (Cth)
s 164

Environment Protection and Biodiversity Conservation Act 1999 (Cth)
The Act

Excise Act 1901 (Cth)
s 78A

Excise Tariff Act 1921 (Cth)
The Act

Heritage Conservation Act 1991 (NT)
The Act

Income Tax Assessment Act 1936 (Cth)
s 83
s 122
s 123AA
s 124AH
Division 10
Division 10AA

Income Tax Assessment Act 1946 (Cth)
The Act

Income Tax Assessment Act 1997 (Cth)
s 330-20 of Division 330
s 40-730(4) of Division 40

Northern Territory Environmental Assessment Act 1982 (NT)
The Act

Petroleum (Submerged Lands) Act 1967 (Cth)
s 5
s 19
s 28
s 33
s 39A
s 40

Petroleum (Submerged Lands) Royalty Act 1967 (Cth)
The Act

Petroleum Resource Rent Tax Assessment Act 1987 (Cth) as at 1 April 2002
s 2
s 2B
s 4
s 5
s 19(1)
s 19(4)
s 21
s 22
s 23
s 33
s 34
s 34A
s 35
s 35A
s 37(1)
s 38(a)
s 38(b)
s 41
s 44
s 45A
s 45B

Petroleum Resource Rent Tax Assessment Bill 1986 (Cth)
The Act

Petroleum Resource Rent Tax Assessment Bill 1987 (Cth)
The Act

Petroleum Resource Rent Legislation Amendment Act 1991 (Cth)
The Act

Taxation Administration Act 1953 (Cth)
s 14ZZK

Taxation Laws Amendment Act (No 3) 2003 (Cth)
Schedule 5

Tax Laws Amendment (2013 Measures No. 2) Act 2013
The Act

Case References:
Federal Commissioner of Taxation v Australia and New Zealand Savings Bank Ltd
[1994] HCA 58
94 ATC 4844
(1994) 29 ATR 11
(1994) 181 CLR 466

Berry v Federal Commissioner of Taxation
[1953] HCA 70
(1953) 89 CLR 653
(1953) 10 ATD 262
(1953) 5 AITR 591

Burswood Management Limited v Attorney-General (Cth) and Another
(1990) 23 FCR 144

Claremont Petroleum NL v Cummings
(1992) 110 ALR 239

Collector of Customs v Cliffs Robe River Iron Associates
(1985) 7 FCR 271

Collector of Customs v Pozzolanic Enterprises Pty Ltd
(1993) 43 FCR 280
[1993] FCA 322

Commissioner of Taxation v Ampol Exploration Ltd
(1986) 13 FCR 545
(1986) 18 ATR 102
86 ATC 4859

Customs and Excise Commissioners v Top Ten Promotions Ltd
[1969] 1 WLR 1163

Esso Australia Resources Ltd v Federal Commissioner of Taxation
(1997) 144 ALR 458
(1997) 36 ATR 65
(1997) 97 ATC 4371

Esso Australia Resources Ltd v Federal Commissioner of Taxation
(1998) 84 FCR 541
(1998) 39 ATR 394
98 ATC 4768

Esso Australia Resources Pty Ltd v Federal Commissioner of Taxation
[2012] FCAFC 5
(2012) 200 FCR 100
(2012) 87 ATR 124

Federal Commissioner of Taxation v Broken Hill Pty Co Ltd
(1969) 120 CLR 240
(1969) 1 ATR 40
69 ATC 4028

Federal Commissioner of Taxation v Dalco
[1990] HCA 3
(1990) 168 CLR 614
90 ATC 4088
(1990) 20 ATR 1370

Federal Commissioner of Taxation v Greenhatch
[2012] FCAFC 84
(2012) 203 FCR 134
2012 ATC 20-322
(2012) 88 ATR 560

Hatfield v Health Insurance Commission
(1987) 15 FCR 487
(1987) 77 ALR 103

HP Mercantile Pty Ltd v Commissioner of Taxation
(2005) 143 FCR 553
[2005] FCAFC 126
2005 ATC 4571
(2005) 60 ATR 106

Minister for Immigration and Ethnic Affairs v Pochi
[1980] FCA 85
(1980) 4 ALD 139
(1980) 44 FLR 41

Mitsui & Co (Australia) Ltd v Commissioner of Taxation
[2012] FCAFC 109
2012 ATC 20-341
(2012) 205 FCR 523
(2012) 90 ATR 171

Mount Isa Mines Limited v Federal Commissioner of Taxation
(1954) 92 CLR 483
(1954) 10 ATD 423

Nanaimo Community Hotel Ltd v British Columbia
[1944] 4 DLR 638

NSW Associated Blue-Metal Quarries Ltd v Commissioner of Taxation (Cth)
(1956) 94 CLR 509
(1956) 11 ATD 50

Project Blue Sky Inc v Australian Broadcasting Authority
(1998) 194 CLR 355
[1998] HCA 28

Re BHP Petroleum Pty Ltd and Collector of Customs
(1987) 11 ALD 413

Re Heaney SM Ex Parte Flint v Nexus Minerals NL
(unreported, Supreme Court, FC, WA, Malcolm GJ, Kennedy and Pidgeon JJ, No 1652 of 1996, 26 February 1997)

Re His Honour Warden Calder SM Ex parte Lee
(2007) 34 WAR 289

Re Kirby and Collector of Customs
(1989) 20 ALD 369

Robe River Mining Co Pty Ltd v Commissioner of Taxation
(1989) 21 FCR 1
(1989) 20 ATR 768
89 ATC 4606

Stevens v Kabushiki Kaisha Sony Computer Entertainment
[2005] HCA 58
(2005) 224 CLR 193
(2005) 221 ALR 448

Transfield ER Futures Ltd v The Ship 'Giovanna Iulianao'
[2012] FCA 548

Travelex Ltd v Federal Commissioner of Taxation
(2010) 241 CLR 510
[2010] HCA 33
(2010) 76 ATR 329
2010 ATC 20-214

Tweddle v Federal Commissioner of Taxation
(1942) 180 CLR 1
[1942] HCA 40
(19442) 2 AITR 360
(1942) 7 ATD 186

Visy Packaging Holdings Pty Ltd and Others v Federal Commissioner of Taxation
[2012] FCA 1195
2012 ATC 20-357

Woodside Energy Ltd v Federal Commissioner of Taxation (No 1)
[2006] FCA 1303
(2006) 155 FCR 357
(2006) 64 ATR 379

Woodside Energy Ltd v Federal Commissioner of Taxation (No 2)
[2007] FCA 1961
(2007) 69 ATR 465