Legal database - View: Cases: Re ZZGN and Federal Commissioner of Taxation

ZZGN v Commissioner of Taxation
[2013] AATA 351

The impact of this case on ATO policy is discussed in Decision Impact Statement: ZZGN and Commissioner of Taxation (2010/4354).

(Decision by: President D Kerr, Senior Member C R Walsh)

ZZGN
v.Commissioner of Taxation

Tribunal:

Administrative Appeals Tribunal

President D Kerr
Senior Member C R Walsh

Subject References:
Petroleum Resource Rent Tax
exploration expenditure
exploration expenditure incurred in relation to a petroleum project
payments liable to be made in carrying on or providing 'operations and facilities involved in or in connection with exploration for petroleum'
exploration for petroleum in the eligible exploration or recovery area in relation to the project
permit derived production licence
production licence
general project expenditure
operations and facilities preparatory to the activities
feasibility or environmental study
operations, facilities and other things comprising a petroleum project
petroleum project
carrying forward of undeducted expenditure
excluded expenditure
transferrable expenditure
transfer of unused exploration expenditure between group companies
procuring the carrying on of operations by others
Commissioner's objection decision affirmed in part and set aside in part and remitted to Commissioner for reconsideration in accordance with the Tribunal's reasons for decision and directions

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; Division 330; s 40-730(4); 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) - 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; Schedule, Part 4
Petroleum Resource Rent Tax Assessment Bill 1986 (Cth) -
Petroleum Resource Rent Tax Assessment Bill 1987 (Cth) -
Petroleum Resource Rent Tax Legislation Amendment Act 1991 (Cth) - The Act
Taxation Administration Act 1953 (Cth) - s 14ZZK
Taxation Laws Amendment Act (No 3) 2003 (Cth) - Schedule 5

Case References:
Federal Commissioner of Taxation v. Australia and New Zealand Savings Bank Ltd - (1994) 94 ATC 4844
Berry v. Federal Commissioner of Taxation - (1953) 89 CLR 653
Burswood Management Limited and Others v. Attorney-General (Cth) and Another - (1990) 23 FCR 144
Claremont Petroleum NL v. Cummings & Another - (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
Commissioner of Taxation v. Ampol Exploration Ltd - (1986) 13 FCR 545
Customs and Excise Commissioners v. Top Ten Promotions - [1969] 1 WLR 1163
Esso Australia Resources Ltd v. Federal Commissioner of Taxation - (1997) 144 ALR 458
Esso Australia Resources Ltd v. Federal Commissioner of Taxation - (1998) 84 FCR 541
Esso Australia Resources Pty Ltd v. Federal Commissioner of Taxation - (2012) 200 FCR 100
Federal Commissioner of Taxation v. Broken Hill Pty Co Ltd - (1969) 120 CLR 240
Federal Commissioner of Taxation v. Dalco - (1990) 90 ATC 4088
Federal Commissioner of Taxation v. Greenhatch - (2012) 203 FCR 134
Hatfield v. Health Insurance Commission - (1987) 15 FCR 487
HP Mercantile Pty Ltd v. Commissioner of Taxation - (2005) 143 FCR 553
Minister for Immigration and Ethnic Affairs v. Pochi - (1980) 4 ALD 139
Mitsui & Co (Australia) Ltd v. Commissioner of Taxation - [2012] FCAFC 109
Mount Isa Mines Limited v. Federal Commissioner of Taxation - (1954) 92 CLR 483
Nanaimo Community Hotel Ltd v. British Columbia - [1944] 4 DLR 638
NSW Associated Blue-Metal Quarries Limited v. Federal Commissioner of Taxation - (1956) 94 CLR 509
Project Blue Sky Inc v. Australian Broadcasting Authority - (1998) 194 CLR 355
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 CJ, 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
Stevens v. Kabushiki Kaisha Sony Computer Entertainment and Others - (2005) 224 CLR 193
Transfield ER Futures Ltd v. The Ship "Giovanna Iulianao" - [2012] FCA 548
Travelex Ltd v. Federal Commissioner of Taxation - (2010) 241 CLR 510
Tweddle v. Federal Commissioner of Taxation - (1942) 180 CLR 1
Visy Packaging Holdings Pty Ltd v. Commissioner of Taxation - [2012] FCA 1195
Woodside Energy Ltd v. Federal Commissioner of Taxation (No 1) - (2006) 155 FCR 357
Woodside Energy Ltd v. Federal Commissioner of Taxation (No 2) - [2007] FCA 1961

Other References:
ABARE Research Report No 96.4, Net Economic Benefits from Australia's Oil and Gas Resources, Australian Bureau of Agricultural and Resource Economics, 1996
Commonwealth Government, Discussion Paper on Resource Rent Tax in the Petroleum Sector, December 1983
Commonwealth Government, Effects on Exploration of Resource Rent Tax with Full Exploration Loss Offsets, February 1984
Explanatory Memorandum to the Petroleum Resource Rent Legislation Amendment Bill 1991
Explanatory Memorandum to the Petroleum Resource Rent Tax Assessment Bill 1987
Joint Press Release of the Federal Treasurer and the Minister for Resources and Energy, Future Taxation Arrangements for the Petroleum Sector, 18 April 1984
Joint Statement of the Federal Treasurer and the Minister for Resources and Energy, Resource Rent Tax on "Greenfields" Offshore Petroleum Projects, 27 June 1984
Kemp, A (1997) Petroleum Rent Collection Around the World, The Institute for Research on Public Policy
Mining Industry Advisory Panel of the Secondary Industries Commission Department of Post-war Reconstruction, Second Report (Mining Taxation), 1945
Second Reading of the Petroleum Resource Rent Tax Assessment Bill 1987, Minister for Primary Industries and Energy, 21 October 1987 (House of Representatives, Debates (1987) Vol HR157, pp 1215-1217)
Second Reading Speech of the Petroleum Resource Rent Legislation Amendment Bill 1991, Treasurer, 9 May 1991 (House of Representatives, Debates (1991) Vol HR177, pp 3435-3438)
Taxation Ruling IT 2642 , 27 June 1991
Taxation Ruling TR 98/23 , 16 December 1998

Hearing date: 5-9 November 2012
Decision date: 5 April 2013

Perth

Decision by:
President D Kerr
Senior Member C R Walsh

INTRODUCTION

1. This review application concerns the deductibility of expenditure under the Petroleum Resource Rent Tax Assessment Act 1987 (Cth) (PRRTA Act).

2. The taxpayer seeks a review of the Commissioner's Objection Decision (dated 9 August 2010) which disallowed in part deductions claimed by the taxpayer in its objection (dated 16 June 2008) in respect of expenditure (comprising three broad categories, being "Company C Billed Expenditure", "Company A Direct Expenditure" and "Allocated Expenditure") incurred by Company A (a company related to the taxpayer), in relation to Company A's participation in the "Apple" offshore petroleum joint venture in the area of exploration permit WA-000-P, in the financial years ended 30 June 2002 to 30 June 2005. If the expenditure concerned constituted 'exploration expenditure' for the purposes of s 37 of the PRRTA Act it was required to be transferred from Company A to the taxpayer, pursuant to s 45B of the PRRTA Act, and was deductible against the taxpayer's "assessable receipts" from the "Pear Project", for the purpose of calculating the taxpayer's "taxable profit" under the PRRTA Act for the 2005 year.

BACKGROUND TO APPLICATION

3. In the tax years ended 30 June 2002 to 30 June 2005, Company A incurred certain expenditure (but did not derive a taxable profit) in relation to its participation in the "Apple Joint Venture".

4. The expenditure referrable to Company A's participation in the Apple Joint Venture comprised the following three broad categories:

(i): Company C Billed Expenditure totalling $20,032,874, being amounts charged by Company C, as "Operator" of the Apple Joint Venture, to Company A pursuant to a joint venture agreement between the joint venture participants (Company C Billed Expenditure);
(ii): Company A Direct Expenditure totalling $1,258,175, being amounts incurred by Company A itself in connection with the Apple Joint Venture (Company A Direct Expenditure); and
(iii): Allocated Expenditure totalling $1,184,830, being amounts charged by the taxpayer to Company A (and other related entities of Company A) in connection with the Apple Joint Venture (Allocated Expenditure).

5. In the tax year ended 30 June 2005, the taxpayer derived a taxable profit in relation to its participation in the "Pear Project", being a 'petroleum project' for the purposes of the PRRTA Act. In its Petroleum Resource Rent Tax Return for the tax year ended 30 June 2005 (dated 11 August 2005) (2005 PRRT Return), the taxpayer calculated its taxable profit to be $208,233,196, including by deducting from its assessable receipts an amount of $18,877,719 (augmented) of unused transferable 'exploration expenditure' incurred by Company A in relation to the Apple Joint Venture in the tax years ended 30 June 2002 to 30 June 2005, and transferred to the taxpayer, in relation to the Pear Project, pursuant to s 45B of the PRRTA Act (Original Transfer Amount).

6. The taxpayer subsequently amended the Original Transfer Amount on 28 September 2006 to $18,438,286 (augmented) and on 16 June 2008 to $18,049,826 (augmented).

7. By notice of assessment dated 26 August 2005, the Commissioner assessed the taxpayer's taxable profit in respect of the Pear Project for the tax year ended 30 June 2005 to be $208,233,196, which amount was calculated by deducting the Original Transfer Amount, in accordance with the taxpayer's 2005 PRRT Return (Original Assessment).

8. On 12 June 2006, the taxpayer requested that the Commissioner amend the Original Assessment by transferring from Company A to the taxpayer, pursuant to s 45B of the PRRTA Act, additional expenditure of $27,579,887 (unaugmented) which it alleged was incurred by Company A in connection with the Apple Joint Venture in the 2005 year, in relation to the Pear Project. The additional expenditure claimed by the taxpayer was subsequently amended to $27,569,742 (unaugmented) or $31,893,425 (augmented).

9. In the period 12 June 2006 to 16 October 2007 the taxpayer provided the Commissioner, at his request, with further information relating to the nature of the additional expenditure sought to be transferred.

10. On 23 April 2008 the Commissioner issued the taxpayer with a notice of amended assessment which assessed the taxpayer's taxable profit in respect of the Pear Project for the tax year ended 30 June 2005 to be $202,125,538 (Amended Assessment). In calculating the Amended Assessment, the Commissioner:

(i): allowed an additional $4,616,829 (unaugmented) or $6,107,658 (augmented) of unused transferable 'exploration expenditure', incurred by Company A in connection with the Apple Joint Venture, to be transferred to the taxpayer (in relation to the Pear Project) pursuant to s 45B of the PRRTA Act; and
(ii): disallowed the remainder of the additional expenditure claimed by the taxpayer.

11. On 16 June 2008, the taxpayer lodged an objection to the Amended Assessment with the Commissioner claiming that the assessment of its taxable profit should be further reduced by allowing an increase in the amount of unused transferable 'exploration expenditure' to be transferred from Company A to the taxpayer in relation to the Pear Project pursuant to s 45B of the PRRTA Act (the taxpayer's Objection). The additional amount of unused transferable 'exploration expenditure' (comprising Company C Billed Expenditure, Company A Direct Expenditure and Allocated Expenditure) claimed by the taxpayer in its objection was $22,952,913 (unaugmented) and $23,949,815 (augmented).

12. On 9 August 2010, the Commissioner determined the taxpayer's Objection by:

(i): allowing an additional amount of $477,033 (unaugmented) or $493,438 (augmented) of unused transferable 'exploration expenditure' to be transferred from Company A to the taxpayer in relation to the Pear Project; and
(ii): disallowing the balance of expenditure claimed, on the ground it was not expenditure incurred by Company A in or in connection with exploration for petroleum for the purposes of s 37(1)(a) of the PRRTA Act (Objection Decision).

13. In relation to the Company C Billed Expenditure, the Objection Decision provides that the expenses not permitted by the Commissioner to be transferred from Company A to the taxpayer (pursuant to s 45B of the PRRTA Act) were amounts described as:

•: Sub-surface engineering expenses;
•: Banana Pipeline expenses;
•: Project facilitation expenses;
•: Commercial expenses;
•: Project management expenses;
•: Well engineering expenses;
•: Environmental expenses;
•: Upstream project expenses;
•: Survey expenses;
•: Authority for Expenditure (AFE) Apple development expenses (a small amount of these expenses were allowed: see p 77 of Attachment C to the Objection Decision at [12]);
•: Project services and assurance expenses;
•: Upstream facilities engineering expenses (a small amount of these expenses were allowed: see p 78 of Attachment C to the Objection Decision at [15]); and
•: Onshore gas pipeline expenses.

14. In relation to the Company A Direct Expenditure and the Allocated Expenditure, the Objection Decision provides that the expenses not permitted to be transferred by the Commissioner from Company A to the taxpayer (pursuant to s 45B of the PRRTA Act) were amounts described as:

•: Head office other service expenses;
•: Well control insurance expenses;
•: General permit activity expenses; and
•: Business development and commercial cost expenses (some of these expenses were allowed).

15. On 8 October 2010 the taxpayer applied to the Tribunal for a review of the Objection Decision on the basis that "[t]he decision is wrong as a matter of fact and a matter of law."

16. Counsel for the Commissioner informed the Tribunal that the Commissioner conceded that the sub-category of Company C Billed Expenditure referred to as 'sub-surface engineering' (as identified in Mr A's witness statement dated 24 October 2011 - paras 148(a)(i) and (b) to (f), 153-155, 215(a), 254, and 328-339) constituted activities which were 'in connection with exploration' and thus 'exploration expenditure' for the purposes of s 37(1) of the PRRTA Act. Those items were no longer in dispute. All other categories of Company C Billed Expenditure (above at [13]) and Company A Direct Expenditure and Allocated Expenditure (above at [14]) remained in dispute.

17. Also at the hearing of this application, the parties informed the Tribunal that they did not expect the Tribunal to reach a decision concerning the quantum of each category of disputed expenditure, merely that they wanted the Tribunal to determine the characterisation of each category of disputed expenditure as falling within s 37 of the PRRTA Act or not, as the case may be. The Tribunal is indebted to the parties for their willingness to co-operate in resolving the consequential calculations and has proceeded in the hearing of this application, and in preparing its Reasons for Decision, on that basis. The Tribunal observes that a similar approach was adopted, almost 60 years ago, by the parties before the High Court in Mount Isa Mines Limited v Federal Commissioner of Taxation (1954) 92 CLR 483 where Taylor J commented (at 485):

...it was apparent at an early stage of the proceedings that further evidence might well be necessary after consideration of the questions of principle involved before attempting to deal specifically with the items of expenditure. In these circumstances I was invited by the parties to deal with the broad questions which the appeal raises leaving the parties, thereafter, to agree as far as possible upon an appropriate allocation of the various items and, to the extent that the parties should fail to agree, to reserve the matter for further consideration.

ISSUES

18. The central issue for determination by the Tribunal is whether all (or some) of the disputed Company C Billed Expenditure, Company A Direct Expenditure and Allocated Expenditure, incurred by Company A in relation to its participation in the Apple Joint Venture in the 2002 to 2005 years, which the Commissioner has not permitted to be transferred from Company A to the taxpayer (to be deducted by it against the income of the Pear Project), was 'exploration expenditure' within the meaning of s 37(1) of the PRRTA Act.

19. The taxpayer's review application therefore concerns both the correct construction of s 37 of the PRRTA Act and the characterisation of the disputed expenditure (as being 'exploration expenditure' or not) and gives rise to the following questions:

(i): what is meant by the phrase "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" in s 37(1)(a) of the PRRTA Act; and
(ii): does any of the disputed expenditure constitute 'exploration expenditure' for the purposes of s 37(1)(a) of the PRRTA Act?

20. In relation to the two smaller categories of disputed expenditure, namely the Company A Direct Expenditure and the Allocated Expenditure, the Tribunal must also determine whether s 41 of the PRRTA Act applies so as to permit Company A to deem payments made by it to group companies as a liability incurred by it for the purpose of claiming a deduction. This issue arises since, as discussed below, these categories of expenditure were not incurred directly by Company A.

BURDEN OF PROOF

21. By virtue of s 14ZZK of the Taxation Administration Act 1953 (Cth), the taxpayer bears the burden of proving that the Amended Assessment is excessive: Federal Commissioner of Taxation v Dalco (1990) 90 ATC 4088 and Federal Commissioner of Taxation v Australia and New Zealand Savings Bank Ltd (1994) 94 ATC 4844. This means that the taxpayer must prove to the Tribunal, on the balance of probabilities, that all (or some) of the disputed expenditure is 'exploration expenditure' for the purposes of s 37 of the PRRTA Act: Minister for Immigration and Ethnic Affairs v Pochi (1980) 4 ALD 139 and Re Kirby and Collector of Customs (1989) 20 ALD 369.

22. In so far as any of the disputed expenditure is found by the Tribunal to constitute 'exploration expenditure', the Commissioner accepts that it is transferrable pursuant to s 45B of the PRRTA Act.

RELEVANT LAW

Statutory framework

23. Section 4 of the PRRTA Act imposes a tax "in respect of the taxable profit of a person of a year of tax in relation to a petroleum project". Section 5 of the PRRTA Act provides that the rate of petroleum resource rent tax (PRRT) is 40%.

24. The PRRTA Act (which is divided into ten Parts) establishes the statutory regime for the assessment and collection of the PRRT imposed by the PRRTA Act.

25. Part V of the PRRTA Act deals with Liability to Taxation . The following relevant divisions appear in that Part:

•: Division 1 Liability to tax on taxable profit (comprising ss 21 and 22) creates the liability to pay PRRT;
•: Division 2 Assessable receipts (comprising ss 23 to 31A) sets out the criteria for determining what is an assessable receipt; and
•: Division 3 Deductible expenditure (comprising ss 31B to 45) outlines the criteria for determining what expenditure is deductible.

26. Section 22 of the PRRTA Act (Pt V Div1) provides that tax imposed in respect of the "taxable profit of a person of a year of tax in relation to a petroleum project is payable by that person". The phrase 'taxable profit' is defined in s 22 as follows:

Where, in relation to a petroleum project and a year of tax, the assessable receipts derived by a person exceed the sum of:

(a)
the deductible expenditure incurred by the person; and

...

(c)
the total amounts (if any) transferred by another person to the person in relation to the project and the year of tax under section 45B;

the person is taken for the purposes of this Act to have a taxable profit in relation to the project and the year of tax of an amount equal to the excess.

27. Section 23 of the PRRTA Act (Pt V Div2) provides that a taxpayer's 'assessable receipts' in relation to a petroleum project may be of five kinds: assessable petroleum receipts, assessable exploration recovery receipts, assessable property receipts, assessable miscellaneous compensation receipts and assessable employee amenities receipts.

28. There are several categories of 'deductible expenditure' (Pt V Div3), including class 1 and class 2 'augmented bond rate general expenditure' (ss 33 and 34A, which provisions, in turn, refer to 'general project expenditure') and class 1 and class 2 'augmented bond rate exploration expenditure' (ss 34 and 35A).

29. What is meant by 'exploration expenditure' and 'general project expenditure' for the purposes of the PRRTA Act is considered in turn below.

Exploration expenditure (section 37)

30. 'Exploration expenditure' is defined in s 37(1) of the PRRTA Act (as at 1 April 2002) as follows:

37 Exploration expenditure

(1)
For the purposes of this Act, a reference to exploration expenditure incurred by a person in relation to a petroleum project is a reference to payments (not being excluded expenditure ), whether of a capital or revenue nature, liable to be made by the person in carrying on or providing :

(a)
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

(b)
such of the following as are or have been carried on or provided:

(i)
operations and facilities involved in the recovery of any petroleum from the eligible exploration or recovery area (other than any production licence area) in relation to the project;

(ii)
operations and facilities involved in moving any petroleum so recovered to or between any storage or processing facilities prior to the production of any marketable petroleum commodity from the petroleum;

(iii)
operations and facilities involved in the storage, processing or treating of any petroleum so recovered to produce any marketable petroleum commodity from the petroleum;

(iv)
operations and facilities involved in the moving or storage of any such marketable petroleum commodity before it becomes an excluded commodity;

(v)
services, or facilities for the provision of services, in connection with the operations, facilities, amenities and services referred to in this section;

(vi)
employee amenities in connection with the operations, facilities and services referred to in this section;

and includes any exploration permit, retention lease or other fee (not being an excluded fee) liable to be paid by the person in relation to the carrying on or providing of any operations, facilities or other things referred to in this section. [Emphasis added]

31. The definition of 'exploration expenditure' was amended with effect from 14 October 2003 by Sch 5 of the Taxation Laws Amendment Act (No 3) 2003 (Cth). However, it was common ground, and the Tribunal accepts, that those amendments are not relevant and that s 37 of the PRRTA Act (as set out above) is the relevant provision for the purposes of this application.

32. Section 37 of the PRRTA Act contains a number of terms that are further defined elsewhere within the Act. The phrase 'exploration for petroleum in the eligible exploration or recovery area in relation to the project', as it appears in s 37(1), is defined in s 5(2) of the PRRTA Act, as follows:

For the purposes of this Act, a reference to exploration for petroleum in , or recovery of petroleum from, the eligible exploration or recovery area in relation to a petroleum project is a reference to exploration for petroleum in, or recovery of petroleum from:

(a)
where the production licence or any production licence in relation to the project is a permit derived production licence - the exploration permit area in relation to the exploration permit to which the production licence is related (being exploration or recovery occurring either before or after the production licence came into force but not after marketable petroleum commodities cease, otherwise than temporarily, to be produced in relation to the project) ...

33. Section 5(1) of the PRRTA Act provides that for the purposes of the Act a reference to:

...exploration for petroleum in, or recovery of petroleum from, ... an exploration permit area ... is a reference to exploration for petroleum in, or recovery of petroleum from, ... the exploration permit area ... while the ... exploration permit ... concerned is or was in force.

34. A 'permit derived production licence' is defined in s 2 of the PRRTA Act to mean "a production licence that is derived from an exploration permit".

35. Section 4(2) of the PRRTA Act provides:

For the purposes of this Act:

(a)
a production licence is derived from an exploration permit if the licence is related to the permit because of subparagraph (1)(a)(i); ...

36. Section 4(1)(a)(i) of the PRRTA Act states:

...a production licence shall be taken to be related to an exploration permit if:

(i)
because of the grant of the production licence, the exploration permit ceased to be in force in respect of the block or blocks in respect of which the production licence was granted.

37. An 'exploration permit area' is defined in s 2 of the PRRTA Act as "a permit area within the meaning of the Petroleum (Submerged Lands) Act 1967 ".

38. Section 5 of the Petroleum (Submerged Lands) Act 1967 (PSLA) defines "permit area" to mean the area constituted by the 'graticular blocks' (as defined in the PSLA) that are the subject of an exploration permit.

General project expenditure (section 38)

39. 'General project expenditure' is defined in s 38 of the PRRTA Act (as at 1 April 2002) as follows:

38 General project expenditure

For the purposes of this Act, a reference to general project expenditure incurred by a person in relation to a petroleum project is a reference to payments (not being excluded expenditure, exploration expenditure or closing-down expenditure), whether of a capital or revenue nature, liable to be made by the person :

(a)
in carrying on or providing operations and facilities preparatory to the activities referred to in paragraph (b), including in carrying out any feasibility or environmental study; and

(b)
in carrying on or providing the operations, facilities and other things comprising the project;

and includes any production licence or other fee (not being an excluded fee) liable to be paid by the person in relation to the carrying on or providing of any operations, facilities or other things referred to in this section. [Emphasis added]

40. In 2003 amendments were made to the definition of 'general project expenditure', similar to those made to the definition of 'exploration expenditure'. However, it is common ground, and the Tribunal accepts, that s 38 (as set out above), is the relevant provision for present purposes.

41. The meaning of the expression in s 38 of the PRRTA Act 'the operations, facilities and other things comprising the project' is defined by s 19(4) of the PRRTA Act (as in force at the relevant time) as follows:

For the purposes of this Act, reference to the operations, facilities and other things comprising a petroleum project is a reference to:

(a)
operations and facilities for the recovery of petroleum from the production licence area or production licence areas in relation to the project; and

(b)
such of the following as are carried on or provided:

(i)
operations and facilities involved in moving petroleum so recovered between any storage or processing facilities prior to the production of any marketable petroleum commodity from the petroleum;

(ii)
operations and facilities involved in the storage, processing or treatment of petroleum so recovered to produce any marketable petroleum commodity from the petroleum;

(iii)
operations and facilities involved in the moving or storage of any such marketable petroleum commodity before it becomes an excluded commodity;

(iv)
services, or facilities for the provision of services, in connection with the operations, facilities, amenities and services referred to in this section;

(v)
employee amenities in connection with the operations, facilities and services referred to in this section.

Petroleum project (section 19)

42. 'Petroleum project' is defined in s 19 of the PRRTA Act (for the purposes of ss 37 and 38 of the PRRTA Act) in part, as follows:

(1): ...for the purposes of this Act, where a production licence is in force and not specified in a project combination certificate that is in force, there shall be taken to be a petroleum project in relation to the eligible production licence.

43. An 'eligible production licence' is defined in s 2 of the PRRTA Act as meaning a "production licence other than a production licence that is related to one of the North West Shelf exploration permits". A 'production licence' is defined in s 2 as meaning "a production licence for petroleum under Part III" of the PSLA.

44. Section 19(4) of the PRRTA Act provides that for the purposes of the Act a reference to the 'operations, facilities and other things comprising a petroleum project' is a reference to:

(a): operations and facilities for the recovery of petroleum from the production licence areas in relation to the provided; and
(b): such of the following as are carried on or provided:; ...

Excluded expenditure (section 44)

45. What constitutes 'excluded expenditure', for the purposes of ss 37(1) and 38 of the PRRTA Act (as in force at the relevant time), is set out in s 44, as follows:

44 Excluded expenditure

For the purposes of this Act, a reference to excluded expenditure is a reference to:

(a)
payments of principal or interest on a loan or other borrowing costs; or

(b)
interest components of hire-purchase payments; or

(c)
payments of dividends or the cost of issuing shares; or

(d)
the repayment of equity capital; or

(e)
payments of a kind known as private override royalty payments; or

(f)
payments to acquire, or to acquire an interest in, an exploration permit, retention lease, production licence, pipeline licence or access authority, otherwise than in respect of the grant of the permit, lease, licence or authority; or

(g)
payments to acquire interests in petroleum project profits, receipts or expenditures; or

(h)
payments of tax under the Income Tax Assessment Act 1936 or the Income Tax Assessment Act 1997 or the Fringe Benefits Tax Assessment Act 1986 ; or

(i)
payments of GST under the GST Act; or

(j)
payments of administrative or accounting costs, or of wages, salary or other work costs, incurred indirectly in carrying on or providing operations , facilities or other things of a kind referred to in sections 37 , 38 and 39; or

(k)
payments in respect of land or buildings for use in connection with administrative or accounting activities in respect of the carrying on or provision of other operations, facilities or things of a kind referred to in sections 37, 38 and 39, not being land or buildings located at or adjacent to the site or sites at which those other operations, facilities or things are carried on or provided. [Emphasis added]

Carrying forward undeducted expenditure (sections 33 to 35)

46. Under the PRRTA Act, the opportunity to carry forward and compound undeducted expenditure exists in relation to both 'exploration expenditure' and 'general project expenditure'. That is:

•: Section 34 ( Class 1 augmented bond rate exploration expenditure ) and s 35 of the PRRTA Act ( Class 1 GDP factor expenditure ) provide for the carrying forward of 'exploration expenditure' incurred up to 5 years before the grant of a production licence: see ss 34(1)(a) and 35(1)(a) of the PRRTA Act;
•: Section 33 ( Class 1 augmented bond rate general expenditure ) covers the incurrence and carrying forward of 'general project expenditure' for up to 5 years before the grant of a production licence: see s 33(1)(a) of the PRRTA Act; and
•: Section 35 ( Class 1 GDP factor expenditure ) addresses the carrying forward of 'general project expenditure' incurred 'more than 5 years before the production licence in relation to the project came into force': see s 35(1)(a) of the PRRTA Act.

47. Different compounding rates apply in relation to the above classes of expenditure.

Transferable exploration expenditure (section 45B)

48. Part V Div3A of the PRRTA Act contains provisions relating to the transfer of 'exploration expenditure' incurred by a person on or after 1 July 1990.

49. Section 45B ( Transfer of expenditure - group companies ) requires the transfer within a group of companies of expenditure that is, in accordance with the Schedule to the PRRTA Act, transferable by the person in relation to the financial year and has not already been transferred under s 45A of the PRRTA Act.

50. That applies where, in relation to a particular financial year, a company within a group of companies has 'unused transferable exploration expenditure': s 45B(1) of the PRRTA Act. Such a company is referred to in the section as a 'loss company'.

51. The expression 'unused transferable exploration expenditure' is defined in s 45B(6) of the PRRTA Act to mean "in relation to a company and a financial year ... so much of the transferable exploration expenditure in relation to the company and the financial year as is not transferred, or to be transferred, under s 45A".

52. The term 'transferable exploration expenditure' is defined in s 2 of the PRRTA Act to mean "in relation to a person and a financial year, expenditure that is, according to the Schedule, transferable by the person in relation to the financial year".

53. Section 45B(2) of the PRRTA Act then provides:

In relation to the financial year, each loss company must transfer , to such of the other companies as are not loss companies and in relation to specified petroleum projects, as much of the loss company's unused transferable exploration expenditure as can be transferred in accordance with the rules set out in Part 6 of the Schedule . [Emphasis added]

54. The transfer must be made within 42 days of the end of the financial year or such longer time as the Commissioner allows and s 45B(5) states that a contravention of the obligation to transfer, that is cast by the section, attracts a fine not exceeding $2,000.

55. The Schedule Pt 4 to the PRRTA Act is Transferable exploration expenditure not incurred in relation to a project and cl 13(1) states that Part 4:

(1)...deals with the calculation of the amount of expenditure incurred by a person in relation to an exploration permit or retention lease that is transferable from the permit or lease in relation to a financial year.

56. Part 4 does not apply if the production licence derived from the relevant exploration permit (or retention lease) was actually in force in the relevant year (Sch Pt 4 cl 13(2)).

57. The effect of cl 14 (Sch Pt 4) Assumptions on which amounts to be worked out , is to require the assumption to be made that a production licence derived from the relevant exploration permit or retention lease was in force at all times during the relevant financial year and that the petroleum project to which that (assumed) production licence related consisted only of that production licence. This (assumed) petroleum project is referred to in Sch Pt 4 as the 'notional project'. In this way, s 37 (which explains what is meant by references in the PRRTA Act to 'exploration expenditure incurred by a person in relation to a petroleum project') is engaged. That is, the petroleum project in question is the 'notional project' created by Sch Pt 4 cl 14 of the PRRTA Act.

58. Clauses 15 to 18 of Pt 4 then prescribe what expenditure is transferrable. The provisions contemplate the transfer of 'exploration expenditure' to the extent that the 'exploration expenditure' exceeds assessable receipts: see Sch Pt 4 cls 16 and 18(1).

59. Expenditure which represents 'general project expenditure' under s 38 of the PRRTA Act, rather than 'exploration expenditure' under s 37 of the Act, cannot be transferred between group companies under s 45B since s 45B refers only to 'transferable exploration expenditure'.

60. Part V Div3A and the Schedule to the PRRTA Act were introduced with effect from 1 July 1990, along with a suite of further amendments to require the transfer of exploration expenditure between exploration interests and projects under common ownership and between exploration interests and projects owned by related corporations.

61. As will become evident from the Tribunal's detailed discussion of the history of the PRRTA Act (see Relevant Extrinsic Materials below), the Act, as originally enacted, did not contemplate transfers of expenditure between projects or between related corporations except where more than one production licence was derived from a single exploration permit.

RELEVANT BACKGROUND FACTS

62. In the tax year ended 30 June 2005, Company A (a company incorporated pursuant to the laws of the Netherlands) was a 'group company' in relation to the taxpayer for the purposes of ss 2B and 45B of the PRRTA Act, as both companies were and are wholly owned subsidiaries of Company AA (a company incorporated pursuant to the laws of the Netherlands), which, in turn, is a wholly owned subsidiary of Company B (a company incorporated pursuant to the laws of Italy).

63. The taxpayer was at all relevant times a participant in, and the Operator of, a petroleum joint venture project carried on between the taxpayer (as to 65%), Company D Pty Limited (as to 20%) and Company L Pty Ltd (as to 15%) in respect of the area of Production Licence WA-00-L issued pursuant to the PSLA. The area is offshore from Mango Island, Western Australia, and contains a petroleum field known as the "Pear field" (Pear Project).

64. In the years of tax ended 30 June 2002 to 30 June 2005, Company A was a participant in a joint venture between Company A, Company C (as Operator) and, for part of that period, Company E Pty Ltd (in respect of the area of exploration permit WA-000-P. This located in Southern Plum Basin (in the Agave Sea) approximately 100km west of Lemon point, Western Australia, and contains a gas field known as the "Apple field".

65. On 19 August 1998 the Commonwealth-Western Australian Offshore Petroleum Joint Authority (Joint Authority) had granted Company E and Company C a six year "Exploration Permit for Petroleum No WA-000-P" pursuant to the PSLA (Exploration Permit WA-000-P).

66. On 31 August 1999, Company E and Company C entered into "WA-000-P Farmin Agreement" in relation to Exploration Permit WA-000-P (Original Farmin Agreement). The Original Farmin Agreement provided, among other things, that Company E (the Farmor) and Company C (the Farminee) held participating interests in Exploration Permit WA-000-P, as at the date of the Original Farmin Agreement, of 50% each.

67. On 4 January 2000, the Original Farmin Agreement was registered with the Department of Minerals and Energy, Petroleum Operations Division, with Company E's participating interest in Exploration Permit WA-000-P reduced to 35% and Company C's participating interest increased to 65%.

68. On 29 June 2000, Company C and Company E executed a "WA-000-P Joint Operating Agreement" (JOA) which was agreed to take effect from the date of the grant of Exploration Permit WA-000-P (being 19 August 1998). The JOA states that Company C and Company E entered into the JOA to create a joint venture "for the purpose of exploring for Petroleum and, if appropriate, appraising, developing or otherwise exploiting Discoveries within the Title Area" (being the area described in Exploration Permit WA-000-P), to appoint Company C as Operator of the joint venture and to define their respective rights and obligations regarding operations (Apple Joint Venture). The key features of the JOA are dealt with separately below ([92] to [108]).

69. By letter dated 10 April 2001 and email sent 1 May 2001, Company C and Company A agreed the terms upon which Company A would 'farmin' to Exploration Permit WA-000-P.

70. On 18 July 2001, Company C, Company A and Company E executed a "Farmin Agreement WA-000-P" (Farmin Agreement) to record their understanding of the basis upon which Company A would 'farmin' to Exploration Permit WA-000-P (as previously agreed by letter and email). Pursuant to that agreement Company A would obtain a 30% interest in the Apple Joint Venture from Company C and agreed to become a party to the JOA.

71. From July 2001 the joint venturers in the Apple Joint Venture were Company C (as Operator under the JOA) as to 35%, Company E as to 35% and Company A as to 30%.

72. By "Deed of Assignment and Assumption" (dated 3 October 2001), between Company C, Company A and Company E, Company A's acquisition of a 30% interest in the Apple Joint Venture (as contemplated by the Farmin Agreement) was effected. The "Assignment Date" under that deed was 24 July 2001.

73. In about August 2001 the first 'wildcat' exploration well ("Apple-1"), located in the area of Exploration Permit WA-000-P, was drilled and the presence of hydrocarbons ('dry gas') was detected.

74. Pursuant to a "Sale and Purchase Agreement - Plum Basin assets" (dated 17 February 2003) between Company E and Company C, Company C then acquired Company E's 35% interest in the Apple Joint Venture. To effect this acquisition, Company E, Company C and Company A executed a deed titled "Transfer of Title Under Section 78 of the Petroleum (Submerged Lands) Act 1967" (dated 5 March 2003) and a "Deed of Assignment and Assumption" (dated 5 March 2003) with an "Assignment Date" of 1 January 2003.

75. On 6 March 2003 Company C and Company A entered into a non-binding "Option Agreement - Letter of Intent" (LOI) granting Company A an option over 16.15% of its interest in exploration permit WA-000-P (which, if exercised, was to be effective from 1 January 2003). The LOI contemplated that the parties would enter into a preliminary "Sales and Purchase Agreement" based on the terms set out in the LOI.

76. Pursuant to a "Sale and Purchase Agreement - Plum Basin Assets" (dated 1 May 2003) between Company C and Company A, Company A exercised its option and acquired an additional 16.15% interest in the Apple Joint Venture effective 1 January 2003. Thus, during the period from 1 January 2003 to 1 December 2005 (when Company A interest in the Apple Joint Venture became 100%), Company A held a 46.15% interest in the Apple Joint Venture.

77. On 6 June 2003, Company C and Company A (the "Sellers") and Company F, for and on behalf of Company I Australia Limited and Company J Australia Limited (the "Buyers"), entered into a Heads of Agreement (HOA), as had been contemplated by the LOI.

78. In September 2003 Company C and Company A applied to the Western Australian Department of Industry and Resources for a "Declaration of a Location" (Location Declaration) covering four graticular blocks (Block Numbers 1614, 1615, 1686 and 1687) of the Darwin Map Sheet area in relation to Apple Field Location No 1ISL/100/100. The Location Declaration was granted to Company C and Company A on 22 December 2003 (and declared in the Government Gazette on 2 January 2004).

79. On 5 November 2004, Company A and Company C entered into a "Gas Sales Agreement" (Company F Gas Sales Agreement) with Company H Pty Ltd. The Company F Gas Sales Agreement was conditional upon a "Final Investment Decision" (FID) being made by the joint venturers on or before 31 May 2005. However, due to increasing costs, the gas sales price under the Company F Gas Sales Agreement proved not to be, in the opinion of the Apple Joint Venture, economically or commercially viable and the parties' attempts to renegotiate the gas sales price were unsuccessful.

80. As at 31 May 2005, no FID had been made by the Apple Joint Venture participants and the Company F Gas Sales Agreement was terminated in June 2005.

81. On 18 August 2005 Company C applied to the Western Australian Department of Industry and Resources for the relinquishment and partial renewal of the Apple exploration permit WA-000-P for the reason that Company C and Company A were "keen to continue exploring within WA-000-P, and to renew the permit" and to "upgrade [their] proposed work programme, despite the adverse change in commercial circumstances around WA-000-P."

82. On 1 December 2005, pursuant to a "Sale and Purchase Agreement - Apple Assets" Company A acquired Company C's 53.85% interest in the Apple Exploration Permit such that, from that date, Company A became the sole owner of the Apple exploration permit WA-000-P.

83. On 6 December 2005, Company A applied to the Western Australian Department of Industry and Resources for an extension of time in which to apply for a production licence or retention lease over Location ISL/100-100 (Apple) within Exploration Permit WA-000-P. This was on the basis that:

During 2005 it was expected that a Production Licence application would be submitted for the development of Apple to supply gas under a Gas Sales Agreement (GSA) to Company F in Orange cove, Northern Territory. In June 2005 Company F terminated the GSA and consequently a Production Licence application was not made.

[Company A] is currently negotiating for the sale of Apple gas to another substantial customer, but it is not in a position to submit a Production Licence application prior to expiry of the Location on 1 January 2006.

84. On 22 December 2005, the Western Australian Department of Industry and Resources advised Company A that the application period in which for it to apply for a production licence or retention lease had been extended a further two years until 1 January 2008.

85. In June 2006 Company A requested a renewal of exploration permit WA-000-P "for a guaranteed three year period and an optional two year extension".

86. On 1 June 2006, Company A entered into a "Gas Sales Agreement" (Company K Gas Sales Agreement) with Company K for a term of 25 years and conditional upon a FID being made by Company A on or before 30 June 2006.

87. On 23 June 2006, Company A made a FID to proceed with the development of the Apple Project and the Company K Gas Sales Agreement became unconditional.

88. On 17 July 2007, production licence WA-01-L was issued to Company A in respect of the area covered by Apple exploration permit WA-000-P.

89. On 14 September 2009, production on the Apple Project commenced. It is common ground that this project was a different project than that which had been originally envisaged by Company C, Company E and Company A.

RELEVANT EVIDENCE

The taxpayer's evidence

90. The taxpayer relied on the evidence (witness statement and testimony) of:

(i)

Mr A - Mr A is an engineer with over 25 years of experience in the oil and gas industry. His witness statement was dated 24 October 2011. He was a member of Company A's team responsible for appraisal and evaluation of the Apple discovery between 2001 and 2006. In summary, Mr A's evidence explained:

•: the multi-staged decision making process that Company C, as Operator and agent for the joint venturers, followed and the work undertaken in the course of that process, it had required before any decision could be made to proceed with production of gas from the offshore gas project;
•: his recollection of the work performed by the joint venturers in relation to the Apple Joint Venture and which gave rise to the disputed expenditure in this case; and
•: his recollection of the means by which Company A was required to pay for its share of the work involved in the Apple Joint Venture.

The Tribunal accepts the evidence of Mr A. It was given by him based on his own knowledge and extensive experience working in the mining industry and, in particular, the oil and gas industry. The Tribunal finds no reason to question the credibility of Mr A's evidence.

(ii)

Ms B - Ms B is the taxpayer's Senior Tax Adviser. She filed two witness statements, dated 24 October 2011 and 29 March 2012. Ms B explained:

•: how payments were made by Company A to Company C's bank account following "cash calls" made by Company C;
•: the Company A Direct Expenditure and certain adjustments to the amounts claimed; and
•: the concept of "time writing" which is a process commonly used by companies operating in the oil and gas industry to allocate staff costs to particular projects.

Although not employed by the taxpayer in the relevant income years, the Tribunal finds no reason to question the credibility of the evidence provided by Ms B which was based on her current knowledge, as the taxpayer's Senior Tax Advisor, of the taxpayer's accounting systems and procedures (which she testified were substantially the same in the years in question) and her review of the 2005 PRRT Return and associated documentation.

(iii)

Ms C - Ms C is the taxpayer's Chief Accountant. Her witness statement was dated 31 October 2011. She explained the mechanisms used to calculate the Allocated Expenditure and the taxpayer's accounting treatment of "explorations assets" (costs), "pre-development assets" (costs) and "development assets" (costs). Whilst not employed by the taxpayer in the relevant income years, the Tribunal finds no reason to question the credibility of the evidence given by Ms C which was based on her current knowledge, as the taxpayer's Chief Accountant, of the taxpayer's accounting systems and procedures (which she said are presently substantially the same as they were in the years in question) and her review of the relevant company accounts.

(iv)

Mr Bailey - the taxpayer also filed three witness statements, exhibiting reports, of forensic accountant, Mr Bailey. Mr Bailey's three statements (with exhibited reports) were dated 21 October 2011, 30 March 2012 and 7 May 2012. Mr Bailey quantified amounts paid by Company A to Company C having regard to various accounting records provided by Company C and which relate to Company C Billed Expenditure. In the report exhibited to Mr Bailey's witness statement dated 7 May 2012 he quantified the amounts paid by Company A to Company C on the basis of cost designation codes and descriptive titles recorded in Company C's accounting records.

Since the Tribunal has not been asked to calculate the quantum of the disputed expenditure, it is unnecessary for the Tribunal to refer to Mr Bailey's evidence in any detail in these reasons because his evidence specifically addressed the quantification, rather than the characterisation, of the disputed expenditure.

Commissioner's Evidence

91. The Commissioner relied on the evidence (witness statement, exhibited reports and testimony) of forensic accountant Mr Samuel. Mr Samuel filed two witness statements, exhibiting reports, dated 24 February 2012 and 12 June 2012. Since the Tribunal has not been asked to determine the quantum of the disputed expenditure, it is unnecessary to refer to Mr Samuel's evidence in any detail because it related specifically to the quantification, rather than the characterisation, of the disputed expenditure. However, to the extent it later may become relevant, the Tribunal finds no reason to question the credibility of Mr Samuel's evidence.

COMPANY C BILLED EXPENDITURE

92. The principal component of the disputed expenditure is the Company C Billed Expenditure. As set out above (under Relevant Facts ), the work that was the subject of the disputed Company C Billed Expenditure was performed by Company C as Operator of the Apple Joint Venture and as Agent for the venturers (including Company A), pursuant to the JOA. The "Structure of the JOA" and the "Funding Obligations under the JOA" are summarised below.

Joint Operating Agreement

Structure of the JOA

93. The following features of the JOA are relevant to this review application:

•: Company C was appointed as Operator of the joint venture and as Agent for the venturers (cl 4.1 of the JOA);
•: Company C (as Operator) had exclusive charge of and was obliged to conduct all "joint operations" under the overall supervision and direction of the "Operating Committee" (cl 4.2(a) of the JOA). Company C was entitled to engage independent contractors or agents or both and to delegate part or all of its functions to an "Affiliate" (cl 4.2(b) of the JOA);
•: 'Joint Operation' was defined (in cl 1.1) as meaning any operation or activity carried out within the scope of the joint venture for the benefit of, and the costs of which were chargeable to all venturers;
•: the 'Joint Venture' was defined (in cl 1.1) as meaning the Joint Venture established as described in cl 3.2 and by that clause the parties (which included Company A once it had entered into the Farmin Agreement and the Deed of Assignment and Assumption) agreed to associate themselves in a joint venture in accordance with the agreement "to explore for Petroleum and appraise, develop and exploit Discoveries in relation to the Title Area";
•: there was, except as stated, no business in common, relationship of trust or agency and no fiduciary duties to be owed (cl 3.3);
•: The Operating Committee established by cl 5 was to provide for the overall supervision and direction of Joint Operations. However Company C (as Operator in respect of the Joint Operations) had duties and responsibilities that included proposing a "Work Program & Budget" and "Authorities for Expenditure" (AFEs) (cl 4.3(b)(i)); and
•: Work Programs and Budgets for exploration and appraisal operations were to be approved annually by the Operating Committee by 10 December each year (cl 6.1(b)(ii)).

94. Under the JOA, Company C, as Operator, was responsible for carrying on the joint venture operations. It had various responsibilities, including:

•: implementing Work Programs and Budgets (cl 4.3(b) (ii));
•: acquiring any necessary consents, approvals or the like (cl 4.3b(iii));
•: obtaining requisite services and materials (cl 4.3(b)(viii)); and
•: maintaining and protecting joint property (cl 4.3(b)(ix)).

95. The JOA distinguished, in cl 6, between: (i) exploration and appraisal operations activities required to be undertaken before any decision to progress to production could be made; (ii) the development operations that would be required once a decision to progress to production was made; and (iii) the production operations.

96. In relation to "Exploration and Appraisal Operations":

•

The effect of cls 6.1(a) and (b) was to require a preliminary and then a finalised Work Program and Budget for Exploration and Appraisal Operations to be provided by Company C to the Operating Committee for approval. Clause 6.1(c) required minimum works to be undertaken by Company C to ensure that the Apple Exploration Permit would be maintained; and

•

The effect of cls 6.1(d) to (g) was that:

(i): If a discovery was made, Company C had to notify the parties and make a recommendation as to whether appraisal was warranted (cl 6.1(d));
(ii): If the Operating Committee decided that appraisal was warranted, a Work Program and Budget for appraisal had to be submitted for approval (cl 6.1(e)); and
(iii): Following appraisal activities, a decision was to be made by the Operating Committee as to whether any discovery was currently non-commercial, non-commercial but likely to become commercial, or currently commercial. The Operating Committee was required to determine whether a "Location" under the PSLA was required to be applied for (cl 6.1(f)) and whether a retention lease application should be made in respect of non-commercial discoveries that might become commercial (cl 6.1(g)).

97. As regards "Development Operations" the JOA provided that in the event of a commercial discovery, Company C was required to deliver a "Development Plan" for consideration by the Operating Committee which could approve, amend or reject it. The Operating Committee would decide whether Company C should apply on behalf of the joint venturers, for a "Licence" as defined in the PSLA, ie a production licence: cl 1.1. The parties were required to use their best endeavours to ensure that any production licence applied for was obtained (cl 6.2).

98. With respect to "Production Operations" the JOA provided that, on or before 15 July of each year beginning with the year before that in which production was to start, a preliminary then a finalised Work Program and Budget for production was to be provided by Company C to the venturers for approval by the Operating Committee (cl 6.3).

Financing of JOA activities

99. Where a Work Program & Budget and any necessary AFEs had been obtained, Company C as Operator was authorised to enter into contracts relating to Joint Operations. A tender process was required where the cost was or was likely to exceed $5 million (for an exploration operation or an appraisal operation) or $20 million (for development operations or production operations) (cl 6.5).

100. Company C was required to obtain approval from its joint venture partners before undertaking works - this was done by way of AFEs, as contemplated by cl 6.6. Clause 6.6 of the JOA provided the regime for AFEs whereby the joint venturers were required to fund the activities undertaken by Company C as Operator of the Joint Venture. By cl 6.6(a) approval was required for an AFE, and by cl 6.6(c)(i) approval for an AFE could not unreasonably be withheld. The content of an AFE was specified by cl 6.6(b):

...each AFE must contain:

(i)
Operator's estimate of the total funds required to carry out the work the subject of the AFE, and the timing of expenditure;

(ii)
other necessary supporting information.

Operator may consolidate expenditures listed in a Work Program & Budget by significant categories and prepare and submit AFEs for a category of expenditure.

Funding obligations and accounting principles under JOA

101. By cl 3.5, costs, obligations, claims, liabilities etc arising in the conduct of Joint Operations were to accrue to the Venturers and be borne by them in proportion to their respective participating interests. As noted above, however, Company C had exclusive charge of and was obliged to conduct all Joint Operations and was authorised to engage independent contractors (cl 4.2), was responsible among other things for implementing approved Work Programs and Budgets and obtaining services and materials (cl 4.3) and was authorised to enter into contracts (cl 6.5).

102. The Joint Venturers' obligations to pay costs attributable to Company C entering into contracts and incurring liabilities in carrying on the Joint Operations were required to be discharged by making contributions to a "Joint Account", as contemplated by cl 3.8(d). The Joint Account as defined (in cl 1.1) was an account required to be maintained by Company C as Operator, under the "Accounting Principles" (contained in the JOA Sch 1) to record assets, liabilities, costs and credits arising in the conduct of Joint Operations.

103. By the Accounting Principles (in the JOA Sch 1), Joint Venturers were required to pay to the bank account designated by Company C, amounts necessary for Company C to carry on the Joint Operations on their behalf. Company C made cash calls referrable to particular AFEs which were required to be paid by the Joint Venturers.

104. Section 3 of the Accounting Principles (as set out in the JOA Sch 1) provided the following:

3.1 Operator will call forward cash advances from Venturers for Joint Operations and will maintain such accounts and records as are necessary to identify cash balances for the Joint Venture.

3.2 Operator will submit to each venturer on or before the 15th day of each Month, cash calls for the following Month of the amounts expected to be paid during that Month and will nominate the AFEs to which the cash calls relate, the due dates for payment and the currencies involved.

Concurrently Operator will provide to each Venturer a cash forecast analysed by AFE and currency for the next 12 Months or such other period as agreed by Affirmative Decision. The forecasts in no way bind Operator.

3.3 Each Venturer will pay, on or before the due date or dates, its proportionate share of the cash payments to the credit of the bank account designated by Operator.

105. By reasons of the contractual mechanism described above Company A was required to make payments to Company C to procure it to carry on joint venture operations.

106. The JOA dealt with currency (Sch 1 s 4) and with "Classification and Allocation of Expenditure" (Sch 1 s 5). Expenditure was to be incurred initially by Company C (as Operator) as either a "direct cost" or a "shared cost" (as defined in ss 5.2 A and B). "Direct costs" were to be charged directly to the Joint Account. "Shared costs" attributable to or incurred by Company C for the benefit of more than one venture were to be apportioned, with an amount charged to the Joint Account that was "calculated on an equitable basis in accordance with Operator's accounting procedures and be representative of the service provided to the Joint Venture".

107. The JOA dealt with "Charges and Credits" (Sch 1 s 6.1). The principal types of charges and credits were associated with:

(a): Rentals, fees and taxes;
(b): Employee and associated costs;
(c): Materials;
(d): Transport;
(e): Services and facilities;
(f): Damage to and loss of joint property;
(g): Legal and litigation expenses "incurred in dealing with, resolving and paying any claims or demands arising out of or in connection with Joint Operations, Joint Property or Petroleum";
(h): Environmental and ecological costs "incurred in the course of Joint Operations as a result of statutory regulations for archaeological and geophysical surveys..."
(i): Insurance;
(j): Field office supervision and camp expenses;
(k): Certain management and administration expenses;
(l): Other costs "necessarily and properly incurred by Operator in the conduct of Joint Operations"; and
(m): Other credits.

108. In relation to employment costs, the Accounting Principles (the JOA Sch 1) dealt with the situation in which Company C employees might work partly on the Joint Operations and partly on other activities. The Accounting Principles (in the JOA Sch 1 s 6.1(b)(i)) provided:

If people are engaged other than exclusively for Joint Operations their salaries, wages and related overheads will be apportioned on the basis of Operator's time writing procedures.

Company C's OEP

109. Mr A's uncontested evidence was that Company C carried out the work required by the JOA (as Operator) in accordance with its "Opportunity Evaluation Process" (Company C OEP). The Company C OEP was a risk-based decision-making framework developed and utilised by Company C for the management of projects, including the Apple Joint Venture "opportunity" or "project". The Company C OEP framework was based around three key factors: (i) phases, (ii) assurance checks, and (iii) decision gates. The Company C OEP divided the Apple Project into the following five key phases: (i) assess, (ii) select, (iii) develop, (iv) execute, and (v) operate and evaluate. Mr A described the OEP process as one which was constantly "transitioning".

110. Completion of a phase of the Company C OEP occurred when the joint venturers reviewed the work undertaken during the phase (under an "Assurance Review") and authorised expenditure on the activities required in the next phase (by signing an AFE).

111. In order to explain how the AFEs were issued, Mr A summarised the steps taken following the discovery of the Apple field by the drilling of Apple-1 and described the multi-staged decision making process that ensued.

112. Mr A's evidence was that the initial exploration well was drilled in July and August 2001. Subsequently, at a meeting in September 2001, Company C reported that the discovery was not yet commercially viable and the following "risks" were identified:

•: Quality and quantity of the reserve was uncertain;
•: There were competing gas supplies;
•: There was only limited technical data regarding the sub-surface, wave currents, the terrain and the well head fluid;
•: A pipeline would be required which would require construction costs and consent of landholders and environmental concerns to be dealt with; and
•: It was necessary to secure a customer (two possible customers had been identified).

113. Mr A said that at a presentation given by Company C representatives on 3 September 2001, future operations for the conduct of the joint venture were proposed. At that meeting, Company C put forward its OEP timetable in relation to the Apple Project. In summary, the Company C OEP referred to the steps to be taken within each phase of the Apple Project, the outcome or objective of each phase and certain specific items of work that were to be completed by Company C (as Operator) during each phase.

114. The table below (which is derived from Mr A's witness statement) indicates each phase of the Company C OEP in relation to the Apple Project and notes the corresponding AFE.

Commencement	Phase	Assurance Review	Decision Gate	AFE
October 2001	2A - Select	AC2 - Feasibility Review	Accept appropriate certainty in studies to select lead concepts	111120
1 April 2003	2B - Concept Select	AC3 - Concept Selection Review	Accept single development concept confirmed with market	111140
December 2003	3A - Develop		Approve Field Development Plan and Basis of Design	111141
March 2004	3B - Develop	AC4 - Final Investment Decision Review	Final Investment Decision	111151 and 111190

115. Phase 1 ("Assess"), Mr A said, involved activities such as 3-D and seismic exploration, initial reserves estimates, scouting economics etc. Following that, there needed to be an "agreed budget & schedule to stay on 'fast track'". That would lead to Phase 2.

116. According to Mr A, Phase 2 ("Select") involved steps such as understanding the costs required to develop the project, evaluating the gas reserves range and market volumes, deciding on an appraisal strategy and identifying and eliminating "technical showstoppers/risks". Once these steps were taken this would lead to a "concept and market select" which would enable Phase 3 to occur.

117. Phase 3 ("Develop"), Mr A stated involved a refining of the project concept and included the development of a project execution plan, a field development plan, a gas supply agreement and a basis of design, which would lead to FID following which Phase 4 would proceed.

118. What was to occur during Phases 4 and 5 ("Execute" and "Operate & Evaluate") is self-explanatory.

119. The Company C OEP identified the scope of the operations to be undertaken. Under the heading "Givens" it states that "Exploration is ongoing". The object of the process was to achieve a FID. The Company C OEP noted the importance of achieving a sales agreement.

120. Mr A explained that the phases and various Assurance Checks (ACs) were required as part of the multi-staged decision making process comprising the Company C OEP. He said that unless each AC (also known as "Decision Gates") was passed it was the Operator's intention that the Apple Project would not proceed to a further phase.

121. Shortly after it gave its OEP specifications to the Joint Venturers Company C provided them with a "Project Initiation Note" in October 2001. The Project Initiation Note discussed the "opportunities" and "risks" of the Apple Project and observed that:

•: "Apple is a customer driven opportunity. There is currently one customer that can provide the volume and price mix to make Apple commercial in the short term. In the event that this customer cannot be gained then larger gas volumes will be required ...";
•: key schedule risks included laying of the onshore pipeline;
•: at that early stage of the project, "there is a lack of site specific geotechnical data. This may rule out some development concepts and increase the estimated scope of work";
•: securing Government approvals for environmental and land access would be essential;
•: the primary sub-surface risk was related to "the uncertainty of the reservoir quality away from the Apple-1 Well ..." and that sub-surface work would be required to address one of the risks; and
•: "a significant risk involves the limited amount of geotechnics, geophysical and metocean data available ... this can be overcome with the appropriate focus on surveys and data gathering during the select phase."

122. Mr A stated that Company C envisaged that the Select phase would be divided into stages 2A and 2B. It proposed that the work required by Phase 2A:

...will focus on identifying the major subsurface risks and whether these risks are managed or manageable. In order to identify these risks the subsurface work during the select Phase 2A will comprise of the following:

•: Develop understanding of subsurface and initial development concept
•: Detailed reservoir core and fluid evaluation
•: Detailed reservoir structural and AVO modelling
•: Construct full field geological and simulation models
•: Update hydrocarbon volumetrics
•: Identify further appraisal options and potential value
•: Develop regional exploration strategy.

123. Mr A explained that before proceeding to each successive phase of the Company C OEP, Company C presented a Work Program and Budget in the form of an AFE to the joint venture parties for approval. AFEs were required pursuant to the JOA cl 6.6.

Phases 2A to 3B of the Company C OEP

124. The disputed Company C Billed Expenditure relevant to this application was incurred during Phases 2A to 3B of the Company C OEP (comprising the Select, Concept Select and Develop phases). That expenditure was incurred pursuant to corresponding AFEs (111120, 111140, 111141, 111151 and 111190). It was classed as "development" in the capital account of Company C.

Phase 2A (AFE 111120)

125. Pursuant to the structure of the Company C OEP, Phase 2A covered the following activities:

(i): sub-surface and technical work to underpin an offer to a customer;
(ii): identification of and negotiation with foundation customers;
(iii): execution of a letter of intent with a foundation customer;
(iv): execution of a heads of agreement with a foundation customer; and
(v): assembly of a small team for VAR2 (Assurance Review 2);
(vi): each of (i) to (v) being undertaken in furtherance of the objective of completing sub-surface, feasibility and volumetric studies, a preliminary sale and purchase agreement with a foundation customer and a plan and budget for Phase 2B.

126. Mr A gave evidence that AFE 111120 was originally for Phase 1 (Assess) of the OEP but was updated in May 2002 (for Phase 2A) and further updated on 19 September 2002 (also for Phase 2A). As initially formulated in January 2002, AFE 111120 sought approval for expenditure of $1,701,000. At that point, the AFE was for work between 13 October 2001 and 31 March 2002.

127. All of this expenditure was incurred after Company E had withdrawn from the joint venture.

128. Pursuant to the AFEs, Company A paid cash calls to Company C on a regular basis (as it was obliged to do under the JOA and the Accounting Principles) between 13 March 2002 and 18 June 2003 in order to procure Company C to carry on the work. The amounts paid by the taxpayer as its share of the joint venturers obligations under AFE 111120 totalled $1,373,227.

129. According to Mr A, at a meeting of the Operating Committee in November 2001, representatives of Company E had informed Company C and Company A that it did not want to proceed with the proposed appraisal program. In a subsequent email from Company E's General Manager - Agave Sea, Mr D, Company E did not approve the Work Program and Budget. Following a further meeting of the Operating Committee, Company C and Company A had agreed to embark on the appraisal of Apple as a "sole risk project", by which Company A would bear 46.1538% of the costs of the AFE.

130. Mr A's evidence was that the work undertaken under AFE 111120 included:

•: establishing an Apple Project team and incorporating the results of geological and interpretation studies into volumetric calculations;
•: interpretation of Apple 3-D seismic data;
•: a detailed evaluation of the Apple-1 reservoir units, which concluded that the sedimentary environment for the main Keyling reservoir units was estuarine to the marginal marine shoreface;
•: proposals for an exploration well in the "Echidna-A field";
•: Sub-surface modelling and field modelling, to estimate reservoir volumes and consider further work required to gain greater certainty;
•: further work relating to the design and cost of the proposed wellhead platform, the offshore pipeline and the onshore gas plant;
•: preparation of a technical project schedule for further work, including surveys, concept selections for the proposed onshore plant and for the offshore facilities (tab 27, page 413). The photographs at pages 415 to 418 illustrate the proposed pipeline landscape; and
•: work undertaken to secure environmental approvals.

131. Mr A said that the work under AFE 111120 also included preparation of a palynology report on the basis of core samples taken from the Apple-1 Well. He explained palynology is the study of pollen in connection with plant geography and dating of fossils, and that the report examined the character of the samples taken from the Apple Well and reached conclusions about whether samples were "immature" or of "marginal maturity" for oil generation.

132. Further, Mr A said that a detailed 3-D full field modelling report was prepared relating to geophysical, geological modelling and probabilistic volumetric analysis. Key conclusions and deliverables from the study were:

•: a suite of seismically supported 3-D geological models that are representative of the range of sub-surface uncertainties and are suitable for use in dynamic flow simulation;
•: a new work flow for the integrated application of Company E's proprietary 3-D static reservoir modelling tools; and
•: as a result of the integrated 3-D static and dynamic modelling reservoir modelling, an increase in "P50 GIIP bookings" by "611 bcf at the P50 level and 265 bcf at the P90 level". (In other words, the gas initially in place and recoverable volumes of gas were updated by being increased).

All of the work identified above was, according to Mr A, necessary to determine whether commencement of development and production would be "justified or prudent".

133. Mr A summarised the work done under AFE 111120 as comprising:

•: further sub-surface evaluation;
•: well engineering design;
•: concept design for the proposed facility;
•: considering the impact of the possible development on third party stakeholders;
•: conducting preliminary anthropological work;
•: considering the environmental regulatory requirements; and
•: identifying and entering into negotiations with possible foundation customers.

134. Mr A's evidence was that the work undertaken to secure prospective customers was classified as "Commercial" or "Commercial Management" work. $251,000 from the total AFE for $3,084,000 was referrable to this work. Company A's contribution to this (at 46.1538%) was $115,846. Due to the remoteness of the Apple field, the viability of the project was dependent upon the joint venturers identifying a customer. There was (then) only one customer that could "provide the volume and price mix to make Apple commercial in the short term". That customer was Company G, a subsidiary of Company F, which operated a bauxite mine and an alumina refinery at Orange cove and which used high sulphur fuel oil (HSFO) to meet its energy needs. Company G was thought to have a number of reasons to purchase gas, including environmental pressure to switch to natural gas, reducing energy costs and wishing to upscale production for which gas would be essential. A non-binding LOI was signed with Company F on 7 March 2003.

Progression from Phase 2A to 2B

135. Mr A's evidence was that work progressed in Phase 2A throughout 2002 and into March 2003. On 24, 25 and 26 March 2003, representatives of the joint venturers met to undertake Assurance Check 2 (AC2) reviews. Reports were tabled summarising the work undertaken and a presentation summarising recommendations was given. In summary, the Operator recommended that there should be a progression from Phase 2A Select to Phase 2B Concept select.

136. According to Mr A, a "concept selection report" was finalised in May 2003 and the parties decided to proceed with Phase 2B and to enter into a HOA with Company F to supply gas for the alumina refinery at Orange cove. A further AFE was prepared for work required under Phase 2B.

137. Mr A's evidence established that the focus of Phase 2A had been to secure the agreement (preliminary to a formal gas sales agreement) of a customer to purchase gas extracted from the Apple field. The feasibility studies he mentioned were also directed to this end. The point of progression from Phase 2A to Phase 2B required "appropriate certainty to enable the selection of lead concepts and proceed to Concept Selection".

Phase 2B - Upstream (AFE 111140)

138. According to the Company C OEP, Phase 2B entailed the following activities:

(i): signing a heads of agreement;
(ii): refining concept select and cost estimate for base case (and possible upside);
(iii): further exploration and appraisal to improve the base case;
(iv): negotiation of a sale and purchase agreement; and
(v): each of (i) to (iv) being undertaken in furtherance of the objective of completing a preliminary field development plan, selecting a preferred concept, a business proposal and a sale and purchase agreement.

139. Mr A's evidence was that AFE 111140 sought approval for $10,924,000 "associated with VAR2 ("VAR" meaning "Value Assurance Review") to VAR3 work program costs for the Apple (upstream) development project".

140. At approximately the same time that AFE 111140 (related to upstream work) was prepared, AFE 111141 was prepared which dealt specifically with work relating to the Banana Pipeline (ie the proposed downstream pipeline from the proposed gas processing plant to transport gas to Orange cove).

141. Mr A explained that the work undertaken under AFE 111140 corresponded with Phase 2B of the Company C OEP, the purpose of which was to consider further and define the preferred concepts for development of Apple as identified in Phase 2A.

142. Ms B's witness statement shows the cash calls paid by the taxpayer as its share of the expenditure authorised under AFE 111140 between 16 July 2003 and 17 November 2004. The net amount paid (there were some credits) totalled $3,748,456.

143. Mr A said, the work under AFE 111140 involved refining the concepts identified in Phase 2A, as well as providing for "further exploration and appraisal as required to improve the base case" and negotiating a sale and purchase agreement. The desired outcome was to select a single concept and market "subject to FID of buyer and seller".

144. Mr A stated that the work under AFE 111140 included:

•: preparing a dynamic reservoir model of the Apple gas accumulation and studying surface development options, including a pipeline to the onshore processing plant; and
•: sub-surface evaluations including geological and geophysical studies, estimates of GIIP ("gas initially in place"), static geological models, dynamic simulation models, completion and drilling options and identifying a preferred development concept.

145. According to Mr A, the work under AFE 111140 also included preparing an application for the nomination of a Location for the purposes of the PSLA. That application was submitted in September 2003. He said that that document was the product of detailed analysis of a technical and geological nature. Nomination of part of the area of an exploration permit as a Location was necessary to ensure that the Joint Venture participants retained an interest in the blocks the subject of the Apple discovery and was a prerequisite to applying for a production licence from the area of an exploration permit under the PSLA: see the PSLA ss 39A and 40. The Location application was granted, providing the Joint Venturers with two years to apply for a production licence or retention lease.

146. Mr A said that additional work involved in progressing the concept included preparation of a contracting strategy report (dated 26 August 2003) (Contracting Strategy Report), which noted that the proposed Apple Project included installation and operation of:

•: two initial offshore wells in petroleum permit WA-000-P;
•: offshore facilities and production processing;
•: a 120 km subsea gas export pipeline to shore; and
•: onshore processing facilities in the vicinity of Lemon Point (254 km southwest of Darwin).

147. The Contracting Strategy Report recorded that:

The Apple Gas Project is now in OEP Select Phase 2B scheduled for completion in Qtr 4 2003 when the preferred concept selection will be confirmed.

Funding approval exists until the end of 04, and preliminary funding requirement for the Develop Phase has been established.

Develop Phase 3A is planned to commence in Qtr 1 2004 which will be the subject of a separate AFE.

FID is currently planned for Qtr 3 2004 and RFSU [ready for start up] in Qtr 4, 2006.

JV approval for execute phase will be requested prior to FID ...

148. Mr A stated that the Contracting Strategy Report demonstrated that the Joint Venturers had reached the conclusion that the gas from Apple would be processed onshore and that there would be no processing (apart from well flow and pressure control) on the offshore facilities. It described the proposed onshore processing facilities. The then significant "risks" to the project were understood to be:

(i): Possibly insufficient gas reserves to economically meet Company F's requirements;
(ii): Company F might not achieve FID on the expansion of its alumina refinery to which the gas was then intended to be sold;
(iii): the Banana Pipeline's commercial structure and economics resulting in an unacceptable delivered price for Company F; and
(iv): land access not being achieved on time for the 2007 first gas target.

149. According to Mr A, the work under AFE 111140 included detailed project facilitation work, environmental work and facilities engineering work.

150. As to the "facilities engineering work" undertaken at this stage, Mr A explained in his witness statement that:

... the purpose of facilities engineering at this stage was only to develop what is known as 'concept select designs'. That is not the same as the design work that would have been required to enable the parties actually to construct and operate the facilities. Concept select designs are not detailed enough to allow facilities to be built and operated. They only enable the parties to make cost estimates within a 40% margin of the actual cost ...

151. Part of the work under AFE 111140 involved conceptual work for the "preliminary functional requirements" of the well head platform. Identifying well head platform requirements was a six stage process before the functional requirements could be confirmed. As at the date of preparation of the Contracting Strategy Report the concept had reached stage three of six. Significant further work was required to confirm the well head platform functionality requirements, including further studies, namely:

•: a sand study;
•: a scaling study;
•: a well intervention/maintenance study;
•: a control and communications study;
•: an access study;
•: a material handling study;
•: a power generation study;
•: a hazard assessment; and
•: a pre-investment study.

152. Mr A said that a similar study was prepared for assessing the alternatives for the onshore gas plant and a detailed site selection report was prepared to identify an appropriate location where it might be possible to construct the plant, should a decision to proceed be made.

153. The work undertaken under AFE 111140 also included, Mr A explained, well engineering and surface engineering. Further sub-surface evaluations were undertaken to prove up the resource and to guide viable development concepts. That work included:

•: undertaking further "desk top studies" to review the reservoir characteristics - from which a model for sandstone in the "Platypus Formation at Apple-1" was developed;
•: further modelling was undertaken presenting probabilistic reservoir estimates;
•: a rock trace constrained sparse spike conversion study was undertaken by a third party consultant (Mr M of Geophysics), "for the purpose of obtaining an improved understanding of the deeper reservoirs and to investigate the Apple-North prospect to better understand reservoir volumes"; and
•: a "3-D pre-stack depth migration" project was undertaken for the purposes of appraising the prospectivity of the Apple-North prospect.

154. The work under AFE 111140 also included finalising a HOA with Company F. At the same time agreement was reached with Company F to progress the Banana Pipeline. This was classified as "commercial" work and $842,000 of the total AFE amount of $10,924,000 was referrable to this. At 46.1538% Company A's liability to pay for the commercial component of the AFE was $388,615.

155. On 29 December 2003, Company C received the Location Declaration that was applied for pursuant to the PSLA.

Phase 2B - Banana Pipeline (AFE 111141)

156. Mr A's evidence establishes that in conjunction with entering into a HOA with Company F, the Joint Venturers entered into an agreement with Company F to work collaboratively for proposals for construction of the Banana Pipeline. The pipeline was to run from the exit flange of the onshore gas plant at Lemon Point to Orange cove. Mr A stated that the work undertaken in respect of AFE 111141 corresponds with the work agreed to by Company C, Company A and Company F in the agreement, known as the "Banana Pipeline Joint Study Agreement". Mr A's evidence was that AFE 111141 was prepared in April 2003 (ie at the same time as AFE 111140).

157. Ms B's witness statement shows cash calls were made pursuant to this AFE between 16 July 2003 and 21 June 2004 and that the net amount paid by the taxpayer for cash calls pursuant to AFE 111141 (there were some credits) totalled $367,529.

158. The work undertaken in relation to the Banana Pipeline was described in detail in Mr A's witness statement. In summary, the work included project management and assurance, commercial work, on-shore pipeline project management and engineering and government liaison work for the pipeline.

159. The work carried out by Company C, as Operator, under AFE 111141 included:

...work undertaken in early 2003 by OSD Energy Services for the purpose of reviewing the original proposed route from Lemon Point to Tangerine town to Orange cove and to make recommendations to optimise the pipeline length. This review determined that there were four potential route options. In July 2003, an aerial survey was undertaken to refine several of the identified routes. This aerial survey preceded later detailed route (field) surveys which commenced on 8 October 2003.

160. Mr A said that the Joint Venturers together with Company F prepared a proposal seeking expressions of interest to participate in building, owning and operating the proposed Banana Pipeline from Lemon Point to Orange cove.

Progression from Phase 2B to Phase 3

161. On 24 November 2003, at the conclusion of Phase 2B, the Commercial Committee of the Apple joint venturers undertook a "Commercial Assurance Review". The Commercial Assurance Review meeting was preparatory to Assurance Check 3 (AC3) and the progression to Phase 3A. Its purpose was to enable the Commercial Committee to consider gas reserves and matters affecting gas prices, which presented commercial risks for the Apple Joint Venture. At the AC3 meeting in December 2003, Company C and Company A agreed to cause the project to proceed to the Develop phase of the Company C OEP and to prepare a Preliminary Field Development Plan (Preliminary FDP) in anticipation of an application for a production licence.

162. Mr A explained that the meeting was held in the week commencing 8 December 2003. The meeting to review the work under Phase 2B was described as being for AC3. A number of reports were prepared for the meeting, which summarised the work undertaken in Phase 2B (and for which work Company A was liable to make payments to Company C pursuant to the cash calls made under the AFEs referred to above).

163. According to Mr A, it was intended that after the AC3 review, assuming that the outcome of the review was satisfactory, "the opportunity will pass into the Develop phase for preparation of the BOD and execution of FEED". If the work progressed to Phase 3 (Develop) of the Company C OEP, FEED work and BOD work would be the next steps.

164. In his witness statement, Mr A explained the concepts of "FEED" and "BOD" as follows:

•: Front End Engineering Design (FEED) work - FEED work is done by engineers to prepare and draft an up-front basic design of all of the required facilities, that suffices to identify the required resources for the construction and operation of the facilities - it is merely an outline of the development concepts for each of the facilities and is not sufficient to specify, purchase, install, start up or operate the facilities. The work done to prepare detailed engineering design of the facilities is done after there is a FID and after the regulatory approvals have been obtained; and
•: Basis of Design (BOD) work - BOD work is undertaken for the purpose of procuring estimates of the cost to construct facilities and is necessary in support of a Preliminary FDP which is required to be submitted to the Joint Authority as part of the first stage of the consultative process for obtaining a production licence.

165. More specifically, Mr A's witness statement recounts that FEED is, in his experience, used for two purposes, being:

(a): to obtain an understanding of the cost of constructing, installing and operating the facilities to evaluate the economic value of proceeding; and
(b): in some cases, to support project financing proposals.

166. Mr A told the Tribunal that in the case of Apple, the FEED was not done for the second purpose but, rather, to gain a better and more certain understanding of the cost of designing, constructing, installing and operating the facilities and that "prior to your final investment decision you need to go out to market and you need to tender for the final design and the FEED allows you to develop that tender".

167. Mr A's evidence was that the point of progression from Phase 2B to Phase 3A required a "single concept and market confirmed subject to FID of buyer and seller".

168. Mr A's evidence was that, as at that point in time, there remained a "large number of sub-surface uncertainties" in relation to the Apple reservoir. Despite those uncertainties, Mr A explained that a decision was made to proceed with the project and to enter Phase 3 (Develop) of the Company C OEP "on the condition that Company C develop a negotiating strategy in respect of the risk of insufficient reserves". This condition was included in light of the conclusion of the review of the work completed under Phase 2B which had revealed:

Lowering of reserves below 800 PJ (820Bcf) since signing HOA is a key impediment to making progress as it influences many aspects and is likely to lead to a new risk/reward balance that differs from that in HOA.

Phases 3A and 3B - Upstream Engineering (AFE 111151)

169. Mr A's evidence explained that from January 2004, activities progressed in Phase 3 were in two phases: 3A and 3B. The work done was to further develop the concept selected during Phases 2A and 2B. It was envisaged that once the work done under Phase 3 was completed, the Joint Venturers would be in a position to determine whether to make a FID.

170. According to the Company C OEP, Phase 3A entailed the refinement of the field development plan (FDP) and preparation of a BOD, with the approval of both documents marking the progression from Phase 3A to 3B.

171. Phase 3B involved the preparation of the FEED project specifications, revised cost estimate and a project execution plan. The objectives of Phase 3B were to determine a final business case, a FID package and the execution of an unconditional gas sales agreement.

172. Mr A described the Phase 3A work as involving:

•: preparation of a preliminary field development plan; and
•: preparation of BOD documentation.

173. Mr A recounted the Phase 3B work as involving:

•: finalising FEED;
•: preparing tender documentation;
•: preparing cost estimates;
•: preparing a final business case; and
•: drafting and finalising the terms of the gas supply agreement.

174. According to Mr A, this work was necessary to enable a decision to be made as to the economic viability of mining the discovered resource. A FID would involve commitment of several hundred million dollars in development costs.

175. As originally formulated, AFE 111151 (which related to upstream work) sought approval for expenditure of $27,732,000. AFE 111151 was authorised in February 2004 but was updated by "Release 1" September 2004, which was accepted by Company A in October 2004. As updated it sought approval for $30,800,000.

176. Mr A explained that the work undertaken pursuant to AFE 111151 was described under the heading "Development Studies" in the reports prepared for statutory reporting purposes. Those reports demonstrate:

•: by May 2004, the development BOD had been completed; and
•: by August 2004, a Preliminary FDP had been prepared for submission, as the first stage of the consultation, to the Joint Authority and FEED activities had commenced.

177. One of the large components of the expenditure for which approval was sought under AFE 111151, survey expenses of $9,700,000, was approved for this activity. Mr A explained in his witness statement that the following surveys were covered by that expenditure:

•: the environmental noise assessment;
•: the intertidal environmental survey;
•: the technical report into sea turtles, dugongs and sea grasses in the region of the Apple Project, which Mr A said was necessary for the purpose of obtaining information on the existing marine environment in the vicinity of the well head platform location, the pipeline route including the shore crossing and the location of the proposed pipeline and export mooring;
•: an assessment of acid sulphate soils;
•: the hydrology and water quality report;
•: a flora and vegetation study for the proposed Apple Project;
•: a biting insect survey and assessment. Mr A explained that this report was commissioned for the purpose of identifying risk areas where the construction of the onshore facilities may lead to the creation of mosquito breeding sites, so as to prevent the importation of exotic mosquito species and identify possible health impacts;
•: the terrestrial fauna study;
•: the archaeology and history heritage survey;
•: the report into Apple produced formation water, which was in respect of the discharge of treated water from the onshore gas processing plant to the ocean;
•: an oil spill risk assessment modelling report;
•: a report assessing species with indigenous conservation values and related environmental cultural values;
•: a study of health related hazards to assess the potential health exposure risks to the project workforce and the public, which Mr A explained was required for the purpose of meeting health and safety regulatory requirements;
•: a framework environmental offshore management plan; and
•: a framework marine and intertidal monitoring program.

178. In addition, Mr A's evidence was that a detailed Environmental Impact Statement (EIS) was prepared. The draft EIS also incorporated a report Social Impact Assessment of the Proposed Apple Project, Lemon Point, Northern Territory which assessed the social impact of the proposed Apple Project.

179. Engineering and other technical work continued whilst survey and other related work was undertaken. This included preparation of a Preliminary FDP (dated 1 December 2004) and review of that, and preparation and review of the BOD document.

180. The contributors to the Preliminary FDP included geologists, geophysicists, engineers, analysts and environmental personnel. The document contains a great deal of information on the technical feasibility of production from Apple and the nature of the reservoir and represents the cumulative work undertaken over the preceding years.

181. The BOD report (finalised by July 2005) represented the accumulation of work undertaken in previous years, all of which, which Mr A stated, was collectively necessary to make a decision as to whether it would be viable to commit the funds necessary to produce gas.

182. The commercial work undertaken in respect of AFE 111151 was described by Mr A as consisting of negotiations with Company F concerning the HOA for the sale of gas. Of the $30,800,000 for which approval was obtained under AFE 111151, $1,530,000 was referrable to this commercial work. At 46.1538%, Company A's liability to pay for this work was $706,153.

183. As explained in Ms B's witness statement, the cash calls made pursuant to AFE 111151 were paid between 26 March 2004 and 15 June 2005. The amounts paid by the taxpayer as its share of the expenditure authorised by AFE 111151 totalled $12,401,554.

184. On 5 November 2004, the Joint Venturers entered into a Conditional Gas Supply Agreement with Company F. The conditions of that agreement included:

•: the board of Company C and Company A making a FID to proceed with development by 31 May 2005;
•: the board of Company F and its subsidiaries making a FID to proceed with the development of the Banana Pipeline and the gasification of the Orange cove alumina plant by 31 May 2005; and
•: Company F notifying Company C and Company A that it was satisfied with the commercial arrangements relating to the Banana Pipeline.

185. Mr A said that in the period from January to April 2005, Company C, as Operator, prepared a final business case and supporting documents to support a proposal for the boards of each of Company C and Company A for a FID to be made in May 2005. However, it became apparent during this process that the gas price offered to Company F under the Conditional Gas Supply Agreement was too low given increases in steel prices and the projected costs of construction due to demand from China and the resources boom in Australia.

Phase 3 - Banana Pipeline (AFE 111190)

186. Mr A stated that AFE 111190, as initially prepared, sought approval for $2,600,000. It was revised in November 2004 to seek approval for $3,800,000.

187. As explained by Ms B in her witness statement, the cash calls pursuant to this AFE, were paid between 26 March 2004 and 15 June 2005 and the amounts paid by the taxpayer as its share of the expenditure authorised by AFE 111190 totalled $1,354,768.

188. The work undertaken under this AFE was concerned with the Banana Pipeline. As set out in Mr A's witness statement at [363]:

...without a gas pipeline the gas recovered from the well and processed at the gas processing plant could not be delivered to a customer ... the Banana Pipeline was one of three projects (Apple project, Company F gasification and the Banana Pipeline) which needed to be progressed at the same time. For any one of the projects to proceed the schedules for all three projects needed to align.

Activities corresponding to Company C Billed Expenditure

189. In Part 4 of his witness statement (dated 24 October 2011) Mr A described the Company C Billed Expenditure in dispute with reference to corresponding AFEs. He used a set of common "headings" to denote the kind of activities which were the subject of the expenditure. Each of these groups of activities is discussed below.

"Project facilitation" ("external affairs")

190. Based on Mr A's evidence, the majority of this work was commenced at the conclusion of Phase 2B (corresponding to AFE 111140), once the concept of the Banana Pipeline and onshore gas plant had been selected as the means of processing gas extracted from the Apple field. These activities, also described in his evidence as "external affairs". They entailed consultation with stakeholders including the local Aboriginal community and environmental regulatory bodies.

191. The initial external affairs work in Phase 2A appears, from Mr A's evidence, to be aimed at developing a strategy for obtaining necessary stakeholder consent and governmental approvals, which would be implemented in Phase 2B.

192. The project facilitation work during Phase 2B entailed:

•: undertaking a preliminary social impact assessment to assess the socio-economic impacts of the Apple Project, particularly the onshore gas plant, on Lemon Point's indigenous community;
•: planning for the offshore gas pipeline - consultation with traditional land owners in order to determine the route of the proposed offshore gas pipeline;
•: a survey of sacred sites pursuant to the Heritage Conservation Act 1991 (NT); and
•: briefing the Commonwealth Minister for Industry Tourism and Resources regarding the Apple Project, the Banana Pipeline project and Company F's gasification project in connection with Company C's application for a production licence.

193. Project facilitation work during Phases 3A and 3B involved continued attempts to obtain requisite stakeholder consent and governmental approvals, and led to Company C commissioning an assessment of and report on the social impact of the Apple Project on the community of Lemon Point.

"Facilities engineering"

194. Mr A described this category of expenditure as "work undertaken in respect of determining the nature and design of the facilities to be built if the project proceeded to production".

195. In his witness statement, Mr A summarised the "facilities engineering" work undertaken during Phase 2A as encompassing:

the evaluation of preliminary concept design options, including identifying:

(a)
various development concepts and completing preliminary development screening of those concepts;

(b)
collating and reviewing all available metocean studies for the Permit and offshore pipeline area for the purpose of the design of the offshore pipeline;

(c)
considering and selecting possible offshore pipeline construction material;

(d)
considering the processing requirements of the gas ...

196. Various reports were exhibited to Mr A's statement, including a Wellhead Platform Functionality Report, an Onshore Concept Selection Report, an Apple Development Onshore Plant Site Selection Report, Design Intent for Facilities Report, Apple Operations Philosophy Select Phase 2B Report and Phase 2B Gas Condensate Assay Report. Mr A's evidence was that those reports assist in explaining the engineering work done during Phase 2B in that they related to the selection, operational requirements and design of facilities for the Apple gas field. They were intended to enable cost estimates within a 40% margin of actual cost to be made and to inform the choice of alternative bespoke designed facilities. Mr A said that the designs had assumed that Company F would be the customer for the gas extracted from the Apple field.

197. Mr A's evidence was that there were three aspects of the "facilities engineering" work performed during Phases 3A and 3B:

(i): preparation and review of the Preliminary FDP;
(ii): preparation and review of the BOD; and
(iii): completion of early FEED of upstream facilities for the purposes of preparing tender documents.

198. Mr A said that the preparation of a FDP, like the Preliminary FDP, was one of the principal components required for an application for a production licence according to the Guidelines for Grant of a Production Licence and Grant of an Infrastructure Licence . Paragraph 2.1 of the Preliminary FDP (which was exhibited to Mr A's statement) stated:

This document brings together the sub-surface evaluation, concept selection studies and field development planning carried out up to the end of August 2004. This work has focused on a preferred concept market scenario producing a MDQ of approximately 199TJ/day of sales gas through a dedicated export pipeline to an onshore plant at Lemon Point. The objective of the [plan] is to establish a dialogue with the [Joint Authority] with respect to the development concepts and statutory approvals required to secure a Production Licence...

199. Further, paragraph 2.2 of the Preliminary FDP stated:

The purpose of the [plan] is to establish a commercially and technically viable long-term gas supply from the Apple field that: ... permits the [Joint Authority] to review the development concept at an early stage and comment on any perceived deficiencies in the Joint Venture's development proposal.

200. The Preliminary FDP was submitted to the Joint Authority.

201. Mr A's evidence was that the BOD Report, which also comprised facilities engineering during Phases 3A and 3B, contained specifications of the capacity of the offshore pipeline to carry gas from the Apple field to the onshore gas processing plant. Mr A's witness statement establishes (at [324]) that the report:

...encapsulated all of the concept select design criteria set out in the concept select reports [listed at par 229] for the upstream facilities prepared during Phase 2B of the OEP and the additional Front End Engineering Design work undertaken by Company C during Phase 3A and 3B of the Project.

"Project management"

202. This category of activities comprised the management of communications and logistics to ensure the timely completion of the work undertaken in each phase. According to Mr A, during Phase 2A, apart from the sub-surface evaluation discussed below, the work entailed the provision of logistical support, facilitating communication, managing project costs and reporting on projects.

203. Mr A referred to the fact that some time recorded under the "project management" category related to sub-surface evaluation. The sub-surface evaluation was said to be performed to enable a better understanding of the likely volume of gas available in the Apple-1 reservoirs.

204. Mr A's evidence was that project management during Phase 2B also included providing logistical and administrative support and management of the development team.

"Project services and assurance"

205. This activity was directed to "risk management", including through technical reviews and compliance with environmental and health and safety standards. Mr A's evidence was that during Phase 2A, the "project services and assurance" work involved, inter alia, "reviewing the design specifications for the proposed facilities" for the Project.

206. From Phase 2B onwards, the "project services and assurance" activities were said, by Mr A, to have been directed to the development of risk management strategies to facilitate delivery of gas to Company F in accordance with the Company F Gas Sales Agreement.

207. According to Mr A's evidence, "project services and assurance" described the quality control and risk management activities undertaken by Company C on behalf of the Joint Venturers. The work included developing a risk register for the Project and reviewing the design specifications for the proposed facilities. Further, it involved:

•: The management of the overall project and contracting risk, including undertaking due diligence procedures and the implementation of control mechanisms to mitigate risk;
•: The technical review of work done to check the quality of the project teams' work; and
•: Ensuring that the Project conformed with the relevant industry and legislative rules, standards and guidelines concerning health, safety and the environment.

"Commercial"

208. The activities described by Mr A in his witness statement as "commercial" involved marketing gas to prospective customers, principally Company F. A large portion of marketing expenditure was incurred following Company F's public announcement in January 2003 of its plans to undertake an environmental and feasibility study to expand its alumina refinery and bauxite mining plant at Orange cove in the Northern Territory. As part of that expansion, Company F proposed to convert its plant from fuel oil to natural gas.

209. On 7 March 2003, as part of Phases 2A and 2B, Company C and Company F signed a LOI. The stated purpose of the LOI was to establish each party's intent with respect to the negotiations for the supply of natural gas to Company F and setting out the principal terms and conditions of a preliminary sales and purchase agreement (cl 8). Clause 22 of the LOI provides that the parties agree to research and develop strategies for seeking government incentives to support the onshore pipeline. On 6 June 2003, Company C and Company A entered into the HOA with Company F.

"Environmental"

210. As the Apple development was located within Northern Territory and Commonwealth water boundaries, it was subject to two distinct environmental assessment regimes: the Northern Territory Environment Assessment Act 1982 (NT); and the Environment Protection and Biodiversity Conservation Act 1999 (Cth). Mr A's evidence was that an EIS, although not a pre-requisite to the grant of a production licence, was completed for the purposes of Company C's application for a production licence. The preparation of an EIS was recommended by the Resource Division of the Department of Tourism, Industry and Resources in its Offshore Petroleum : Guideline for Grant of a Production Licence and Grant of an Infrastructure Licence , dated May 2002.

211. Mr A's evidence indicates that "environmental" work performed during in Phase 2B was preparatory to the work performed in Phases 3A and 3B, in that it is said to involve preparation of an environmental plan and preparation for seeking environmental approval before applying for a production licence.

212. Mr A's recollection was that following meetings between representatives of Company C and the Minister responsible for administering the Northern Territory Act, the Minister had informed Company C that it was required to produce an EIS in accordance with that statute.

213. Mr A's evidence was that environmental work during Phases 3A and 3B entailed the preparation of Company C's EIS. The introduction to the draft EIS prepared by Company C in respect of the Apple Project (and exhibited to Mr A's statement) records that:

... the objective of the [environmental impact assessment] process is to ensure that potential environmental impacts associated with the project during both routine and non-routine operations, are identified and appropriately assessed.

The draft EIS covered "all phases of the project, including construction, commissioning, operation and decommissioning".

"Well engineering" & "Surface engineering"

214. This work was described by Mr A as volumetric calculations and updated modelling. It was said to have been necessary prior to proceeding to AC3 because it entailed an assessment of the quality of the gas.

215. The work was updated during Phases 3A and 3B, and was said by Mr A to be reflected in the Preliminary FDP. Mr A stated that the sub-surface evaluation was performed to enable a better understanding of the likely volume of gas available in the Apple-1 reservoirs, measured against the minimum requirement specified in the HOA.

"Surveys"

216. Survey work comprised two surveys commissioned by Company C during Phases 3A and 3B. In his witness statement, Mr A describes the purpose of the surveys as enabling Company C to complete the design of the offshore pipeline and other upstream facilities. This included assessing the suitability of the proposed offshore pipeline routes.

"Banana Pipeline"

217. This was said by Mr A to have authorised design and feasibility studies in respect of the onshore gas pipeline (the Banana Pipeline) pursuant to a joint venture between Company F, Company C and Company A, which took the form of the "Banana Pipeline Joint Study Agreement" (executed on 6 June 2003) (JSA).

218. In his witness statement, Mr A explained that under the JSA the parties had agreed to work collaboratively to:

•: Identify and obtain available government incentives for the development and construction of the Banana Pipeline, including developing a strategy for the obtaining of any such approvals;
•: Identify, assess, study and review technical, fiscal and ownership options for the development of the Banana Pipeline; and
•: Minimise gas transportation tariffs and to ensure adequate reliability and sizing of the Banana Pipeline to cater for future gas market growth.

"Time writing"

219. The Company C Billed Expenditure consisted in part of the labour costs of personnel employed by Company C and engaged in work on the Apple Project. According to Ms B's evidence, some of those personnel were engaged "other than exclusively" on the Apple Project and the costs of such personnel were "apportioned on the basis of Company C's time writing procedures".

220. Based on Mr Bailey's report, a substantial proportion of the Company C Billed Expenditure consisted of what is referred to as "time writing".

221. In her witness statement (dated 29 March 2012) Ms B described time writing as follows:

15. My understanding based on my experience in the oil and gas industry of how time writing works in the industry is as follows:

(a)
particular employees of oil and gas companies are required to record their time spent on a particular project against a code designated to that project;

(b)
those employees may work solely on that project or on more than one project at any time;

(c)
there is a pool of overhead costs (which is usually governed by a service agreement or joint venture agreement) which is allocated to the project in proportion with the percentage of time recorded by those employees who are known as time writers.

16. The time spent on any given project is then "charged" to the project on a fair and reasonable cost basis. The taxpayer has accepted that the charges by Company C staff to the Apple Project, based on the time writing, were fair and reasonable.

17. Time writing represents the costs charged by Company C to the joint venture account [in accordance with the accounting principles set out in Schedule 1 to the JOA].

Payments of Company C Billed Expenditure

222. Ms B explained how payments of the Company C Billed Expenditure were made by the taxpayer to Company C. In her witness statement, Ms B referred to the accounting arrangements between Company C and the Joint Venturers as follows:

cash advances were required to be paid by Company A for Joint Operations by the Operator submitting to the joint venture parties on or before the 15th day of each month a cash call for sums expected to be paid during that month and nominating the AFE to which the cash calls relate and the due date for payment (cash calls).

223. According to Ms B, the total of the amounts paid to Company C was $22,838,074, slightly more than the amount remaining in dispute of $19,838,881 (subject to the Commissioner's concession at the hearing of this application regarding "sub-surface engineering" expenditure).

224. Ms B's evidence was that the difference (which reduces the amount in dispute) is attributable to the following:

•: The cash calls were estimates and the amounts actually spent by Company C may have been more or less. Company C periodically provided Statements of Expenditure and Working Capital recording amounts actually charged. Un-spent amounts from over-estimated cash calls made in one accounting period would result in lower cash requirements (and reduced cash calls) in future periods;
•: certain other minor adjustments have been made to allow for excision of a foreign exchange loss and a balancing adjustment incorrectly claimed as Company C Billed Expenditure; and
•: some amounts were allowed on objection.

225. Exhibited to Ms B's witness statement were records of payments made to Company C's accounts held with the Chase Manhattan Bank in respect of each cash call that concerns disputed Company C Billed Expenditure.

226. Ms C gave evidence of the taxpayer's accounting treatment of "exploration assets" (comprising geological, geophysical and geochemical surveys, exploration drilling and other costs of exploration). She said that the costs of exploration assets had been capitalised (broadly meaning they were moved from the company's profit and loss account to its balance sheet) when they were incurred. Once in the company's balance sheet as an asset they were amortised as a cost in the year in which the cost was incurred.

227. Ms C also explained the taxpayer's accounting treatment of "predevelopment assets" (comprising feasibility study expenditure incurred to evaluate the economic feasibility of mining once oil or gas reserves have been discovered). She said that the accounting treatment of predevelopment assets was the same as for exploration assets (or costs). That is, they were capitalised to the balance sheet when they were incurred and they were amortised as an expense at the same time as they were incurred. According to Ms C, expenses ceased to be a predevelopment asset for accounting purposes after a FID had been made.

228. Ms C gave evidence about the taxpayer's accounting treatment of expenses incurred in relation to a petroleum project after a FID had been made. She said that such expenses were capitalised to the balance sheet as a "development asset" where they would sit untouched until the asset started production or until it was written-off because it had been damaged or scrapped. Once production commenced, those expenses would be amortised under the "unit of production" method which broadly reflects the producing life of the asset. Thus, development expenditures, Ms C said, are amortised over the life of the petroleum project.

CONSTRUCTION OF SECTION 37

The relevance or otherwise of the treatment of exploration expenditure in the Income Tax Assessment Acts

229. Australia's Federal income tax legislation (in its various forms) has long contained provisions for the concessional treatment of exploration expenditure.

230. Concessional income tax treatment of exploration expenditure was first introduced in 1947, following recommendations made in the Second Report (Mining Taxation ) of the Mining Industry Advisory Panel of the Secondary Industries Commission of the Department of Post-war Reconstruction (Advisory Panel Report) in 1945. The Advisory Panel Report adopted the following definition of 'exploration' (at page 3):

Exploration or prospecting shall be defined as:

a)
Geological mapping, and systematic search for mineralised areas, and detailed search for ore deposits within these areas.

b)
Search for ore within or in the vicinity of an orebody by drives, shafts, cross-cuts, winzes, rises and drilling.

231. Importantly, the Advisory Panel Report (at page 3) recommended that the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) be:

.....widened to provide that any sums expended on exploration or prospecting on any mining tenures held, or held under option by companies, syndicates or individuals - whether such expenditure is incurred "in gaining or producing the assessable income" or not - be allowed as a deduction from income before assessing income tax of the company, syndicate or individual. Such allowance shall not include sums expended on the preparation of a deposit for mining and the onus shall be on the company, syndicate or individual to establish that the expenditure concerned relates only to exploration or prospecting . [Emphasis added]

232. Section 123AA, which was subsequently introduced into the ITAA 1936 by Income Tax Assessment Act 1936-1946 (Cth) provided:

(1)

Subject to this section, expenditure incurred by the taxpayer during the year of income on exploration or prospecting (other than for coal or gold, or for petroleum (as defined in the next succeeding section)) on any mining tenures held or held under option shall be an allowable deduction.

...

(4)

In this section ' exploration or prospecting' means -

(a): geological mapping, geophysical surveys, systematic search for mineralized areas, and detailed search by drilling or other means for ore deposits within those areas; and
(b): search for ore within or in the vicinity of an ore-body by drives, shafts, cross-cuts, winzes, rises and drilling, not being normal development. [Emphasis added]

233. In Taxation Ruling IT 2642 "Income Tax: Mining Exploration Expenditure" (IT 2642) (issued on 27 June 1991) the Commissioner addressed his views on when exploration or prospecting commences and ceases for the purposes of divs 10 and 10AA of the ITAA 1936. Former s 122JF of Div10 of the ITAA 1936 allowed deductions for expenditure incurred by the taxpayer on exploration or prospecting for minerals (but not petroleum) on mining tenements in Australia and former s 124AH of Div10AA allowing deductions for expenditure incurred on exploration or prospecting in Australia for the purposes of discovering petroleum. At [22] of IT 2642, the Commissioner stated:

There is no hiatus between the exploration and development stages of a mining operation, but the exploration stage generally continues until a decision is made to undertake the development stage of the mining operation. The development stage is part of the prescribed mining or petroleum operations......, and does not embrace exploration or prospecting work undertaken antecedently to any decision to establish a mine...

234. At [23] of the IT 2642 the Commissioner stated:

However, as a general proposition a decision to mine is taken when it is established that there exists a sufficient commercial quantity of mineral resources and that it would be economically feasible to carry out the mining operation. In determining the economic viability of a project it is necessary to weigh the market for the resource which is to be won and the price obtainable for it against all costs which will be incurred in winning a marketable commodity.

235. The Commissioner's views on "feasibility studies" were set out at [25] to [27] of IT 2642. The Commissioner's view, at that time, was that feasibility studies should be considered as part of exploration and prospecting expenditure for the purposes of the ITAA 1936.

236. In 1997, all of the mining and prospecting provisions were re-written into div 330 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) as part of the Government's "Tax Law Improvement Project". As part of the re-write, the definition of 'exploration' was substantially expanded. Division 330 dealt with both 'exploration expenditure' (for which a taxpayer was entitled to an immediate deduction for income tax purposes) and allowable capital expenditure (which cost was spread over the life of the mine).

237. The phrase 'exploration or prospecting' was defined in s 330-20 of div 330 of the ITAA 1997 (in part) as follows:

(1)

Exploration or prospecting includes:

...

(b)

in the case of *petroleum mining:

(i): geological, geophysical and geochemical surveys; and
(ii): exploration drilling and appraisal drilling; and

(c)

feasibility studies to evaluate the economic feasibility of mining *minerals or *quarry materials once they have been discovered

...

238. In 2001, the definition of 'exploration or prospecting' was moved from div 330 of the ITAA 1997 to div 40. It is now contained in s 40-730(4) and relevantly provides:

Exploration or prospecting includes:

(a)
for mining in general, and quarrying:

(i)
geological mapping, geophysical surveys, systematic search for areas containing minerals (except petroleum) or quarry materials, and search by drilling or other means for such minerals or materials within those areas; and

(ii)
search for ore within, or near, an ore-body or search for quarry materials by drives, shafts, cross-cuts, winzes, rises and drilling; and

(b)
for petroleum mining:

(i)
geological, geophysical and geochemical surveys; and

(ii)
exploration drilling and appraisal drilling; and

(c)
feasibility studies to evaluate the economic feasibility of mining minerals or quarry materials once they have been discovered ; and

(d)
obtaining mining, quarrying or prospecting information associated with the search for, and evaluation of, areas containing minerals or quarry materials. [Emphasis added]

239. On 16 December 1998, following the amendments to the ITAA 1997, the Commissioner issued Taxation Ruling TR 98/23 "Income Tax: Mining Exploration and Prospecting Expenditure" (TR 98/23) (to replace IT 2642). At [10] and [11] of TR 98/23 the Commissioner stated:

10. The exploration stage of a mining or quarrying project continues until a decision to undertake the development stage is made. It is a question of fact, having regard to the nature and purpose of the expenditure being incurred, whether a taxpayer is in the exploration or development stage. However, expenditure on exploration or prospecting can continue after a decision to mine or quarry has been made.

11. Expenditure incurred on feasibility studies to evaluate the economic feasibility of mining minerals or quarry materials once they have been discovered, is expenditure within the meaning of 'exploration or prospecting' in section 330-20.

The taxpayer's position

240. According to the taxpayer, the Commissioner's views as expressed in IT 2642 (and, its replacement, TR 98/23), are consistent with the taxpayer's contention that operations directed to ascertaining whether an identified resource is viable to enable a decision to proceed to production to be made is 'in connection with' exploration. In support of the relevance of these concepts, the taxpayer referred to the Commissioner's Objection Decision in this case which stated TR 98/23 "provides some guidance in determining the meaning of 'exploration' for the purposes of paragraph 37(1)(a) of the PRRTAA."

241. However, Mr de Wijn QC for the taxpayer submitted, the Commissioner now seeks to confine the scope of "operations ... in connection with exploration" to activities "for the purposes of determining whether a discovered petroleum pool is technically capable of production" and that activities directed to evaluating a petroleum discovery are not "in connection with" exploration. In the taxpayer's submission, that approach should not be accepted.

242. First, the taxpayer submits, the text of the PRRTA Act does not permit the character of operations as being 'in connection with exploration' to be determined merely by reference to whether the operations are directed to determining whether a petroleum pool is "technically capable of production".

243. Second, activities such as feasibility studies are necessary pre-requisites to any decision to proceed with development of a petroleum project. In the absence of identifying the most efficient way to extract and transport a resource safely and in the absence of liaising with regulatory authorities it would not be possible to decide to develop a petroleum project.

244. Third, the Commissioner's Taxation Ruling IT 2642, which expressed his then view that feasibility studies should be considered as part of exploration and prospecting expenditure for the purpose of the ITAA 1936, was published prior to the income tax legislation being amended to accord with that position. IT 2642 was not dependant on the word 'exploration' being read in the context of an extended statutory meaning. It was an application of the ordinary meaning in the relevant context. Similar language in other tax related legislation should be understood to have been intended to carry a similar meaning.

Commissioner's position

245. The Commissioner's position, as advanced by Mr Steward SC, was that there is no equivalent to s 40-730(4)(c) of the ITAA 1997 in s 37 of the PRRTA Act. Rulings by the Commissioner concerning the meaning of the language in the ITAA cannot be relevant to the meaning of expenditure contained in the PRRTA Act. The only equivalent to s 40-730(4)(c), for PRRT purposes, is found in s 38(a) (now s 38(1)(a)). The absence of similar words, as those found in s 40-730(4)(c), in s 37 of the PRRTA Act, is, in the Commissioner's submission, telling.

246. Accordingly the Commissioner submitted:

•: that the ordinary and natural meaning of the term 'exploration' does not include expenditure on "feasibility studies to evaluate the economic feasibility of mining minerals or quarry materials once they have been discovered". If it did, sub-Para (c) of the definition in s 40-730(4) of the ITAA 1997 would not have been required; and
•: that s 37 of the PRRTA Act, because it contains no equivalent to such language as that found in subpar (c) of s 40-730(4), does not provide a deduction for expenditure of the kind contended for by the taxpayer in this review application.

247. The Commissioner submitted that the definition of 'exploration or prospecting' in the income tax legislation (as it then read) was inclusive. That is, it included everything encompassed by the ordinary and natural meaning of the word 'exploration'. According to the Commissioner, notwithstanding IT 2642, by inserting the words that appeared in subparagraph (c) of that definition, Parliament recognised that they were not part of the ordinary meaning of the word 'exploration'. If they had been there would have been no need for their inclusion. In support of that proposition, the Commissioner referred to the decision of the Full Federal Court in Commissioner of Taxation v Ampol Exploration Ltd (1986) 13 FCR 545.

Tribunal's view

248. The Tribunal considers that both IT 2642 and TR 98/23, relied upon bythe taxpayer, addressed a different section, with different language, contained in a different Act, with its own quite different history, purpose and context. We accept the Commissioner's submissions that those Rulings cannot govern, and do not assist in understanding, what is meant by 'exploration' in s 37(1) of the PRRTA Act.

249. The Commissioner's rulings, whether they relate to income tax legislation or the PRRTA Act, do not bind this Tribunal or the courts. They are of considerable significance for the administration of the taxation system but in strict legal theory they simply represent the Commissioner's views on that legislation at a particular point in time. Whilst the taxpayer may understandably feel aggrieved, we can identify no reason why the Commissioner is estopped on this review from withdrawing his concession in the Objection Decision in this case in which he had stated TR 98/23 could be used as some guidance in determining the meaning of 'exploration' for the purposes of s 37(1)(a) of the PRRTA Act: see [241].

250. The Tribunal is obliged to reach the 'correct or preferable' decision. It is obliged to apply the law as it understands it to be. As the Full Federal Court observed in Esso Australia Resources Pty Ltd v Federal Commissioner of Taxation (2012) 200 FCR 100 at [96]:

The taxation regime established by the [PRRTA] Act is significantly different from that established under the [ITAA 1936] and the [ITAA 1997]. The [PRRTA] Act is not concerned to impose tax on the net income of a resident taxpayer ascertained by deducting from the entirety of the taxpayer's assessable income, derived from all sources, the entirety of the taxpayer's allowable deductions. The Act is concerned to impose tax on the taxable profit derived by a person in relation to a particular petroleum project.

Subject to what we have written at [255]-[291] below with respect to relevant extrinsic materials we are of the view that the current construction of s 37 of the PRRTA Act must be discerned from the terms of that legislation alone.

Relevant Extrinsic Materials

251. In Stevens v Kabushiki Kaisha Sony Computer Entertainment and Others (2005) 224 CLR 193 at 230 McHugh J said at [124]:

In determining issues of statutory construction, the text of the relevant statutory provision must be evaluated not only by reference to its literal meaning but also by reference to the purpose and context of the provision......For purposes of statutory construction, context includes the state of the law when the statute was enacted, its known or supposed defects at that time and the history of the relevant branch of the law, including the legislative history of the statute itself. It also includes in appropriate cases "extrinsic materials" such as reports of statutory bodies or commissions and parliamentary speeches - indeed any material that may throw light on the meaning that the enacting legislature intended to give to the provision. That is the process required by the modern approach of the common law to statutory construction. In many jurisdictions, the common law principles have been incorporated, extended or modified by statute. Section 15AA of the Acts Interpretation Act 1901 (Cth) requires a court construing federal legislation to have regard to its purpose. Section 15AB of that Act authorises the use of various forms of extrinsic material to determine the meaning of that legislation.

It is therefore useful, in order to determine the correct construction of s 37 of the PRRTA Act, to commence with a brief analysis of the legislative history.

History

252. We are indebted to the careful research of counsel and their instructing solicitors which has informed the summary which follows.

253. The PRRTA Act was enacted in 1987 as a project based profits tax. It replaced the pre-existing royalty regime. Crude oil and LPG had been subject to an ad valorem 'excise' levied by the Commonwealth government pursuant to the provisions of the Excise Act 1901 (Cth) and the Excise Tariff Act 1921 (Cth). Petroleum production was subject to 'royalties' levied by the States and the Northern Territory in respect of onshore and offshore production in the territorial sea and by the Commonwealth in respect of production beyond the territorial sea: see Petroleum (Submerged Lands ) ( Royalty) Act 1967 (Cth). The 'royalty' was a fixed percentage of the "wellhead value" of the petroleum calculated as sales receipts less certain deductions for costs incurred in bringing the petroleum from the wellhead to the point of sale (including excise).

1983 Discussion Paper

254. The Commonwealth Government's Discussion Paper on Resource Rent Tax in the Petroleum Sector , dated December 1983 (1983 Discussion Paper) proposed the introduction of a PRRT. By way of Introduction, the 1983 Discussion Paper stated:

2 The Government has decided to concentrate at this time on the petroleum sector.....The objective is to have the [P]RRT encompass all petroleum mining (ie for crude oil, condensate, LPG and natural gas) and to replace existing excises and royalties...

3 This paper is being circulated as a basis for discussions and consultation with State Governments, petroleum producers and explorers and other interested participants in the petroleum industry. It identifies the major issues arising from the [P]RRT proposal and canvasses possible responses on those issues.

4 It is emphasised that the while the paper indicates the Government's current thinking on a number of points, it does not indicate the Government's final position ... [Emphasis added]

255. The Government's 'thinking' on the PRRT (at [15]) was that the tax:

...would apply to profits derived from petroleum activities which exceed some minimum or threshold level. Profitability would be determined by reference to actual expenditures which can be determined objectively from accounting records, rather than by reference to less easily defined concepts such as shareholder's funds...

and, further (at [31]), that it:

...would apply to profits derived from activities within the boundaries of petroleum development projects.

256. The 'project' based nature of the proposed PRRT was described at [29] as follows:

Where the immediate deductibility of capital expenditure is allowed for [P]RRT purposes, as in the proposed system, it is important, in the interests of protecting the revenue base, that the tax be applied separately to each individual project and not to aggregate company results. This suggests that expenditures (with the possible exception of exploration expenditures, see below in paragraph 37) incurred on a petroleum project should only be offset against income for [P]RRT purposes derived from that project and not against income the company might have from other petroleum projects.

257. However, the 1983 Discussion Paper also acknowledged the need for restrictions to be placed on the entitlement to deductions for "exploration expenditure". In this regard, the 1983 Discussion Paper stated at [36]:

...in practice, some restrictions will need to be placed on the eligibility of exploration expenditures as deductions against RRT, and/or the value of eligible deductions restricted. With a project basis of assessment, exploration expenditure incurred within the boundaries of a successful project would be deductible in full. That incurred in areas outside those where successful finds were made, however, would not, on a strict project basis, be permitted to be written off, for RRT purposes, against income generated from producing fields. Such an interpretation could impact adversely on exploration activity which, as already indicated, is not the Government's intention.

258. At [37] it identified two possible approaches to the treatment of 'unsuccessful exploration expenditure'. One approach would be to incorporate in the threshold rate(s) a uniform allowance for the 'risks' associated with exploration. An alternative approach "would be to allow some modification to the project basis of assessment in the case of unsuccessful exploration expenditures". By way of illustration the following possible options were set out (at [37]):

(i): Permit, within limits, abortive exploration expenditure incurred by a company after the introduction of the RRT to be carried forward up to the point in time at which a project, in which the company has an interest, begins paying RRT. This carried forward expenditure would be deductible for RRT purposes at any time. Subsequent abortive exploration expenditure by that company outside the RRT project area would be carried forward similarly until a second project in which it had an interest became liable for RRT, and so on.
(ii): Allow, subject to certain safeguards, the purchase by companies with projects liable to RRT, the rights to (undeducted) unsuccessful exploration expenditure incurred after the introduction of the RRT by other companies for use as a basis for an immediate deduction for RRT purposes. Revenue considerations are likely to dictate that such deductions be allowed at a "standard" rate, with an overall objective of maintaining incentives for exploration.

259. The Government's 'thinking' included the following at [56]:

Both current and capital expenditure (but not interest payments and other expenses of servicing capital) would be written off in the year in which they were incurred, with any excess of expenditures over income at the end of the year being compounded forward to the following year at a "threshold rate".

When a project had recouped its outlays plus the threshold rate of return, compounded from year to year as appropriate, further returns would be liable for tax at the relevant tax rate. If in subsequent years net receipts were negative (eg because of new capital expenditures) the project would cease to pay tax until the threshold rate had been earned on that new expenditure.

The tax would be applied separately to each individual project and not to aggregate company results. In other words, with the possible exception of exploration expenditures, expenditures incurred on one petroleum project would only be able to be offset against income derived from that project , and not against any income the company might have from its other activities. [Emphasis added]

260. The 1983 Discussion Paper stated at [57] that it would be particularly interested in receiving industry comments on:

The treatment of unsuccessful exploration expenditure , accepting that in one way or another appropriate arrangements will need to be made to help sustain exploration activity at an acceptable level. [Emphasis added]

1984 Discussion Paper

261. In February 1984, the Commonwealth Government published a further discussion paper entitled Effects on Exploration of Resource Rent Tax with Full Exploration Loss Offsets (1984 Discussion Paper). At page 4 (Concluding Remarks) it noted:

An RRT with full exploration loss offsets could be expected to have a positive effect on decisions to explore compared with the existing arrangements for "new" oil

...the Government has not offered to provide full exploration loss offsets.

Industry responses to the RRT Discussion Paper appear to be particularly concerned at the effects on exploration activity of an RRT which reduces net revenue without any reduction in exploration outlays...

April 1984 Joint Press Release

262. On 18 April 1984, the then Treasurer, the Hon Paul Keating, and the then Minister for Resources and Energy, the Hon Peter Walsh announced, by joint press release ( Future Taxation Arrangements for the Petroleum Sector ), the Government's intention to introduce a resource rent tax applicable to 'greenfields' offshore petroleum projects (April 1984 Joint Press Release). The April 1984 Joint Press Release included the following statement:

(iii): offshore petroleum projects which have not yet reached the development stage (ie "greenfields" projects) will be subject to a resource rent tax but no excise or royalty will apply.

June 1984 Joint Statement

263. In a joint statement, Resource Rent Tax on " Greenfields " Offshore Petroleum Projects (dated 27 June 1984) the then Treasurer, the Hon Paul Keating, and the then Minister for Resources and Energy, the Hon Peter Walsh, outlined the principal policy elements of the proposed resource rent tax (June 1984 Joint Statement).

264. At page 6 of the June 1984 Joint Statement the Ministers announced the Government's resolution on the threshold tax rate issue as follows:

The government has given further consideration to the threshold tax rate. In light of strong representations made by industry, it has decided that the threshold should be set at the long term bond rate plus 15 percentage points. And that the tax rate is to be 40%.

265. The June 1984 Joint Statement described the concept of 'exploration expenditure' (at page 7) as follows:

Eligible exploration expenditure will be expenditure within the original exploration permit area from which the associated production licence(s) is drawn. Eligible exploration expenditure from 1 July 1984 will be deductible for RRT purposes against assessable receipts derived from the production licence area(s) contained within the original permit area in which the exploration takes place. The Government has also decided to allow deductions for eligible exploration expenditure made in the 5 years preceding 1 July 1984 on the same basis as for that made on or after that date.

Any eligible undeducted exploration expenditure at the end of a year will be carried forward year by year. However, the period prior to the granting of the first production licence over which the eligible exploration expenditure may be compounded year by year at the threshold rate will be limited to 5 years. Expenditure prior to that 5 year period will not attract compounding at the threshold rate; instead, such expenditure will be compounded year by year at a rate equal to the GDP deflator so as to allow for the effects of inflation and deducted after all expenditure subject to the threshold rate has been deducted.

266. Attachment 1 to the June 1984 Joint Statement provided further detail on the tax base, specifically assessable receipts and deductible expenditures. It stated, relevantly (at pages 2 to 3):

DEDUCTIBLE EXPENDITURE

Capital and current expenditures directly related to a project which is assessable for RRT purposes will be deductible in the year of payment.

Exploration Expenditure

Exploration expenditure for RRT purpose will be defined in broadly the same manner as it is under the company tax provisions for petroleum miners, and will include, for example, geological, geophysical and geochemical surveys, exploration drilling and appraisal drilling .

Other expenditure

Other deductible project expenditures will generally comprise those in respect of a production licence area and expenditures outside that area necessary to obtain a marketable petroleum product.

Some indicative examples of the kinds of expenditures which will be allowed as deductions are:

•
expenditure on production platforms, drilling plant and equipment and overheads at the wellhead;

•
expenditure on pipelines and other facilities (including tankers dedicated to the project) for transporting petroleum from the wellhead to a mainland reception point or to a point of further treatment as described hereunder;

•
expenditure on plant for use in treatment processes necessary to produce a marketable petroleum product, eg expenditure on a crude oil stabilisation plant, or a gas liquids fractionation plant; ...

•
costs of feasibility studies and environmental studies related to the project. [Emphasis added]

1986 PRRTA Bill

267. The Petroleum Resource Rent Tax Assessment Bill 1986 (1986 PRRTA Bill) was introduced into Parliament in 1986. The 1986 PRRTA Bill lapsed when Parliament was dissolved for the 1987 Federal election: see Woodside Energy Ltd v Federal Commissioner of Taxation (No 2 ) [2007] FCA 1961 at [244]-[259].

1987 PRRTA Bill

268. Following the 1987 election the Petroleum Resource Rent Tax Assessment Bill 1987 (1987 PRRTA Bill) was introduced into Parliament. In his Second Reading in the House of Representatives on 21 October 1987, Mr Kerin (then Minister for Primary Industries and Energy) stated (House of Representatives, Debates (1987) Vol HR157, pp 1215-1216):

In contrast to production-based secondary tax regimes, the petroleum resource rent tax will be payable only in respect of projects earning a high rate of return on outlays.....It strikes a reasonable balance between the objectives of satisfying the right of the community as a whole to share in the benefits of a profitable offshore petroleum projects, and of providing the participants with adequate returns for the risks they accept in undertaking offshore exploration and development activities. The Bill incorporates amendments made after Government consideration of representations made by the petroleum industry. The provisions of the Bill, nevertheless, follow closely the proposal as announced in June 1984...

Exploration expenditure consists, broadly, of expenditure-other than excluded expenditure-in an exploration permit area that is directly related to exploration for petroleum and will include expenditure on the recovery of petroleum and the production of a marketable commodity prior to the coming into force of a production licence. Exploration expenditure includes related expenditure on storage and processing facilities and on employee amenities. Exploration expenditure will be deductible against assessable receipts of any project established within the exploration permit area.

269. The Explanatory Memorandum (EM) to the 1987 PRRTA Bill described the main features of the Bill. It explained (at page 4):

[u]nlike royalty and excise arrangements, the petroleum resource rent tax is profit-based, rather than being based on production. It will apply only where there is an excess of project-related receipts for a financial year over project-related expenditure for the year [in addition to other types of expenditure].

270. The EM further stated (at page 8):

Deductible expenditure

(Clauses 32 to 45)

Expenditure of both a capital and revenue nature which is directly related to a petroleum project will be deductible in the year it is incurred against any assessable receipts for the year.........Deductible expenditure is of 3 types - exploration, general project expenditure and closing-down expenditure.

Exploration expenditure comprises all expenditure (other than excluded expenditure...) in an exploration permit area prior to the coming into force of a production licence that is directly related to exploration for petroleum, its recovery and the production of a marketable commodity. Such expenditure includes that on storage and processing facilities and on employee amenities.

271. In relation to the meaning of 'exploration expenditure incurred by a person in relation to a petroleum project' the EM (at pages 67 to 68) stated:

By sub-clause (1), exploration expenditure in relation to the petroleum project will be taken to have been incurred when certain payments (other than excluded expenditure in terms of clause 44) of either a capital or revenue nature are liable to be made . The payments include, in terms of paragraph (a), those liable to be made 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.

...

Exploration expenditure will also consist of payments liable to be made in providing services, or facilities for the provision of services, in connection with the operations, facilities, amenities and services referred to in the clause...

272. As regards the distinction between 'exploration expenditure' and 'general project expenditure' the EM (at page 67) stated:

Expenditure on operations and facilities involved in recovering any petroleum from the eligible exploration or recovery area (other than any production licence area) in relation to the project will form part of a person's exploration expenditure ... As a project comes into existence when a production licence comes into force, expenditure on recovery of petroleum from the production licence area, being a project-specific cost, would form part of the person's general project expenditure...

273. In relation to the concept of 'petroleum project' the EM stated (at pages 35 to 36):

As petroleum resource rent tax is to be assessed on a project basis, the concept of a petroleum project is an essential aspect of the tax ......Broadly, a petroleum project will exist in relation to a production licence area and will comprise recovery, treatment and other facilities and operations which are integral to the production and initial on-site storage of a marketable petroleum commodity. The project boundary will not extend beyond the point at which a marketable petroleum commodity is initially stored, on-site, after production.

274. The EM explained (at page 54) that 'exploration expenditure' might be incurred years before it was eligible to be deducted at varying compounding rates (see ss 34 and 35):

Where there is an excess of deductible expenditure (other than closing-down expenditure) over receipts at the end of a year, that excess will be compounded forward for deduction against future receipts from the project. As explained in earlier notes, the rate of compounding will depend upon the time at which the relevant liability was incurred - expenditure incurred more than 5 years before the first production licence in the exploration permit area came into force being compounded at the GDP deflator rate and other expenditure being compounded at the long-term bond rate plus 15 percentage points.

1991 Amendment Act

275. In 1991, the Petroleum Resource Rent Legislation Amendment Act 1991 (Cth) (1991 Amendment Act) amended the PRRTA Act to enable undeducted 'exploration expenditure' for a project (incurred after 1 July 1990) to be transferred by a company to another of its projects, where a notional taxable profit had been achieved by that company. In the case of a company within a corporate group, the expenditure was also made transferable to other projects liable to PRRT held within the group. Those changes represented a 'modification' to what otherwise was the strict 'project' approach of the PRRTA Act.

276. In the Second Reading Speech to the 1991 Amendment Bill (on 9 May 1991) the then Treasurer, the Hon Paul Keating, having discussed the proposed application of the PRRT to the Bass Strait, stated the following in relation to the policy underlying the proposed changes (House of Representatives, Debates (1991) Vol HR177, pp 3436-3437):

The [1991 Amendment] Bill also introduces a generous concession to exploration activities, permitting the deduction of exploration expenditure incurred from 1 July 1990 in respect of all offshore operations subject to the [P]RRT, against [P]RRT liability on a wider basis than at present.

...

The resource rent tax is based on achieved profits rather than production levels and is, therefore, sensitive to changes in prices and costs.

...

The introduction of wider deductibility for exploration expenditure will improve the efficiency of the resource rent tax and stimulate the exploration effort in offshore Australia. Previously, deductibility was limited to individual permit areas. The new arrangements make the after tax cost of exploration within RRT paying permits the same as the cost outside those permits. The current disincentive to explore in frontier areas will, therefore, be removed, an important change for the discovery of new hydrocarbon accumulation.

In recognition of the significant benefits to industry of wider deductibility of exploration expenditure, the existing carry forward arrangements for undeducted expenditures under the RRT will be modified. The new arrangement will reflect the relative likelihood of recovering exploration and development expenditures, in contrast to the existing composite carry forward rate. The carry forward rate for general expenditures incurred from 1 July 1990 will be reduced from the long term bond rate plus 15 percentage points to the long term bond rate plus five percentage points. Undeducted exploration expenditure will continue to be eligible for compounding at the long term bond rate plus 15 percentage points.

...

To minimise the risk that project specific expenditure for unsuccessful or marginal projects would not be deducted, the amendments will provide for an order of deductions that will ensure project specific expenditures are written off first.

277. The Explanatory Memorandum to the Petroleum Resource Rent Legislation Amendment Bill 1991 (1991 Amendment Bill) set out (Ch 6 page 48) the principles governing the calculation of transferable expenditure as follows:

PRRT is currently assessed on a project basis - the essential boundary of a project being a production licence. Only assessable receipts and deductible expenditure of the project are taken into account when assessing the taxable profit of the project.

A limited exception to this rule is that augmented bond rate exploration expenditure and GDP factor expenditure incurred by a person in relation to a project that is within a project group can be offset against assessable receipts of any person within that project group. Broadly, a project group is made up of projects with production licences drawn from the same exploration permit.

278. This modification extended only to 'exploration expenditure' under s 37 of the PRRTA Act. In contrast 'general project expenditure' under s 38 of the PRRTA Act remained (and remains) incapable of transfer. It remained only deductible against the assessable petroleum receipts of the same project.

279. Following the 1991 Amendment Act, 'deductible expenditure' is now defined in s 32 of the PRRTA Act as follows:

...the deductible expenditure incurred by a person in a financial year in relation to a petroleum project ... is a reference to the total expenditure of the following kinds incurred by the person in the financial year in relation to the project:

(a)
class 1 augmented bond rate general expenditure;

(b)
class 1 augmented bond rate exploration expenditure;

(c)
class 2 augmented bond rate general expenditure;

(d)
class 1 GDP factor expenditure;

(e)
class 2 augmented bond rate exploration expenditure;

(f)
class 2 GDP factor expenditure;

(g)
closing-down expenditure.

280. Whether transferable or not, expenditure on 'exploration' is only deductible after there is a project which produces assessable petroleum receipts. The reason for this is that there must be a "project" in order to include exploration expenditure in any calculation of a "taxable profit' for the purposes of s 21 of the PRRTA Act. The Explanatory Memorandum to the 1991 Amendment Bill describes this design feature (at page 59) as follows:

Parts 2 and 3 of the Schedule calculate amounts of expenditure incurred in relation to a petroleum project. Broadly, a petroleum project is taken to exist under section 19 of the Principal Act [namely, the PRRTA Act] only when there is a production licence in force. Therefore, under the existing law, assessable receipts delivered and deductible expenditure incurred cannot be brought into the PRRT calculation unless a production licence has been granted. The general principle of wider deductibility of exploration expenditure is that any undeducted exploration expenditure be transferred to a project that would otherwise have a PRRT liability. Consequently Part 4 of the Schedule will calculate transferable exploration expenditure that is incurred in respect of an exploration permit or retention lease prior to an issue of a production licence. The undeducted exploration expenditure will be transferable in the same way as transferable expenditure incurred in respect of a project.

281. All expenses in relation to a petroleum project (whether on capital or revenue account) are taken into account by way of a system of "augmentation". That is, the expenditure is augmented by reference to the long-term bond rate plus an amount which is intended to reflect the "risks" associated with the petroleum industry. Then, once the revenue or incomings exceed the outgoings (as augmented) the tax rate of 40% applied to that difference.

282. The policy behind the proposed reduction under the 1991 Amendment Bill in the augmentation rate for "exploration expenditure" to that of "general expenditure" appears, from Mr Keating's Second Reading Speech, to be to encourage 'exploration' for petroleum and since there is greater "risk" in the search for new reserves, a higher augmentation rate should be available in that expenditure.

Meaning of 'exploration'

283. The term 'exploration' is not defined in the PRRTA Act for the purposes of s 37. We are bound to construe it according to its ordinary meaning albeit taking into account its context and legislative purpose "unless some technical or special meaning is indicated": see Woodside Energy (2007) per French J at [261].

284. "Exploration" is defined in the latest edition of The Macquarie Dictionary (Fifth Edition, 2009) (at page 584) as "1. The act of exploring. 2. The investigation of unknown regions".

The term "explore" is defined (at page 584) to mean:

1. To traverse or range over (a region, etc ) for the purpose of discovery. 2. to look into closely; scrutinise; examine. 3. Surgery to investigate, especially mechanically, as with a probe. 4. Obsolete to search for; search out - verb (i) 5. To engage in exploration.

'Exploration' and 'explore' are defined in numerous other dictionaries in substantially similar terms.

Mr A's evidence on the "exploration" and "production" phases

285. The taxpayer's witness, Mr A, gave evidence based on his experience in the mining industry, that there are two broad phases to a successful gas project - "exploration" and "production". Mr A was not purporting to define what was meant by "exploration" for the purposes of s 37(1) of the PRRTA Act but rather to illustrate his understanding of what the exploration phase of the project involved. The Tribunal received Mr A's evidence on that basis.

286. According to Mr A, the 'exploration phase' of an oil and gas project commences with the grant of an exploration permit. If hydrocarbons (oil or gas) are discovered then it continues until a decision is made to proceed with production or abandon the project.

287. Mr A said that a number of different activities are undertaken during the 'exploration phase' in order to enable geological, engineering, commercial, regulatory and environmental issues to be investigated.

288. Mr A's experience is that, during the "exploration phase", if a gas discovery is made, the following questions are normally addressed:

•: How much gas is in the place (known as GIIP);
•: What is the composition of the gas;
•: What additional information is required about the sub-surface to better understand the reservoir volumes and the flow rate of the gas over time;
•: Where the reserves are situated, and are there any geographical or environmental constraints in extracting the resource;
•: Should an appraisal well (or further appraisal wells) be drilled;
•: What available options are there for developing the reserve;
•: Is there a green field or brown field market by which the resource can be sold;
•: What are the market constraints;
•: Are there any other constraints such as resourcing, regulatory or native title considerations;
•: Are there any technical or engineering difficulties with developing the reservoir or getting the gas to market; and
•: Are there any political impediments to the project proceeding?

289. Mr A observed that the above process of analysis is iterative rather than linear and some or all of these steps may be repeated several times during the 'exploration phase'. In other words, during the exploration phase, the permit holder will continuously review the available information and decide whether or not the investigations should continue, with a view ultimately to commit to the 'production phase'.

290. According to Mr A, the exploration phase ends when a decision to make the capital investment necessary to enable the project to go into production is made. That decision is known in the industry as a FID.

291. In the course of giving evidence before the Tribunal, extracts from two publications were put before Mr A: the Australian Bureau of Agricultural and Resource Economics (ABARE) Research Report No 96.4 'Net economic benefits from Australia's Oil and Gas Resources Exploration, Development and Production' (ABARE Report) which was issued in 1996; and the publication Petroleum Rent Collection around the World by Alexander Kemp of The Institute for Research on Public Policy (1997) (Kemp Publication). He said that, based on his own experience, he broadly agreed with the content of those extracts. In Mr A's experience, the production phase of a gas field commences once the exploration phase is completed, which is usually marked by: (i) entry into an unconditional gas sales agreement; and (ii) the making of a formal application for the grant of a production licence. Only then, he stated, is there a commitment by the joint venture to begin the development, construction and operation of the facilities to deliver gas as contracted during the production phase.

The taxpayer's approach

292. In the taxpayer's submission, the ordinary meaning of 'exploration' when referred to in the context of mining is not limited to the discovery or identification of a particular thing (in this case, the detection of the presence of a petroleum resource) but extends to the investigation, scrutiny, examination and appraisal of that which is sought. In the context of offshore petroleum, the taxpayer's contention is that the concept of 'exploration' includes not only work directed to detecting the presence of hydrocarbons, but also to work directed to evaluating, appraising and scrutinising a potential project after a discovery has been made to ascertain whether production might be economically or commercially viable. According to the taxpayer, the breadth of the ordinary meaning of the term 'exploration' in the context of mining projects is demonstrated in Mount Isa Mines Limited v Federal Commissioner of Taxation (1954) 92 CLR 483.

293. In discussing the distinction between 'development' and 'exploration' (in the context of s 122 of the ITAA 1936), Taylor J (at 489 to 491) expressed himself as follows:

The section permits a person who is carrying on mining operations for the purpose of gaining or producing assessable income to treat a wide class of expenditure of a capital nature as deductible for the purposes of the Act over a period calculated by reference to the estimated life of the mine, and it is inconceivable that the legislature intended to permit such a deduction in the case of capital expenditure incurred on development, in the sense of work preparatory to the commencement of or ancillary to actual mining operations, and yet deny such a deduction in respect of expenditure of a capital nature necessarily incurred contemporaneously with and directly in association with mining operations. This consideration alone would, I think, dispose of any suggestion that the word "development" should be understood in any restricted sense ...

At all events I am satisfied that all other expenditure of a capital nature directly attributable to the establishment of the mine and to the working of it or to its expansion or extension from time to time should, for the purposes of the section, be regarded as expenditure on the development of the mining property.

...

But quite apart from the provisions of s 123AA it is reasonably clear that, in general, prospecting and exploration work precedes the work of "development" however broadly that term may have been used in s 122. As a rule the former work is undertaken to ascertain , as far as possible, whether the commencement of mining operations would be justified or prudent . Prospecting work which is preparatory in this sense is, in my opinion, not embraced by the word "development". [Emphasis added]

294. The taxpayer submitted that the reference by Taylor J to exploration work being undertaken to ascertain whether commencement of mining would be "justified or prudent" is significant in that it demonstrates that the concept of 'exploration' is not limited to detecting the presence of a resource but is also concerned with ascertaining the viability of developing that resource and commencing production. Thus, as a rule 'exploration' work includes everything undertaken to ascertain whether the commencement of mining operations would be "justified or prudent".

295. In support of its position, the taxpayer referred the Tribunal to the ABARE Report. In the ABARE Report, a distinction was drawn between the "exploration phase" which, in the case of gas projects was stated to include establishing sales contracts, appraisal activities and feasibility studies for future development and production, and the "development phase" which involves constructing the infrastructure required for production of the resource. The relevant passages of the ABARE Report the taxpayer relied upon (from pages 23 to 24) were:

Key stages in the exploration, development and production of oil and gas resources

Although there is considerable uncertainty in the BRS assessment, Australia is likely to have significant quantities of undiscovered oil and gas resources. Exploration is required to discover the location, size and quality of oil and gas fields. Producers must identify the appropriate technology, subject to environmental and other constraints, for the development of the field. If a field is assessed to be economic - in the case of gas or LNG, long term contracts must be established for sales - the field is subsequently developed and economically recoverable share of the oil and gas resources is produced. Notably, there are significant time lags involved in the exploration, development and production of oil and gas ...

In the exploration phase , oil and gas companies use a range of survey techniques to identify prospective fields. These may be geological, gravity, magnetic, seismic (2D and 3D) or geometrical surveys. In prospective areas, new field wildcat wells are drilled to discover the location of accumulations. In the event of a discovery, appraisal wells may also be drilled to provide a more accurate indication of the potential size and quality of the oil and gas resources. If the discovery is significant, a feasibility study of the field for future development and production is undertaken.

The development phase involves the construction of the infrastructure required for the production of the resource. Depending on the location and resource type, this infrastructure includes development wells, production facilities, a gathering system to connect individual wells to processing facilities, temporary storage facilities, and transport facilities such as pipelines, ships or trucks. Offshore and onshore accommodation facilities may also be required. There is an important distinction in the production process required for oil and natural gas. Oil field developments can incorporate relatively simple storage and mobile transport facilities. However, this is not the case for gaseous products. Gas producing wells must be connected to pipeline facilities. Nevertheless, irrespective of the fuel type, the oil and gas extraction process involves a complex set of integrated processes . [Emphasis added]

296. In further support of its position, the taxpayer referred the Tribunal to an extract from the Kemp Publication, which states (at page 12):

When contemplating an exploration program, investors have to consider all the factors discussed above in addition to the most basic risk, namely, that of finding petroleum in commercial quantities. At the exploration phase the investor has to consider not only the chance of finding oil but also the likely sizes of the fields, their exploitation costs, and the revenues which could be obtained.

297. The taxpayer also referred the Tribunal to the decision of Sundberg J (at first instance) in Esso Australia Resources Ltd v Federal Commissioner of Taxation (1997) 144 ALR 458 as support for what it submitted was meant by 'exploration'. In that case, Sundberg J considered certain evaluation activities of the taxpayer, albeit in the context of the ITAA 1936 and not the PRRTA Act. At 467 his Honour stated:

In each year of income the taxpayer claimed as a deduction the expenditure it had incurred in investigating the acquisition of interests in potential joint ventures for the exploration and mining of coal, oil shale and minerals.

...

The nature of the evaluation varied from case to case. Sometimes there was a simple in-house review of published geological information. In other cases there was a full-scale study requiring on-site work, geological review, mine planning, marketing studies and a full economic appraisal.

298. His Honour concluded that the taxpayer was not entitled to an income tax deduction for the cost of those activities because they were exploration costs and the taxpayer's business was not an exploration business. In reaching that conclusion, his Honour stated (at 470):

The costs in question were of course incurred in the course of the taxpayer's exploration activities. But in the relevant years the taxpayer was not in the business of exploration. It did not engage in exploration for reward. It did not sell any of its exploration information, or otherwise earn fees for its exploration activities.

299. On appeal, in Esso Australia Resources Ltd v Commissioner of Taxation (1998) 84 FCR 541 at 556 [C], the Full Federal Court (Lee, Heerey and Merkel JJ) held that "no error has been demonstrated in relation to his Honour's characterisation of the appellant's exploration activities...".

Commissioner's approach

300. The Commissioner's position was that there is no indication in the PRRTA Act (or in the relevant extrinsic materials) that the term 'exploration' carries a meaning other than its ordinary meaning: NSW Associated Blue-Metal Quarries Limited v Federal Commissioner of Taxation (1956) 94 CLR 509 at 511-512 per Kitto J. The Commissioner submitted that, applied in its ordinary sense, 'exploration' in s 37 means seeking to detect the presence of a petroleum resource.

301. The Commissioner submitted that there was nothing in the PRRTA Act to suggest that a trade usage of the term 'exploration' should be preferred over its ordinary meaning. The Commissioner did not dispute that the Tribunal had received evidence that might suggest that trade usage was attached to the expression 'exploration phase'. However that expression was not one used in the PRRTA Act. Nor was the distinction between the 'exploration phase' and 'production phase' a relevant distinction for the purposes of the PRRTA Act. The relevant distinctions referred to in the PRRTA Act were those relating to exploration expenditure, general expenditure and exempt expenditure. Accordingly, the Commissioner submitted, there is nothing in the PRRTA Act to suggest that a trade usage of the term 'exploration' existed or that it should be preferred to the word's ordinary meaning.

302. In support of its contention, the Commissioner referred the Tribunal to one of the AAT's earlier decisions Re BHP Petroleum Pty Ltd and Collector of Customs (1987) 11 ALD 413 wherein Deputy President Nicholson and Member Woodard had been required to construe the word 'exploration' and the phrase 'other operations connected with exploration' in s 164 of the Customs Act 1901 (Cth). The question the Tribunal had to determine was whether or not movement of a drilling rig was 'exploration'. The Tribunal held that 'exploration' is not a word with a technical or special meaning within the off-shore drilling industry and said (at 421 to 422):

Here the question is whether exploration extends beyond the making of surveys and drilling and appraisal work to include movement of the rig between sites at which exploration is incontestably conducted.

...

The words with which we are concerned here ("exploration" and "prospecting") are not words of that type. They are words of common parlance. They are not given a juxtaposition which would indicate that they are being used other than in their ordinary sense. The words are to be interpreted, as the word "mining" in [ Re Cliffs Robe River Iron Associates and Collector of Customs (1984) 6 ALN N255], in their everyday sense.

303. Applying the Shorter Oxford English Dictionary definition of 'exploration', the Tribunal had held in BHP Petroleum (at 422) that:

[e]xploration takes place when exploring is being undertaken, when the search is being conducted for the purpose of discovery. In the view of the Tribunal, it would not be said that exploration was taking place in the everyday sense of that word when the rig was moving from one point at which exploring was carried on to another at which it was proposed to be carried on.

304. Failing to show that the moving the rig was 'exploration', BHP contended that moving the rig was 'in connection with' exploration. The Tribunal concluded (at 423):

The planning by the applicant of an exploration program as a continuous program planned in advance and operating to a schedule is further proof of such connection, the movement of the rig being an essential part of such a program. In our opinion the applicant has established that the movement of the rig is an operation "connected with" exploration.

305. In the Commissioner's submission, although in BHP Petroleum the Tribunal was concerned with a different statutory context, it had applied the ordinary meaning of the word 'exploration'. There was no reason why the same meaning should not be applied to the same word when used in s 37(1)(a) of the PRRTA Act.

306. The Commissioner submitted that the terms of the PSLA supported that conclusion. An exploration permit issued under the PSLA permits the holder to 'explore for petroleum' in a defined area: s 28 of the PSLA. By contrast a production licence permits the holder to 'recover petroleum' in the licence area. The PSLA also permits the licence holder to continue to 'explore for petroleum' in the licence area and to carry on such operations as are necessary for the purposes of recovery and exploration. The scheme of the PSLA was usefully summarised by the Full Federal Court in Mitsui & Co (Australia) Ltd v Commissioner of Taxation (Cth ) [2012] FCAFC 109 at [6]-[14].

307. The Commissioner attacked the taxpayer's submission, as to what was meant by 'exploration', as reliant upon obiter dicta in cases which had not been concerned with the construction of the word 'exploration'.

308. The Commissioner submitted that the decision of Taylor J in Mount Isa Mines Limited v Federal Commissioner of Taxation did not concern the meaning of the term 'exploration' but rather addressed the issue as to whether expenditure on housing and amenities was expenditure incurred on the development of a mining project for the purposes of former s 122 of the ITAA 1936. Moreover, that the quotation from the decision of Taylor J, relied on by the taxpayer, was both selective and incomplete. The Tribunal's attention was drawn to what his Honour went on to state (at 490-491):

It is probable, however, that work which may broadly answer the description of prospecting, in one sense, may be carried on upon an established mining property for the purpose of determining the best means to be adopted to facilitate the winning of minerals, the existence of which is already known. Such work goes hand in hand with the development of the mining property and should, I think, be regarded as expenditure on development.

309. Similarly, the Commissioner submitted, the decision of Sundberg J in Esso (1997) did not concern the meaning of the term 'exploration' but the meaning of the word 'petroleum' as that word is defined in ITAA 1936. The obiter observations of Sundberg J, relied upon by the taxpayer, were not directed to the issue for determination here.

310. The Commissioner referred to the decision of the Full Federal Court in Commissioner of Taxation v Ampol Exploration Ltd (1986) 13 FCR 545, in which Lockhart J (at 560) commented as follows:

Exploration or prospecting activities (for example geological, geophysical or geochemical surveys and appraisal digging) are the kinds of activities in which a prospecting company engages if petroleum is to be found. It is, as the title of the activity suggests, of an exploratory nature. Petroleum may or may not be found; but unless expenses of this kind are incurred it will not be found. Once a proven field has been established other expenses, for example, development drilling or activities in the course of working or establishing a petroleum field will be incurred and they savour more of a capital nature since the work done is to bring into being a proven capital asset which will be the source of income-producing activity.

311. The Commissioner, whilst acknowledging that Ampol Exploration was decided in the context of a different statutory provision and statute, relied on the above remarks as a "sort of anecdotal description" of what, in the Commissioner's view, constituted 'exploration' for s 37(1) purposes.

Tribunal's view

312. The Tribunal acknowledges that the legislative history of the PRRTA Act indicates that, in modifying the PRRTA Act as it did in 1991, Parliament was seeking to further benefit and encourage petroleum exploration, or at least to remove certain disincentives which may have previously existed. However, the Tribunal is of the view that there is nothing in the legislative history of the PRRTA Act or in the extensive case law referred to by either counsel to suggest that the term 'exploration' should be read as meaning other than its ordinary meaning understood in the context in which it appears.

313. The Tribunal takes the view that the evidence advanced by the parties did not rise to the degree to justify any contention that the word 'exploration' is to be read in the context of the PRRTA Act as a term of art or as having a particular technical meaning.

314. We accept the Commissioner's submission that whatever trade usage might attach to the expression 'exploration phase' that expression is found nowhere in the Act. The definition the taxpayer pressed upon the Tribunal relied upon the relevance of that expression. To the extent that it was faintly suggested by counsel for the taxpayer (who referred, on occasion, to the expression "informed trade usage"), that the word 'exploration' should be read as a term of art ultimately that submission was not pursued. Accordingly, applying what was said by French J in Woodside Energy (2007) at [261], the Tribunal considers that the words in the PRRTA Act must be read according to their ordinary everyday meaning.

315. The Tribunal does not accept the taxpayer's submission that the concept of 'exploration', for s 37(1) extends to ascertaining the viability of developing a resource and commencing production. In our view Taylor J's observations in Mount Isa Mines were, with respect, directed at a different section of a different statute - the former s 122 of the ITAA 1936. Suffice it to say that the construction of 'exploration', for income tax purposes, is worthy of its own dissertation. As discussed above (under Relevant Extrinsic Materials ), s 37(1) of the PRRTA Act, under consideration, has its own unique legislative history, purpose and context which must inform its construction.

316. Similarly, the Tribunal disagrees with the taxpayer's reliance on the obiter comments of Sundberg J in Esso (1997) as guidance as to what is meant by 'exploration' for the purposes of s 37(1) of the PRRTA Act. That case involved a consideration of, among other things, the definition of 'exploration' for the purposes of former s 122K of the ITAA 1936. Once again, what was being considered by the Court in that case is the meaning of 'exploration' in the context of a different section of a different statute with its own legislative history, purpose and context.

317. The Tribunal considers, however, that as a matter of ordinary English usage the word 'exploration', understood in the context of exploration for petroleum, has a somewhat wider connotation than that submitted by the Commissioner. For example, on the Commissioner's reasoning, 'exploration' would exclude technical analytical work undertaken to evaluate the scale of discoveries in a gas field. That activity, in the Tribunal's opinion, ordinarily would be considered as an aspect of 'exploration' and within the word's ordinary meaning.

318. In the result we are of the opinion that its meaning is neither as broad as contended by the taxpayer nor as narrow as submitted by the Commissioner. To provide the greatest possible precision to what the Tribunal understands as encompassed by 'exploration' in s 37 of the PRRTA Act the Tribunal has found it useful to borrow from the language of the ABARE Report referred to by the taxpayer.

319. Putting aside the two stage distinction between an 'exploration phase' and 'development phase' which the Tribunal has concluded is not a relevant distinction, the Tribunal finds the report helpful in identifying in more precise technical language what it has concluded falls within the ambit of the ordinary meaning of the word 'exploration'.

320. The ABARE Report refers to:

oil and gas companies using a range of survey techniques to identify prospective fields. These may be geological, gravity, magnetic, seismic (2D and 3D) or geometrical surveys. In prospective areas, new field wildcat wells are drilled to discover the location of accumulations. In the event of a discovery, appraisal wells may also be drilled to provide a more accurate indication of the potential size and quality of the oil and gas resources.

The Tribunal considers that all of those activities, together with the scientific and technical analysis necessarily associated with those activities, naturally fall within the meaning of the word 'exploration', as the word would be understood by a user of ordinary English familiar with oil and gas mining.

321. The ABARE Report then states "[if] the discovery is significant, a feasibility study of the field for future development and production is undertaken". The Tribunal takes the view that although that activity was included by the report as falling within the 'exploration phase' as opposed to the 'production phase', activity of that kind is of a distinctly different nature to that included within the ordinary meaning of the term 'exploration'. As the passage itself suggests, it refers to activities that only occur after a significant discovery has been made.

322. The Tribunal accordingly finds, as a matter of fact, that in the context of s 37(1) of the PRRTA Act, the ordinary meaning of the word contemplates the use of any range of survey techniques to identify prospective oil or gas fields. Those survey techniques would include, but not be limited to, geological, gravity magnetic, seismic (2D and 3D) and geometrical surveys together with any scientific or technical analysis necessarily associated with evaluating their results. 'Exploration' also includes the drilling of appraisal wells to provide a more accurate indication of the potential size and quality of the oil and gas reserves. However, the ordinary meaning of the word 'exploration' does not, in the Tribunal's view, extend to include feasibility studies of the field for future development and production.

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

323. It is then necessary for the Tribunal to address what is conveyed by the phrase 'in connection with' exploration for the purposes of s 37(1) of the PRRTA Act. As acknowledged by both Mr de Wijn and Mr Steward at the hearing of this application, what is encompassed by the phrase 'in connection with exploration' is the "killing ground" in this case. That is, the deductibility of much of the disputed Company C Billed Expenditure turns on the Tribunal's interpretation of the phrase 'in connection with exploration'.

The Taxpayer's approach

324. In the taxpayer's submission the words "in carrying on operations ... involved in or in connection with exploration", in s 37(1)(a) of the PRRTA Act, expand the scope of the activities for which expenditure may be deducted. The taxpayer's contention is that even if the term 'exploration' in s 37 is not to be construed as broadly submitted by the taxpayer, all of the operations the Joint Venturers undertook before a decision to commence production was made (ie the FID), were undertaken to determine whether commencement of production would be "justified or prudent". Accordingly, at the very least, they were operations 'in connection with exploration'.

325. The Taxpayer submits that the Apple Joint Venture involved a continuing "integrated" set of operations undertaken under the JOA all of which was done to determine whether the commencement of mining operations would be "justified or prudent": Mount Isa Mines .

326. In the taxpayer's submission, the phrase 'in connection with' are words of broad connection and, whilst there needs to exist a relationship, the evidence before the Tribunal was all one way - all of the expenditure in dispute was undertaken as part of the OEP system to determine whether or not it was justified or prudent to make a FID. That constituted the relevant relationship.

327. It was critical, in the taxpayer's submission, to appreciate that the nature of the connection necessary to fall within the statute is to be determined by having regard to the statutory context within which the phrase is used and the purpose of the legislation. In support of this view, reference was made by the taxpayer to the following passage French J's reasons in Woodside Energy Ltd v Commissioner of Taxation (No 1 ) (2006) 155 FCR 357 at 375:

Relationships between things in the law do not simply exist to await discovery. They are defined by the common law or by legislation and their authoritative interpreters. The criteria by which a statutory test of 'relationship' is to be applied will have to be relevant to and serve the purposes of the statute.

328. Reference was also made to French J's decision in Woodside Energy (2007), where his Honour in considering the phrase 'in relation to' said (at [270]):

Context and purpose are everything in the construction of such indefinite phrases as 'in relation to'. The citation of authorities, a number of which were canvassed in argument, is of limited assistance where they relate to different statutory settings.

329. To similar effect, the taxpayer submitted, are the observations of Lord Upjohn in Customs and Excise Commissioners v Top Ten Promotions Ltd [1969] 1 WLR 1163 where in considering the phrase 'ancillary thereto or connected therewith' his Lordship said at 1171 [F]-[H] that:

As always happens in cases where Parliament rightly has employed simple non-technical language in every day use, the argument has ranged over a large number of examples where, in the desire to persuade your Lordships that a very limited construction should be placed upon the word "connected," exaggerated cases are exemplified, such as suppliers who could be held to be connected with, or at all events benefiting from, the promotion of the betting; or that T.T.P. might carry on two disconnected businesses but both benefit from the other by the use of, at all events to some extent, the same staff.

My Lords, I am never impressed by these arguments. It is highly dangerous, if not impossible, to attempt to place an accurate definition upon a word in common use; you can look up examples of its many uses if you want to in the Oxford Dictionary but that does not help on definition; in fact it probably only shows that the word normally defies definition. The task of the court in construing statutory language such as that which is before your Lordships is to look at the mischief at which the Act is directed and then, in that light, to consider whether as a matter of common sense and every day usage the known, proved or admitted or properly inferred facts of the particular case bring the case within the ordinary meaning of the words used by Parliament.

330. According to the taxpayer, it was critical to first identify the relevant "operations" being carried on by the joint venture and then ask whether those operations were 'involved in or in connection with exploration for petroleum'. The taxpayer's contention was that the relevant operations were those undertaken by Company A under the Company C OEP in relation to the JOA. The JOA provided that the parties agreed to associate themselves in a joint venture in accordance with the agreement "to explore for Petroleum and appraise, develop and exploit Discoveries in relation to the Title Area".

331. The taxpayer argued that the relevant operations of the joint venture involved determining whether the Apple discovery was economically viable and that those operations involved not only further sub-surface work, seismic studies and analysis of data to define the resource in the ground better but, in addition, an analysis of the "price" for which the gas might be sold and the "costs" of getting it to the customer. All of those matters were relevant, the taxpayer submitted, to determining whether the discovery was economically viable. They were 'operations' which were 'involved in' or were 'connected with' exploration for petroleum. The taxpayer submitted that one must look at the whole of the (integrated) 'operations' and then determine whether those operations were 'in connection with exploration' for the purposes of s 37(1) of the PRRTA Act.

332. In the present case, the taxpayer contended that the relevant 'operations' being carried on was the Company C OEP process itself. The reason for this, the taxpayer says, was that the whole of the 'integrated' Company C OEP process until a FID was aimed at seeking to ascertain whether the initial discovery of gas in the Apple field (in August 2001) was economically or commercially viable. In the taxpayer's submission, all of the activities in Phases 2A to 3B of Company C's OEP (described above in Relevant Evidence ) were necessary before a FID could be made to commit the capital investment necessary to go into production. Consequently, those activities were activities 'in connection with exploration' in the sense contemplated by s 37(a) of the PRRTA Act. It followed, in the taxpayer's submission, that all of the disputed amounts of Company C Billed Expenditure were amounts liable to be made in carrying on operations 'involved in or in connection with' exploration as contemplated by s 37 of the PRRTA Act (as they were all liable to be made prior to a FID).

333. The taxpayer drew the Tribunal's attention to the following passage from the decision of Wilcox J in Claremont Petroleum NL v Cummings & Another (1992) 110 ALR 239 at 280:

The phrase "in connection with' is one of wide import, as I had occasion to observe in a different context in Our Town FM Pty Ltd v Australian Broadcasting Tribunal (1987) 16 FCR 465 at 479-80; 77 ALR 577 at 479-480:

The words 'in connection with'......do not necessarily require a causal relationship between the two things: see Commissioner for Superannuation v Miller (1985) 8 FCR 153 at 154, 160, 163; 63 ALR 237 at 238, 244, 247. They may be used to describe a relationship with a contemplated future event: see Koppen v Commissioner for Community Relations (1986) 11 FCR 360 at 364; 67 ALR 215; Johnson v Johnson [1952] P 47 at 50-1. In the latter case the United Kingdom Court of Appeal applied a decision of the British Columbia Court of Appeal, Re Nanaimo Community Hotel Ltd [1945] 3 DLR 225......The trial judge held...that the phrase 'in connection with' covered matters leading up to, or which might lead up to an assessment. He said..... " One of the very generally accepted meanings of " connection " is " relation between things one of which is bound up with or involved in another ; or, again " having to do with ". The words include matters occurring prior to as well as subsequent to or consequent upon so long as they are related to the principal thing. The phrase "having to do with" perhaps gives as good a suggestion of the meaning as could be had.' This statement was upheld on appeal. [Emphasis added]

334. The taxpayer also referred the Tribunal to the following passage from the decision of the Full Federal Court in Robe River Mining Co Pty Ltd v Commissioner of Taxation (1989) 21 FCR 1 at 12 in support of the view that the phrase 'in connection with' in s 37(1)(a) was intended to significantly expand the activities contemplated beyond mere 'exploration':

The use of the phrase ' in carrying on prescribed mining operations' suggests a quite direct relationship between the expenditure and the operations , to be distinguished from the looser relationship which would be expressed by the words 'in connection with' if they were used in a provision of this kind. [Emphasis added]

335. The taxpayer referred to the judgment of the Western Australian Court of Appeal in Re His Honour Warden Calder SM ; Ex Parte Lee (2007) 34 WAR 289 at 297-8, wherein McClure JA (with whom Pullin and Buss JJA agreed), referring to Re Warden P M Heaney SM ; Ex Parte Flint v Nexus Minerals NL (unreported, Supreme Court FC, WA, Malcolm CJ, Kennedy and Pidgeon JJ, No 1652 of 1996, 26 February 1997) and the authorities discussed therein, including Collector of Customs v Pozzolanic Enterprises Pty Ltd (1993) 43 FCR 280 at 288-9, to show that the words 'in connection with' are words of wide import.

336. In addition, the taxpayer referred to French J's reasons for judgment in Woodside Energy (2006) (at 374):

The words "in relation to" and similar terms like "in respect of" or 'in connection with' or just "in" have been considered in many cases and many contexts. They denote a necessary connection between two subject matters which may be activities, events, persons or things. The nature and closeness or remoteness of the connection depends upon context.

337. The taxpayer submitted that regard should be had to s 38 of the PRRTA Act in constructing s 37. The taxpayer observed that whilst s 38 includes in the scope of 'general project expenditure' certain 'preparatory' activities to operations and facilities contemplated by s 38(b), s 38(b) requires a 'petroleum project' as defined by s 19 of the PRRTA Act to be in existence. Hence, it requires a production licence.

338. In the taxpayer's submission the preparatory activities referred to in s 38(a) also require either the existence of the production licence or that a production licence be imminent. According to the taxpayer, the concept of 'preparation' in s 38(a) is informed and explained by Kitto J in Federal Commissioner of Taxation v Broken Hill Pty Co Ltd (1969) 120 CLR 240 at 244 to 245, albeit in the context of the meaning 'mining operations' for the purposes of div 10 s 122(1) of the ITAA 1936, as follows:

It embraces not only the extraction of mineral from the soil, but also all operations pertaining to mining....It extends to any work done on a mineral-bearing property in preparation for or as ancillary to the actual winning of the mineral (as distinguished from work for the purpose of ascertaining whether it is worthwhile to undertake mining at all)...

339. By contrast, in the taxpayer's submission, the activities contemplated by s 37 were those which preceded the grant of a production licence and the FID. That is, the taxpayer contends, the use of the words 'in connection with' in s 37 enable payments liable to be made prior to making a decision to proceed with a project and prior to the grant of a production licence to be taken into account in calculations made for PRRT purposes. Until a decision is made to embark on the production of petroleum under a production licence the work cannot be described as 'preparatory' to carrying on the project. Only once a decision has been made to go ahead (ie a FID has been made) does any work done in preparation of that production fall within s 38, not s 37.

340. The Taxpayer accordingly submitted that the PRRTA Act distinguishes between carrying on:

•: operations involved in exploration (s 37(1)(a));
•: operations in connection with exploration (s 37(1)(a)), and
•: other operations that are 'preparatory' to carrying on a petroleum project for which a production licence has been granted or where a decision has been made to apply for a production licence (s 38).

341. According to the taxpayer, a close connection between the expenditure and the physical activities involved in production is required by s 38 of the PRRTA Act. To support that proposition, the taxpayer relied on the decision of French J in Woodside Energy (2007). In that case, French J was considering whether expenses incurred in connection with derivative contracts were sufficiently connected with the project to fall within s 38 of the PRRTA Act. Justice French said (at [276]):

In my opinion the requirement that expenditure contemplated by s 38 is liable to be made in carrying on or providing operations, facilities and other things comprising the project is incapable of covering hedging expenses the subject of these proceedings. The section contemplates a close connection between the expenditure and the physical activities involved in the petroleum project . [Emphasis added]

342. The taxpayer submitted that the statutory scheme of the PRRTA Act mirrors the title regime enacted under the PSLA. Thus, the definition of 'petroleum project' (in s 19) requires the existence of a production licence. Until a decision to develop a project is made (ie a FID is made), it is not possible to confirm that activities such as feasibility studies or environmental assessments are in fact 'preparatory' to carrying on a petroleum project at all.

343. Crucially, in the taxpayer's submission, the text of the PRRTA Act also ensures that, to the extent that there is overlap between operations 'in connection with exploration' under s 37 and 'preparatory' operations as contemplated by s 38(a), expenditure on the operations in question must be treated as 'exploration expenditure'.

344. The taxpayer submitted that the words in parentheses in s 38, "(not being excluded expenditure, exploration expenditure or closing down expenditure)", preclude 'exploration expenditure' from being 'general project expenditure'. Accordingly the expenditure must be treated as falling within s 37 as 'exploration expenditure'. That is, if the expenditure is capable of both characterisations the PRRTA Act provides a 'tie-breaker'. In support of this proposition, the taxpayer noted the following:

•: the words in parentheses in s 37(1) of the PRRTA Act do not exclude 'general project expenditure' from being 'exploration expenditure', whereas the words in parentheses in s 38 (as set out above) exclude 'exploration expenditure' from being 'general project expenditure'; and
•: the reasons of Perram J in Esso (2012) confirm that the words in parentheses exclude from s 38 'general project expenditure' that otherwise would fall within the section. As Perram J (at [130]) observed:
But for the exclusion of these matters by the parenthetical excision in s 38, many of the items of expenditure would otherwise constitute general expenditure under its terms. For example, the interest on a loan used to acquire a capital asset to be deployed in the extraction process would be an expense incurred "in carrying on" the project. The effect of the parentheses is, therefore, not descriptive of what then follows but instead operates directly as an excision from what would otherwise have been the ambit of s 38 . [Emphasis added]

345. Based on this analysis, the taxpayer submitted that expenses on operations sufficiently connected with exploration incurred prior to making a decision to proceed with a project (ie pre-FID) must be considered 'exploration expenditure' (as defined). On the other hand, expenses incurred after a decision to develop a project and to apply for a production licence (ie post-FID) that have a close 'connection' to the physical activities involved in the petroleum project are to be 'general project expenditure' under s 38. In the taxpayer's submission, such expenses might include, for example, some feasibility study costs and design costs required for construction of oil and gas offshore facilities and on-shore processing facilities once a decision to invest has been made. However, all preliminary design costs and the cost of work to evaluate the projects economic viability, including the ascertaining of potential customers, required to enable a decision to be made as to whether to proceed at all was 'in connection with' exploration and thus 'exploration expenditure'.

"Connectors"

346. Whether a relevant 'connection' exists in any particular case, the taxpayer submitted was a question of fact: Collector of Customs v Pozzolanic Enterprises Pty Ltd .

347. Even if the more general proposition that all expenditure before FID was inherently 'in connection with' exploration, the taxpayer asserted that there were a number of ways of establishing a relevant 'connection' for s 37(1) purposes (eg temporal, economic etc). In relation to this particular case, the taxpayer identified the following key "connectors" as relevant to all of the disputed expenditure:

(i): The fact that all of the activities for which a deduction was claimed occurred pursuant to one overall highly "integrated" process, being the Company C OEP. That included all activities up to phase 3B. Those activities were carried on "side by side" and "hand in hand" with one another and within the same timeframe. There was thus a temporal 'connection';
(ii): The fact that all of the activities comprising the Company C OEP process (ie the operations) occurred in respect of the same exploration permit, namely WA-000-P. There was accordingly a geographic connection;
(iii): The fact that all of the activities undertaken in respect of exploration permit WA-000-P were reported to the Joint Authority, in conformity with reporting requirements under the PSLA. There thus was a 'connection' between the exploration permit WA-000-P and the joint venture's statutory obligation to report to the Joint Authority;
(iv): The requirement to consider whether to apply for a retention licence or a production licence linked or connected the Company C OEP process with the stages in the PSLA;
(v): The fact that a Preliminary FDP was prepared at the very end of the Company C OEP process and that the Preliminary FDP detailed the results of the exploration and appraisal that had taken place throughout the Company C OEP provided a significant economic link;
(vi): The fact that to determine the viability of the project, it was necessary for the joint venture to secure a gas sales agreement and a customer provided a commercial 'connection';
(vii): The lack of certainty of whether or not enough reserves existed, which was a problem or 'risk' that remained throughout the entire Company C OEP process meant that all of the relevant expenditure remained 'connected' to exploration;
(viii): There was a strong accounting 'connector'. In the taxpayer's submission, the evidence established that the pre-development asset included feasibility studies involving costs to determine whether it was economically viable or feasible to proceed with the project. Further, based on the evidence of Ms C, the pre-FID, pre-development expenditure and the direct drilling costs or ("digging hole exploration" expenditure) were all accounted for in the same way (ie they were effectively written-off in the year they were incurred). In contrast, post-FID expenditure would have been capitalised until the project was producing and, once it commenced producing, the post-FID expenditure was amortised over the life of the project; and
(ix): The JOA itself was submitted to be a connector. That is, the terms of the JOA contemplated that until a decision that there was a commercial discovery and that that commercial discovery should be 'developed' was made all of the operations undertaken pursuant to the JOA constituted exploration and appraisal under its terms.

Commissioner's approach

"Disconnectors"

348. In reply to the taxpayer's identification of "connectors" Mr Steward SC for the Commissioner pointed to a number of what he identified as "disconnectors":

(i): The act of looking for a reserve, in the sense of exploration as it is classically understood, was confined to the Apple-1 drill (work on which was completed in 2001) and the Echidna drill which took place in 2003. Those two "drills" represented two primary activities of 'exploration' for s 37(1) purposes. The other activities and work undertaken with respect to exploration permit WA-000-P occurred years later and were not 'in connection with' exploration;
(ii): The Apple Project proceeded with great speed. As it did so the emphasis or focus of the work undertaken quickly changed from work 'in connection with exploration' to work 'in connection with production';
(iii): The Company C OEP process was itself a "disconnector". As each phase passed (ie from Assess, to Concept, to Select, to Execute and, finally, to Production) the connection with 'exploration' diminished; and
(iv): The work undertaken was detailed, careful, elaborate and considered. In all cases, those qualities increased with time and as the association with 'production' strengthened. For example, the work done on FEED and BOD were not, as suggested by the taxpayer, "back of the envelope" types of work. Rather, they involved detailed engineering and drafting work related to production operations, not discovery.

349. The Commissioner submitted that the following categories of work (and the expenditure on them) were neither 'exploration' nor 'in connection with exploration' for s 37(1) purposes:

•: Work on the Banana Pipeline - since that work was downstream of the production project;
•: Work on the FDP - since that plan was required by the regulator in order to obtain a production licence and, as such, it enjoyed a close relationship with the process of securing a production licence (and records the results of exploration) and did not touch upon or concern 'exploration';
•: Direct work on negotiating the contracts (such as the Gas Sales Agreement and the HOA), including negotiations with Company F and Company K;
•: Work on stakeholder issues - namely the very detailed anthropological, environmental work done and the fairly detailed work done negotiating with government and traditional and indigenous land owners for the purpose of securing land upon which an onshore facility could be built; and
•: Work on possible future onshore and offshore production facilities (ie once the type of production facility has been decided).

"Legal not economic test"

350. The Commissioner also attacked the taxpayer's propositions as wrong in principle. The Commissioner submitted that the taxpayer's approach that required commencing with an examination of the 'operations' and facilities being carried on and then asking whether they are 'in connection with exploration', was fundamentally flawed. In support of that contention, the Commissioner relied on the decision of the Full Federal Court in Esso (2012) where the majority (Keane CJ and Edmonds J) held (at [93]):

The text of the section [ie s38(1)(a) of the PRRTA Act] directs attention to the liability to make the payments, not to whether costs can be discerned to have been met in a general economic sense in carrying on the operations of the project. To elide the reference to liability, as the primary judge seems to have done at [121] of his Reasons, is to liberalise unduly the scope of the section. The test erected by the section [ ie 38 ] is a legal, not an economic, test. The vital question is whether there is a liability to make payments in the carrying on of the operations of the project, not whether payments can notionally be attributed to the carrying on of the operations by a consideration of the economic effects of the payments made in discharge of a liability incurred in carrying on the entirety of the taxpayer's business operations . Further, the nature and extent of the closeness and directness required by ss 32, 37, 38 and 39 is not left at large as a matter of impression and degree. The text of ss 32, 37, 38 and 39, and the context in which they appear, serve to indicate that expenditure which discharges a liability - incurred in the conduct of the generality of the business - of a person who happens to carry on a petroleum project, is not sufficiently connected with the activities of the project. [Emphasis added]

351. Accordingly it was submitted for the Commissioner that the Tribunal was bound, in its review of the Objection Decision, to first identify the legal liabilities which qualify for deductibility under s 37. The starting point must be to identify a specific (not a general) liability or set of liabilities that engage s 37. It is not legitimate, the Commissioner submitted, to skip that step and go straight to a consideration of the operations and facilities being carried on or provided.

352. The Commissioner disputed the taxpayer's contention that all of the expenditure for activities carried out by the joint venture prior to the making of the FID in June 2006 was inherently expenditure 'involved in or in connection with exploration' for the purposes of s 37(1)(a) of the PRRTA Act.

353. In the Commissioner's submission, the distinction between s 37 'exploration expenditure' and s 38 'general project expenditure' cannot be determined in that manner. The term "Final Investment Decision" was not found in the PRRTA Act. Nor was it referred to in any of the relevant extrinsic materials. There was nothing in the words or the scheme of the PRRTA Act to justify the drawing of a distinction between exploration expenditure and general project expenditure as at the point at which a particular taxpayer makes a commercial decision to proceed to invest in a particular project. Rather, the Commissioner submitted the delineation of expenditure as exploration expenditure depended upon the nature of the expenditure in question.

354. The Commissioner's submission regarding the phrase 'in connection with' was that those words neither expand the concept of 'exploration', nor do they alter that concept so that it refers to preparations for development. Rather, in the Commissioner's view, the words 'involved in or in connection with', as they appear in s 37(1), define the requisite nexus between 'exploration' and the expenditure in question.

355. The Commissioner conceded that the words 'connected with' (and similar terms) "are capable of describing a spectrum of relationships ranging from the direct and immediate to the tenuous and remote": Collector of Customs v Pozzolanic Enterprises Pty Ltd per Neaves, French and Cooper JJ at 288.

356. Accordingly the nature of the relationship and the degree of 'connection' required must be determined by the statutory context. In support of that contention, the Commissioner referred to the decision of the Federal Court Woodside Energy (2006) per French J at [57] as well as the decision of the Full Federal Court in Burswood Management Limited and Others v Attorney-General (Cth) and Another (1990) 23 FCR 144, where Lockhart, Wilcox and Hill JJ said (at 146):

The words 'in connection with' are words of wide import; and the meaning to be attributed to them depends on their context and the purpose of the statute in which they appear. As Davies J said in Hatfield at 491:

'Expressions such as "relating to", "in relation to", "in connection with" and "in respect of" are commonly found in legislation but invariably raise problems of statutory interpretation. They are terms which fluctuate in operation from statute to statute......The terms may have a very wide operation but they do not usually carry the widest possible ambit, for they are subject to the context in which they are used, to the words with which they are associated and to the object or purpose of the statutory provision in which they appear.' [Emphasis added]

357. Urging the Tribunal to apply the Full Federal Court's approach in Burswood Management to the present case, the Commissioner submitted that the relevant "statutory context", which must be taken into account to inform the nexus required by s 37(1)(a), included:

•: the ordinary chronology and progression of the development of offshore oil and gas projects from exploration to development, as delineated and regulated by the PSLA;
•: the recognition of that basic chronology and progression by both ss 37 and 38 of the PRRTA Act;
•: the recognition in ss 33 and 35 of the PRRTA Act that 'general project expenditure' may be incurred many years before the grant of a production licence; and
•: the terms of s 38(a) of the PRRTA Act, which expressly address and concern the disputed expenditure here, namely expenditure 'preparatory' to the carrying on of a project and in carrying out any feasibility or environmental studies.

358. According to the Commissioner, this statutory context supported the following five propositions.

359. First, the words 'in connection with' are used in conjunction with 'involved in' and imply a broader relationship between the operations and facilities in question and 'exploration for petroleum in the eligible exploration ... area' than that implied by the words 'involved in'. In Berry v Federal Commissioner of Taxation (1953) 89 CLR 653 Kitto J said (at 659):

The words "for or in connection with" imply that a consideration may satisfy the definition as being "in connection with" one of the subjects mentioned, although not "for" it. Now, while it is true that a payment cannot be described as a consideration "for" anything but that which is given in exchange for it, to speak of a consideration being "in connection with" an item of property parted with is to use language quite appropriate to the case of a payment received as consideration "for" something other than the property in question, so long as the receipt of the payment has a substantial relation, in a practical business sense , to that property. A consideration may be "in connection with" more things than that "for" which it is received.

...

But the purpose of such a payment is to protect, and indeed to provide a valuable addition to, that residue of the goodwill which remains after the outgoing owner has subtracted it from the element which is personal to him.

...In a word, while it is not received for parting with the goodwill, it is consideration for adding to it. [Emphasis added]

360. The Commissioner placed considerable weight upon the Tribunals' decision in Re BHP Petroleum Pty Ltd and Collector of Customs (1987) 11 ALD 413. It was advanced as the leading case in Australia on the meaning of the words in issue. According to the Commissioner, what was determined in BHP Petroleum was that it is not just any 'connection' which will satisfy the statutory test, it must be a connection which is directed to "benefiting", assisting, advantaging or facilitating the activity of exploration. That is, the work done must have some beneficial relationship with the activity of exploration. It must be "yoked inextricably" to the activity of 'exploration' and not to the gaining of a production licence and the securing of a production of the project.

361. Thus the phrase 'in connection with' in s 37 looks to matters that bear a 'substantial relation' to exploration and that 'substantial relation' must be one which benefits, assists, advantages, facilitates the activity in question, namely 'exploration'. In Berry , the relevant connection was satisfied since the payment concerned, assisted or added to the value of the goodwill. It was contended that (with the exception of the expenditure for work which the Commissioner had conceded) none of the work which was undertaken in Phases 2A to 3B of the Company C OEP benefited, assisted, advantaged or facilitated exploration.

362. Second, the Commissioner submitted that the activity, 'exploration for petroleum', that is contemplated by s 37, is an activity which can only occur "in the eligible exploration ... area". This is because what constitutes an 'eligible exploration area' is dependent upon the meaning of a permit area in the PSLA. The concept of 'exploration' in s 37 must therefore be read harmoniously with the definitions of the relevant terms in the PSLA. Section 5 of the PSLA defines a permit area to mean the area constituted by the graticular blocks that are the subject of an exploration permit. Section 19 of the PSLA prohibits exploration otherwise than in accordance with a permit. Section 28 defines the rights and conditions which attach to an exploration permit. Section 33 of the PSLA provides for the imposition of conditions upon the grant of a permit by the Joint Authority.

363. The Commissioner accordingly contended that the series of definitions in the PRRTA Act and the provisions of the PSLA indicate that, in relation to a permit derived production licence, the words 'exploration for petroleum in the eligible exploration or recovery area in relation to the project' in s 37(1)(a) imply temporal and geographical limits to the concept of 'exploration'. Thus, 'exploration' can only be something that takes place in the exploration permit area while the exploration permit is in force.

364. Therefore, the Commissioner submitted, the better view of the phrase 'involved in' is to regard it as confined to expenditure which is incurred within the geographical limitations of an exploration tenement while the phrase 'in connection with' addresses 'exploration expenditure' incurred outside that geographical limit. If that is so, although operations and facilities 'in connection with' exploration for petroleum need not occur in the eligible exploration area, those operations and facilities must nevertheless, the Commissioner submitted, have a relevant relationship to the 'exploration' activities that are being conducted within the exploration permit area.

365. Third, the nature of the relationship between the 'expenditure' and the exploration must be informed by the distinction in the PRRTA Act between 'exploration expenditure' and 'general project expenditure'. Section 37(1)(a) must be read harmoniously with s 38, which defines 'general project expenditure': Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355 at [70]. The Commissioner accordingly submitted that the PRRTA Act contemplated:

•: on the one hand (in s 37(1)), operations and facilities directly related to exploration for petroleum conducted in an exploration permit area while the exploration permit is in force (and within a production licence area once a relevant production licence has been issued: s 5(2)(c) of the PRRTA Act); and
•: on the other hand (in s 38(a)), operations and facilities 'preparatory to' the carrying on or providing of the operations, facilities and other things comprising a 'petroleum project'.

366. The Commissioner argued that both ss 38(b) and 19(4) assume that a production licence will be in force. In the Commissioner's submission, s 38(a) therefore picks up operations and facilities carried on or provided prior to the grant of a production licence.

367. Thus, the Commissioner submitted, the concept of operations and facilities 'involved in or in connection with' exploration for petroleum must be confined by the text of s 37(1)(a): it cannot include operations and facilities 'preparatory to' the carrying on or providing of the operations, facilities and other things comprising a petroleum project, even though such activities may take place while the exploration permit is still in force prior to the grant of a production licence.

368. The Commissioner submitted that in Esso (2012) Perram J was in the minority and that his obiter observations misstated the relationship between provisions. The role of the parenthesis in s 38 did not, as suggested by his Honour and contended by the taxpayer, affect the ambit of activities addressed by s 37. Rather, the parenthesis existed only as a "savings" measure just in case there was overlap between the two provisions.

369. The Commissioner submitted that the structure of ss 37 and 38 reflected choices made by Parliament about the scheme's "architecture" and where certain categories of expenditure would fall. The Commissioner submitted that Parliament was to be understood as having made a deliberate choice to put predevelopment expenditure in s 38(a) and not s 37.

370. It was Parliament's direction to treat the expenditure as being 'general expenditure' in the event of an overlap.

371. Fourth, the Commissioner submitted that because s 38(a) expressly provided that operations and facilities that are preparatory to the carrying on or providing of the operations, facilities and other things comprising a petroleum project include "the carrying out of any feasibility or environmental study" such feasibility or environmental studies are excluded from the concept of operations or facilities involved in or in connection with exploration for petroleum in s 37(1). It was a deliberate choice of the legislature to expressly include feasibility and environmental studies preparatory to the carrying on of a petroleum project in s 38(a) (general project expenditure) and to exclude such studies from the scope of s 37(1) (exploration expenditure).

372. Because the PRRTA Act expressly recognises that s 38 'general project expenditure' may be incurred more than five years before the grant of a production licence (see ss 33 and 35) the Commissioner drew the Tribunal's attention to the circumstance that the ambit of s 38(a) was not confined, as the taxpayer submitted it was, to expenditure incurred just before the grant of a production licence.

373. The Commissioner's submission was that s 38(a) applies to those feasibility studies which are preparatory to the carrying on or providing of the operations, facilities and other things comprising a petroleum project. If, by contrast, the Commissioner conceded, a study was undertaken of the feasibility of carrying out further exploration in an exploration permit area, expenditure on a study of that nature would fall within s 37(1)(a). However, in the Commissioner's submission, no such circumstances had arisen in the present case. In so far as the expenditure in dispute included expenditure on feasibility studies, those studies were all in the nature of operations preparatory to the carrying on of a 'petroleum project' by the joint venturers.

374. Fifth, and in summary, the Commissioner submitted that the concept of 'operations and facilities involved in or in connection with exploration for petroleum' in s 37(1)(a) embraced:

•: 'exploration', meaning searching for a petroleum pool within the eligible exploration area and appraising the physical characteristics of a petroleum pool once discovered, such as its location, size and physical characteristics; and
•: such other operations and facilities as have a substantial relation, in a practical business sense, to those activities in that they are carried out to facilitate those activities: Berry .

375. Whether a particular activity is an activity of such a character was to be ascertained in the manner described by the decision of the majority of the Full Federal Court in Esso (2012) (at [98]):

...[sections] 32, 37 and 38 of the [PRRTA] Act... are not concerned with the taxpayer's purpose in incurring expenditure; they are concerned with whether a liability is incurred in carrying on specified activities... Each of ss 37, 38 and 39 requires that the character of the expenditure to which it refers be determined according to whether the payments in question are liable to be made in carrying on the activities comprising the project.

Tribunal's view

376. As Davies J observed in Hatfield v Health Insurance Commission (1987) 15 FCR 487 at 491, expressions such as 'relating to', 'in relation to', 'in connection with' and 'in respect of', whilst commonly found in legislation, "invariably raise problems of statutory interpretation" and are "terms which fluctuate in operation from statute to statute". According to Davies J (at 491):

The terms may have a very wide operation but they do not usually carry the widest possible ambit, for they are subject to the context in which they are used, to the words with which they are associated and to the object or purpose of the statutory provision in which they appear.

377. Counsel for both the taxpayer and the Commissioner accepted that phrases such as 'in connection with', and similar expressions are elusive concepts. As the Full Federal Court aptly observed in Collector of Customs v Pozzolanic Enterprises Pty Ltd , the words 'in connection with' are capable of describing a broad spectrum of relationships ranging from the direct and immediate to the tenuous and remote. A similar remark was made by the Full Federal Court in Collector of Customs v Cliffs Robe River Iron Associates (1985) 7 FCR 271 at 275 where the Court said that the word 'connection' is both wide and imprecise.

378. In our opinion s 37 should be considered and interpreted in light of the rich legislative history of the section and the statute, to ascertain its purpose. The sufficiency of any 'connection' intended to be consigned by the words 'in connection with' is a matter of judgment which requires us to consider the subject matter, the legislative history and the facts of the case.

379. In the Tribunal's opinion, the words of the text appearing in s 37(1) that:

exploration expenditure...is a reference to payments ... liable to be made by the person in carrying on or providing: (a) operations and facilities....in connection with exploration for petroleum [emphasis added]

make clear that the correct starting point, for construction purposes, should be as the Commissioner contended, to identify the specific legal liabilities which qualify for deduction under s 37(1), rather than, as the taxpayer contended, by identifying the relevant 'operations' being carried on and then considering whether those 'operations' are 'in connection with exploration'.

380. The approach which we adopt is consistent with the opinions in Esso (2012) of Keane CJ and Edmonds J at [93], where, their Honours stated the "vital question is whether there is a liability to make payments in the carrying on of the operations of the project" and, earlier in that paragraph, "the connection required between the liability to make the payments and the carrying on of the project must be close and direct". Further, at [95] of their joint reasons for judgment Keane CJ and Edmonds J observed:

The statutory context in which ss 32, 37, 38 and 39 of the [PRRTA] Act appear confirms that these sections are concerned with the liability of a person to pay for the operations of a particular petroleum project. The statutory context includes ss 22 and 24 of the [PRRTA] Act. If one reads s 22 of the [PRRTA] Act exegetically with the description of "deductible expenditure" in ss 32, 37, 38 and 39 of the [PRRTA] Act one sees that the annual taxable profit of a person in relation to a petroleum project consists of the excess of assessable receipts derived by that person over the total of the payments liable to be made by that person in carrying on or providing the operations, facilities and other things which together comprise the project. Subject to s 41, it is only where a person incurs a liability to make a payment to procure the carrying on of the project that the liability qualifies as deductible expenditure in relation to the project.

381. In the course of the hearing of this application the Commissioner accepted that Company C operated as agent for the Joint Venturers (including Company A) pursuant to cl 4.1 of the JOA and that under the JOA funding obligations when Company C contracted a liability it did so on behalf or as Agent for the Joint Venturers including Company A. Further, the Commissioner accepted, in relation to the Company C Billed Expenditure, that the way in which the funding arrangements in the JOA operated was to create an obligation on the part of Company A (under s 3 of Schedule 1 to the JOA) to pay "cash advances" under each AFE and that that obligation created a relevant liability for s 37(1) purposes. As set out above (in [103]), s 3 of Schedule 1 to the JOA provides (at s 3.1) that the "Operator will call forward cash advances for Venturers for Joint Operations..." and (at s 3.2) the "Operator will submit to each venturer before the 15th day of each Month cash calls for the following Month of the amounts expected to be paid during that Month and will nominate the AFEs to which the cash calls relate." Then, (at s 3.3) "[e]ach Venturer will pay, on or before the due date or dates, its proportionate share of the cash call...".

382. Having identified those at the relevant specific liabilities, it is then necessary to identify the 'operations and facilities' being carried on or provided. This is, in the Tribunal's opinion, critical to the correct construction of s 37(1). In this case, the relevant 'operations' are the activities carried out by Company C, pursuant to the JOA, as agent for the Joint Venturers.

383. The question then becomes whether the relevant operations and facilities being carried on or provided are 'in connection with' exploration for petroleum in the eligible exploration or recovery are in relation to the project. The answer to this question should be able to be answered by reference to the objective circumstances in which the relevant liability was incurred (at the time the relevant liability was incurred), rather than upon any subjective 'purpose' of Company C or the taxpayer as the entity incurring the relevant liability (expenditure). As stated by the majority in Esso (2012), at [98]:

Whether a given liability to make payments is of the desired character depends on the arrangements which have been made; and one should be able to ascertain the character of that expenditure at the time when the liability is incurred by reference to the arrangements under which it is incurred. In our respectful opinion, it is not necessary to consider the purposes of the payer in the operation of s 37, s 38 or s 39 as something distinct from the effect of the commercial arrangements under which the liability was incurred.

384. The Tribunal agrees with the taxpayer's submission that the phrase 'in connection with' is of potentially wide import: Claremont Petroleum NL . Clearly those words were intended by the Parliament to expand the activities for which a deduction could be claimed beyond that which is directly 'involved in' exploration. The critical question, however, is just how much further. The taxpayer submitted that the words 'in connection with', having regard to statutory context, were intended to permit the deductions of expenditure connected with, in the broadest sense, exploration: Robe River Mining, Woodside Energy (2006), Woodside Energy (2007) and Top Ten Promotions .

385. However, as observed by the High Court (French CJ and Hayne J) in Travelex Ltd v Federal Commissioner of Taxation (2010) 241 CLR 510 at [25], phrases such as 'in connection with' can be used in a variety of contexts in which the degree of connection must be shown between the two subject matters joined by the expression may differ. Their Honours (at [25]) referred approvingly to what Hill J had said in HP Mercantile Pty Ltd v Commissioner of Taxation (2005) 143 FCR 553 at [35] in relation to the phrase 'relates to', namely that the connection must be relevant and usually a remote connection will not suffice. His Honour added that "[t]he sufficiency of the connection or association will be a matter for judgment which will depend, among other things, upon the subject matter of the enquiry, the legislative history and the facts of the case."

386. The Tribunal is obliged to follow the approach adopted by the majority of Full Federal Court in Esso (2012) and must focus on the specific liabilities and ascertain, by reference to the relevant objective circumstances, the character of the expenditure concerned.

387. It is therefore not open to the Tribunal to conclude that all operations carried out (under the Company C OEP process) up to the point when a commercial decision to proceed with the petroleum project was made (in Company C's language, the FID) were on that basis, 'in connection with' exploration and, therefore, that all the expenditure which the taxpayer was liable to pay in relation to those operations was deductible. Further such an approach would effectively substitute a particular commercial model for the words in the section. That, in the Tribunal's view, is unacceptable.

388. The text, context and purpose of an Act sometimes require a direct rather than indirect relationship to be applied to seemingly broad words of connection. In Hatfield v Health Insurance Commission Davies J gave several examples where notwithstanding their breadth such terms were held to have required a 'direct and immediate relationship' (at 491-493). More recently in Transfield ER Futures Ltd v The Ship " Giovanna Iulianao " [2012] FCA 548 Gordon J at [34]-[35] recognised, in the particular statutory context her Honour was giving consideration to, that the words 'related to' required a 'reasonably direct' connection with the activities said to be linked.

389. In our opinion, given the history of the legislation which the Tribunal has earlier recounted, it would run counter to the text, context and purpose of the PRRTA Act to give such a wide scope to the words 'in connection with' in s 37 of that Act as would effectively transform a provision that was intended, in view of the commercial and other risks associated with exploration, to provide a special scheme for the deductibility for exploration related expenditures, into one that would apply to all project expenditure incurred by a miner up to the time that miner made a final and irrevocable decision to proceed to production.

390. In our opinion there must be shown to be a reasonably direct relationship between the 'operations' for which expenditure has been incurred and 'exploration' for there to exist a relevant connection between the two. That conclusion is consistent with the Commissioner's contention that remote and indirect connections will not suffice.

391. The Commissioner submitted more specifically that to be characterised as an operation in connection with exploration the work done must be directed at benefiting, assisting, advantaging, or facilitating the activity of exploration. In further submissions counsel for the Commissioner accepted that an operation also would be 'in connection with' exploration if it shared a substantial relation, in a practical business sense, with the activity of exploration.

392. The Tribunal accepts that any expenditure on an operation that fulfils those criteria would have a sufficient relationship with exploration to be 'in connection with' exploration for the purposes of s 37.

393. Taken in that way, the criteria submitted for by the Commissioner provide useful benchmarks for the Tribunal to take into account when determining whether or not any particular expenditure claimed by the taxpayer falls or does not fall within s 37.

394. However, we reject the suggestion that those, or any other tests, can be applied in substitution for the test stated by the words enacted by the Parliament. In our opinion, the starting point in each instance must remain the existence of a specific liability to make a payment in the carrying on of the operations of the project, and then the ultimate issue must be resolved on the basis of whether or not that operation is, or is not, sufficiently in connection with exploration.

395. In particular, were we to approach the matter as the Commissioner suggested, we think there is some danger that words such as benefiting, assisting, advantaging and facilitating might focus attention impermissibly upon irrelevant considerations.

396. Factual situations may exist where an operation is conducted not to benefit, assist, advantage or facilitate exploration, but simply to assess and determine whether exploration work or additional exploration will be undertaken at all. Expenditure on operations involved in those assessments would be, in the Tribunal's view, in connection with exploration whether or not any further exploration was undertaken.

397. The tests the Commissioner proposed are useful 'rules of thumb' and may assist the Tribunal to ascertain whether a relevant connection exists in any particular case, but they cannot be substituted for the words of the statute and cannot be determinative.

398. The Tribunal has concluded that a reasonably direct connection is required for the purposes of s 37 of the PRRTA Act. We would add no further gloss on the terms stated in the Act. For that reason and for the reasons that follow, the Tribunal rejects the Commissioner's submission that the words in parenthesis in s 38 "( not being ..... exploration expenditure .....)" were included by the Parliament as a "savings" measure just in case there was any overlap between 'general project expenditure' and 'exploration expenditure' . We find nothing in the Relevant Extrinsic Materials (identified above), or the relevant case law, to support that contention. Instead, the Tribunal agrees with the approach of Perram J in the Full Federal Court's decision in Esso (2012), namely that the effect of the parenthesis in s 38 is to excise anything which is exploration expenditure from what would otherwise have been within the ambit of s 38. The Tribunal does not accept the Commissioner's submission (see [368]) that Perram J was in the minority in Esso (2012). His Honour reached the same conclusion as did the majority "albeit by a slightly different route" ( Esso (2012) at [123]). The majority held that it was not sufficient for the purposes of s 41 that payments in discharge of a liability incurred for a broad range of operations may subsequently be dissected so as to be attributed in an economic sense to operations comprising the project. As that conclusion disposed of the matter their Honours gave no attention to the questions of statutory construction addressed by Perram J.

399. Perram J reached the identical conclusion but by an analysis of the provisions of ss 37, 38 and 44. Importantly, there is nothing contained in the majority judgment of Keane CJ and Edmonds J to suggest any want of logical consistency between the two paths taken to reach the same conclusion. The Tribunal is bound by the ratio of Esso (2012) as expressed by the majority. It may not be so bound by the reasoning of Perram J but the Tribunal can discern no reason why it should not follow the carefully reasoned and not inconsistent views of the concurring judge in respect of those issues Perram J relied upon in reaching his decision.

400. Accordingly, the Tribunal is of the view that there is nothing to prevent 'feasibility and environmental studies' and other 'preparatory' activities, so long as they share the relevant 'connection' with 'exploration', from constituting 'exploration expenditure' for s 37. What is critical, if they are to do so, is that, as a matter of fact, the 'preparatory' activities are in connection with exploration . As we have noted a reasonably direct connection is required.

Conclusions on Company C Billed Expenditure

401. All of the disputed Company C Billed Expenditure was incurred by Company C as Operator of the Apple Joint Venture in Phases 2A to 3B of Company C's OEP, pursuant to five corresponding AFEs (comprising 111120, 111140, 111141, 111151 and 111190). In making its payments, Company A was not paying for costs incurred by Company C (whether 'direct' or 'shared'). Rather, Company A was paying cash calls required by Company C to enable it to discharge its obligation under cl 4.2 "to conduct all Joint Operations". Company A/the taxpayer had a specific legal liability in relation to that expenditure.

402. Accordingly, but subject to whether there was a sufficient connection between the expenditure on those operations, the taxpayer's expenditure is deductible under the principles enunciated in Esso (2012). The Tribunal's findings on whether the various operations carried on by Company C during Phases 2A to 3B of the Company C OEP were 'in connection with' exploration, for the purposes of s 37(1), are set out below.

Phase 2A (AFE 111120)

403. Based on the evidence before it (see Relevant Evidence above) and, for the reasons provided above (in [312] to [322] and [376] to [400]), the Tribunal is of the view that the following operations carried on by Company C during Phase 2A of the Company C OEP (which work was referrable to AFE 111120) were not 'in connection with' exploration for the purposes of s 37(1):

•: Project facilitation (or ' external affairs' ) work - which broadly involved work aimed at developing a strategy for obtaining necessary stakeholder consent and government approvals, which would be implemented in Phase 2B;
•: Facilities engineering work - which broadly involved work undertaken to determine the nature and design of the facilities which would be built if the project proceeded to production (with the exception of any sub-surface evaluation work: refer to [405] below);
•: Project management work - which broadly involved the provision of logistical support, facilitating communication, managing project costs and reporting on projects (with the exception of any sub-surface evaluation work: refer to [405] below);
•: Project services and assurance work - which broadly involved reviewing the design specifications for the proposed facilities;
•: Commercial work - which included, among other things, work on executing a LOI and HOA with Company F; and
•: Time writing work (except to the extent that the time writing was specifically attributable to a permitted item).

Accordingly, Company A's expenditure on this work is not deductible to the taxpayer as 'transferable exploration expenditure' for s 45B purposes.

404. In the Tribunal's view the above activities are, as submitted by the Commissioner, in the nature of economic feasibility and marketing activities. They were not required in accordance with the specifications of the Apple exploration permit WA-000-P and they lack any requisite 'connection' with 'exploration' for petroleum (within the area of WA-000-P) for the purposes of s 37(1)(a). To the extent those operations were directed to the identification of and negotiation with a potential customer or the selection of the overall concept for the project facilities they involved work which was not relevant to and was too remote from 'exploration' to be considered to be 'in connection with' exploration for petroleum under s 37(1)(a): HP Mercantile and Travelex .

405. However, based on the evidence before it and the reasons provided above, the Tribunal is of the view that the following operations carried on by Company C during Phase 2A of the Company C OEP (which work was referrable to AFE 111120) were 'in connection with' exploration for the purposes of s 37(1):

•: Well-engineering and sub-surface engineering work: refer to [125(i)] above; and
•: the activities described above in [130], [131], [132] and [133] otherwise than as would fall within the terms of [403]: that is, [130] save as to the final three dot points; [131]; [132]; and [133] but only as to the first two dot points.

Consequently, Company A's expenditure on this work is deductible to the taxpayer as 'transferable exploration expenditure' for s 45B purposes.

Phase 2B - Upstream (AFE 111140) & Banana Pipeline (AFE 111141)

406. Based on the evidence before it (see Relevant Evidence above) and, for the reasons provided above (in [312] to [322] and [376] to [400]), the Tribunal is of the view that the following operations carried on by Company C during Phase 2B of the Company C OEP (which work was referrable to AFE 111140 and AFE 111141) were not 'in connection with' exploration for the purposes of s 37(1):

•: Project facilitation work - broadly involved attempts to obtain requisite stakeholder consent and government approvals;
•: Facilities engineering work - broadly comprised the preparation of various reports which assisted to explain the engineering work already done and related to the selection of operational requirements and design of facilities for the Apple gas field. The reports were intended to enable cost estimates and thus inform a choice of alternative bespoke designed facilities (with the exception of any sub-surface evaluation work: refer to [408] below);
•: Project management work - broadly comprised logistical and administrative support and management of the development team (with the exception of any sub-surface evaluation work: refer to [408] below);
•: Project services and assurance work - broadly involved activities directed to the development of risk management strategies to facilitate the delivery of gas to Company F in accordance with the Company F Gas Sales Agreement;
•: Commercial work - broadly involved, among other things, work on executing the LOI and HOA with Company F;
•: Environmental work - broadly involved the preparation of an environmental plan and preparation for seeking environmental approval before applying for a production licence;
•: Banana Pipeline work - broadly entailed design and feasibility studies in respect of an on-shore gas pipeline pursuant to the "Banana Pipeline Joint Study Agreement" between Company C, Company A and Company F (executed on 6 June 2003) JSA; and
•: Time writing work (except to the extent that the time writing is specifically attributable to a permitted item).

Consequently, Company A's expenditure on this work is not deductible to the taxpayer as 'transferable exploration expenditure' for s 45B purposes.

407. The Tribunal is of the view that the above work was, as submitted by the Commissioner, work directed to assessing and maximising the return from the exploitation of the Apple field and to identifying the likely production facilities to enable that exploitation. That is, this work was predominantly directed to the identification of and negotiation with a potential customer and the selection of the overall concept for the project facilities. As such, the Tribunal finds that the work was not sufficiently relevant to and was too remote from 'exploration' to be considered as being 'in connection with' exploration for the purposes of s 37(1)(a): HP Mercantile and Travelex .

408. However, based on the evidence before it and the reasons provided above, the Tribunal is of the view that the following operations carried on by Company C during Phase 2B of the Company C OEP (which work was referrable to AFE 111140 and AFE 111141) were 'in connection with' exploration for the purposes of s 37(1) of the PRRTA Act:

•: Well-engineering and sub-surface engineering work: refer to [153] above;
•: The work described in [138(iii)] above; and
•: The work described in [144] above (except work on a pipeline to the onshore processing plant).

Consequently, Company A's expenditure on this work is deductible to the taxpayer as 'transferable exploration expenditure' for s 45B purposes.

Phases 3A and 3B - Upstream Engineering (AFE 111151)

409. Based on the evidence before it (see Relevant Evidence above) and for the reasons provided above (in [312] to [322] and [376] to [400]), the Tribunal is of the view that the following operations carried on by Company C during Phases 3A and B of the Company C OEP (which work was referrable to AFE 111151) were not 'in connection with' exploration for the purposes of s 37(1) of the PRRTA Act:

•: Project facilitation work - broadly involved continued attempts to obtain requisite stakeholder consent and governmental approvals;
•: Facilities engineering work - broadly included the preparation and review of the FDP and BOD and the completion of early FEED of upstream facilities for the purposes of preparing tender documents;
•: Project management work - broadly related to work on the FDP and work preparatory to any FID;
•: Project services and assurance work - broadly included the management of health, safety and environmental regulatory requirements applicable to the Apple Project and the updating of and evaluation of safety requirements for the design concepts for the proposed facilities;
•: Environmental work - broadly entailed the preparation of an EIS;
•: Surveys work - broadly involved two surveys being undertaken to enable the design of the offshore pipeline and other upstream facilities to be completed, including assessing the suitability of the proposed offshore pipeline routes; and
•: Time writing work (except to the extent that the time writing is specifically attributable to a permitted item).

Therefore, Company A's expenditure on this work is not deductible to the taxpayer as 'transferable exploration expenditure' for s 45B purposes.

410. It is clear from the nature and purpose of the above Phase 3A and 3B activities that they were focused on the basic overall design of the project facilities (in order to enable cost estimates to be obtained) and on the preparation of a FDP (for submission to the Joint Authority in support of an application for a production licence). The Tribunal agrees with the Commissioner's contention that they were neither exploratory nor 'in connection with' with exploration for s 37(1) purposes. That is, the above work essentially involved the refinement of the overall project concept selected during Phase 2B (comprising the preparation of the FDP, BOD and the FEED, continuing negotiations with a potential customer, including a joint feasibility study regarding the proposed Banana Pipeline, and regulatory compliance activities, including an EIS). None of this work was, in the Tribunal's view, 'in connection with exploration' for s 37(1) purposes. It was not relevant to and was too remote from 'exploration' to be 'in connection with' exploration for s 37(1) purposes: HP Mercantile and Travelex .

411. However, based on the evidence before it and the reasons provided above, the Tribunal considers that the following operations carried on by Company C during Phases 3A and 3B of the Company C OEP (which work was referrable to AFE 111151) were 'in connection with' exploration for s 37(1) purposes:

•: Well engineering and sub-surface engineering work - broadly involved updating the well engineering and sub-surface evaluation work done in the previous phases of the Company C OEP.

Consequently, Company A's expenditure on this work is deductible to the taxpayer as 'transferable exploration expenditure' for s 45B purposes.

COMPANY A DIRECT EXPENDITURE & ALLOCATED EXPENDITURE

Construction of Section 41

412. Section 41 of the PRRTA Act, Effect of procuring the carrying on of operations etc. by others , states:

Where a person (in this section referred to as the eligible person ) incurs or incurred a liability to make a payment to procure the carrying on or providing of operations, facilities or other things of a kind referred to in section 37, 38 or 39 by another person, then, for the purposes of [the PRRTA] Act:

(a)
the operations, facilities and other things shall be taken to have been carried on or provided by the eligible person and not by the other person; and

(b)
the liability shall be taken to have been incurred by the eligible person in carrying on or providing the operations, facilities or other things.

413. Thus, s 41 enables a person (eligible person) to claim a deduction where they do not carry on the operations, facilities or other things of a kind referred to in ss 37, 38 or 39 of the PRRTA Act themselves but instead incur "a liability to make a payment to procure the carrying on or providing" of such things by another. The effect of s 41, where it applies, is that the relevant operations, facilities or other things are to be taken to have been carried on or provided by the person (eligible person) and the liability is to be taken to have been incurred by the person (eligible person) in carrying on those things.

414. The operation of s 41 was considered in Esso (2012) and in that case, the majority of the Full Court (Keane CJ and Edmonds J) held:

•: Section 41 is engaged by the incurring of a liability by a person (the 'eligible person') to procure the carrying on by another person of activities relating to a project. That is, s 41, like ss 37 and 38, commences with the identification of a specific liability. The provision operates where the eligible person has incurred a liability to procure another person to carry on or provide operations or things of a kind which would give rise to deductible expenditure if paid for directly by the eligible person. Whether an 'eligible person' incurs a liability to make a payment to procure the carrying on of operations of a kind specified for the purposes of s 41 is to be determined by asking whether the liability is or was incurred in return for the carrying on of the specified operations, which falls to be resolved (at [100]):

...by reference to the contractual arrangements made by the eligible person to procure the carrying on of the specified operations. It is not sufficient for the purposes of s 41 that payments in discharge of a liability incurred for a broad range of operations may subsequently be dissected so as to be attributed in an economic sense to operations comprising the project.

•: Where s 41 is engaged, its effect is to 'deem' the liability incurred by the eligible person to have been incurred in carrying on or providing the relevant operations, facilities or other things. At [102]:

EAR says that the limited deeming by s 41(b) does not go so far as to pierce the corporate veil to erase the character of EAR's liability as a fee under the Service Agreement and leave revealed payments for activities which happen to be excluded expenditure deemed to have been made by EAR. But that is expressly what s 41(a) does.......Where s 41 is engaged, its effect is to deem the liability incurred by the eligible person to the contractor, to have been incurred by the eligible person "in carrying on or providing the operations, facilities or other things." These are the same "operations, facilities or other things" that s 41(a) deems to have been carried on, not by the contractor, but by the eligible person.

•: The question of what the payment was for is to be answered by having regard to the legal agreements entered into - and, in that case, the terms of the "Service Agreement" between the taxpayer (EAR) and the service provider (EAL) did not enable the conclusion that the payments were made to discharge a liability in carrying on the activities comprising the Bass Strait Project. At [104]:

If one looks at the terms of the Service Agreement to fix the character of the payments under clause 4, one cannot say the payments were made to discharge a liability in carrying on the activities comprising the Bass Strait project. An indivisible liability under clause 4 of the Service Agreement is not within the scope of ss 37 or 38 of the Act.

•: Section 41, once engaged, operates as a statutory agency. At [121]:
...if s 41 applies to the Service Agreement relationship between EAR and EAL contrary to the view expressed in [119] above, then its application may be described shortly as working a statutory agency as between EAL and EAR for the purposes of ss 32, 37, 38 and 39 of the Act. By para (a) of s 41, the operations, facilities or other things comprising the project are taken to have been carried on or provided by EAR and not EAL; and by para (b), EAR's liability under the Service Agreement is taken to have been incurred in carrying on or providing the same operations, facilities or other things.

Company A Direct Expenditure

Relevant Facts & Evidence

415. Ms B described the Company A Direct Expenditure as comprising:

(i): costs incurred by Company A in respect of "peer review" and other work carried out on its behalf by Company B (Company A's parent company) and the taxpayer; and
(ii): disbursements incurred in the course of performing the peer review work, such as airfares, couriers and palynological studies (being a form of geological analysis).

416. According to Ms B:

The peer review work performed by personnel from the taxpayer group was essentially in the nature of reviews of the work performed by Company C as operator of the joint venture. The reviews were conducted in respect of areas of uncertainty in the project, including planning work and well design work.

417. Ms B explained that the following process was observed when Company B performed peer review work:

(i): Company A would issue to Company B a Request of Cost Estimate (RCE) for a particular task;
(ii): Company B would respond to the RCE for that particular task with a quote/estimate; and
(iii): Upon receipt of a quote/estimate, Company A would issue a "Job Order" to Company B identifying the work to be done.

418. According to Ms B's witness statement (dated 24 October 2011), Company B would later issue an invoice(s) to Company A for work done under a particular Job Order. Upon receipt of an invoice, Company A would either:

(a): pay the invoice and treat the actual payment as an expense; or
(b): treat the sum as an accrual under an expense code in its accounts.

419. Consistently with Mr A's evidence, Ms B's evidence also described Company A Direct Expenditure by reference to five Job Orders, which referred, in each case, to the nature of the work requested by Company A of Company B, as disclosed in the Job Order. Ms B's evidence then detailed the amounts charged by Company B to Company A for the work recorded in intercompany invoices. In summary, the evidence of Mr A and Ms B was as follows:

(i) Job Order AUS 014

420. Mr A's evidence was that the work performed under this Job Order (dated 4 June 2003) related to determining whether it was viable to commence drilling an appraisal well in the Apple exploration permit area.

421. Ms B's evidence was that that the RCE for Job Order AUS 014 indicated that Company A requested that members of Company B's VALP team (quality control or "prospect validation" team) visit Australia to review several projects, one of which was "Apple 2 Appraisal" and to "review prospects of proposed future exploration drilling activity". She stated that this Job Order related to Direct Expenditures A1 and A2 and, further, that it related to more than one project or exploration permit, including the Apple Exploration Permit WA-000-P.

(ii) Job Order AUS 016

422. Mr A said that the work done under this Job Order (dated 3 September 2003) concerned specific technical work required by Company A, to provide it with an understanding as to how various hydrocarbons formed and migrated into the areas designated by the exploration permits held by the taxpayer and Company A, including the Apple gas fields. The cost also included geochemical analysis.

423. Ms B's evidence was that the Job Order form for AUS 016 indicated that:

Company A requested that Company B perform work comprising gathering and assessment of available data, geochemical model definition, geothermal model and pressure calibration, burial history reconstruction, generation and expulsion computation, regional secondary migration valuation, and thermo-tectonic model and paleobathymetry reconstruction.

424. Ms B also said that this Job Order related to Direct Expenditure B and to more than one project or exploration permit (ie not exclusively to Apple Exploration Permit WA-000-P).

(iii) Job Order AUS 019

425. Mr A explained that the services provided under this Job Order (dated 5 April 2004) concerned missions by Company B's prospect VALP team to peer review the data collected in respect of the Apple Project. As mentioned above, the VALP team provided technical validation of an exploration prospect by Company B.

426. Ms B's evidence was that the RCE for Job Order AUS 019 (dated 16 September 2003) indicates that this Job Order related to "PVT (Prospect VALP Team) and PRC (peer review committee) activities" or missions to "evaluate project proposals". Ms B also stated that this Job Order contained five "line items" and that it related to Direct Expenditure C. She said that since this particular Job Order did not mention a specific project (or exploration permit) it was impossible on its face to ascertain whether it related to more than one exploration permit (ie an exploration permit other than WA-000-P). However, the intercompany invoice for this Job Order (dated 30 April 2005) did contain separate "line items" indicating which expenditure related to which particular project (including "WA000 P Apple").

(iv) Job Order OPG 004-2004

427. The work involved under this Job Order (dated 22 October 2004) was described by Mr A as follows:

...a top level review by Company A of work undertaken by Company C on potential options for drilling an appraisal well on the Apple project. Company B was required to make recommendations as to whether the proposals made by Company C were viable in terms of being able to extract resources using various methodologies proposed.

428. Ms B's evidence was that the RCE for Job Order OPG 004-2004 (dated 19 October 2004) indicated that the work authorised involved, among other things, the preparation of a technical note for conceptual well design and well performance work. Ms B also said that this Job Order related to Direct Expenditures D1 and D2. The line item relating to Direct Expenditure D1 described this expenditure as relating to "Head office services provided for drilling & completion review." The line items for Direct Expenditure D2 shows that the expenditure comprised accommodation, travel and time charged by "L Rossi" of Company B to Company A including his time on the preparation of a document titled "Apple Project - Production Optimisation - Conceptual Well Design Sand Control Completion Strategies".

(v) Job Order OPG 008-2004

429. Mr A described the work under this Job Order as relating to:

... the assistance required from Company B to review documents and work produced by Company C so that the taxpayer could satisfy itself that its requirements in relation to this project were being met.

430. Ms B's evidence was that the RCE for Job Order 008-2004 (15 December 2004) showed that the work requested was to prepare a taxpayer internal technical review of the various items listed in the scope of work. According to Ms B, all of the costs which were anticipated would be incurred under this Job Order related to the Apple Project. She also said that this Job Order related to Direct Expenditures E1 and E2 and confirmed that there were 15 invoices issued in relation to this Job Order (exhibited at pages 478 to 510 of her supplementary witness statement).

Travel expenditure

431. Mr A and Ms B confirmed that the Company A Direct Expenditure included some travel expenditure on personnel (including Mr A) to, among other things, attend meetings with Company F representatives for the purpose of gas sale agreement negotiations and discussions concerning the Banana Pipeline. Travel costs were not always allocated to a Job Order but could be charged directly to the account relating to the project, although some travel costs were recorded by reference to particular Job Orders.

Other expenditure

432. Ms B explained that the Company A Direct Expenditure also comprised expenses which had been "booked" to the Apple Project but which had no records making them referrable to a particular RCE or Job Order.

Service agreements

433. Ms B told the Tribunal that although there were a small number of costs which were incurred by Company A "directly", the majority of the work was performed pursuant to various "back-to-back" "service agreements". That is, the work was done by Company B and was charged back to the taxpayer under the relevant service agreement. That work was then "on-charged" by the taxpayer to Company A under another service agreement.

434. In summary:

•: the work performed by Company B for Company A with respect to the Company A Direct Expenditure A1 and A2 (which related to Job Order AUS 014) was carried out pursuant to a service agreement between Company B and Company A dated 22 May 2003 (Company B/Company A Service Agreement);
•: the work performed by Company B for Company A with respect to the Company A Direct Expenditure B (which related to Job Order AUS 016) was carried out pursuant to a service agreement between Company B and the taxpayer dated 22 May 2003 (2003 Company B/the taxpayer Service Agreement);
•: the work performed by Company B for Company A with respect to Company A Direct Expenditure C (which related to Job Order AUS 019) was carried out pursuant to a service agreement between Company B and the taxpayer), dated 28 February 2005 (2005 Company B/the taxpayer Service Agreement);
•: the work performed by Company B for Company A with respect to Company A Direct Expenditure D1 and D2 (which related to Job Order OPG 004-2004) was carried out pursuant to the Company B/Company A Service Agreement; and
•: the work performed by Company B for Company A with respect to the expenditure identified as Company A Direct Expenditure E1 and E2 (relating to Job Order OPG 008-2004) was carried out pursuant to the 2005 Company B/the taxpayer Service Agreement.

435. Direct Expenditures B, C, E1 and E2 were then recharged from the taxpayer to Company A pursuant to a service agreement between Company A and the taxpayer dated 19 December 2001 (Company A/the taxpayer Service Agreement).

436. The Company B/Company A Service Agreement, as exhibited to Ms B's supplementary witness statement (at pages 13 to 63), provides:

ARTICLE 2 - SCOPE OF THE AGREEMENT

2.1 - [Company B], notably through the Exploration & Production Division, shall provide [Company A] during the term of the Agreement with the Services herein described.

2.2 - [Company B] may involve Affiliates and/or Third Parties in rendering Services and shall use the whole of its applicable knowledge, technical and organizational experience in order to perform the Services.

2.3 - The Services...will include, but not be limited to, the following:

2.3.1 - Specific Services as detailed in Annex. 2.

2.3.2 - Exploration & Production Business Support Coordination Services as detailed in Annex 3.

2.3.3 Expatriates Support Assistance Services as detailed in Annex. 4...

ARTICLE 3 - REQUEST FOR SERVICES PROCEDURE

The Services mentioned in Article 2 may be provided by [Company B] on an "ad hoc - project basis" (Subclause 2.3.1) or on a "yearly basis" (Subclauses 2.3.2 and 2.3.3)

3.1 - [Company A] Request of Cost Estimate

[Company A] shall apply for Services(s) through a "Request of Cost Estimate Form" as per Annex 6 hereto.

3.2 - [Company B] Cost Estimate

Upon receipt of the Request for Cost Estimate Form [Company B] will submit to [Company A] an estimate of the cost(s) involved....of which such estimate shall be firm for a given period of time ("Time Limit") as shown on the Cost Estimate Form.

3.2 - [Company A] Job Order

Having agreed to the estimated cost(s) involved, [Company A] will confirm to [Company B] the request for services within the Time Limit mentioned in the Cost Estimate Form through a "Job Order Form" as per Annex. 8 hereto......

ARTICLE 7 - REMUNERATION

All Services rendered under the Agreement are compensated on the basis of [Company B's] actual cost, irrespective of the remuneration method adopted as set out below (ie lump-sum price, actual cost proper, fee).

...

ARTICLE 10 - INVOICING

10.1 Within thirty (30) days from the end of each calendar month, [Company B] shall invoice [Company A] for the following charges:

- the value of work performed for each Specific Service and/or the portion of lump-sum (as the case may be) during the month concerned

...

10.2 - Proper supporting documents and/or details shall be attached to the invoice(s).

ARTICLE 11 - PAYMENT

11.1 - ...payment shall take place within thirty (30) days from receipt of the invoices(s) by [Company A], but no later than forty-five (45) days from the invoice(s) date.

437. The 2003 Company B/the taxpayer Service Agreement (exhibited at pages 69 to 125 of Ms B's supplementary witness statement) and the 2005 Company B/the taxpayer Service Agreement (exhibited at pages 138 to 185 of Ms B's supplementary witness statement) are in substantially the same terms to the Company B/Company A Service Agreement described immediately above. In particular, those agreements both contain the same "Request for Services Procedure", "Remuneration" and "Invoicing" clauses. Further, those two agreements also permit the services of third parties to be engaged pursuant to their respective "Scope of Agreement" clauses.

438. The Company A/the taxpayer Service Agreement, as exhibited to Ms B's supplementary witness statement (at 126 to 185), provides:

2. SCOPE OF THE SERVICE AGREEMENT

The scope of this Service Agreement is to set out the terms and conditions under which the taxpayer shall provide Company A with Services as may be required by Company A in connection with its operations.

3. PROVISION OF SERVICES

Services shall be provided by the taxpayer to Company A on an "ad hoc project basis" or on a "monthly basis" in accordance with the procedure detailed herein.

439. Clause 4 of the Company A/the taxpayer Service Agreement covers, among other things, Company A's duty to: (i) act in good faith in its dealings with the taxpayer; (ii) provide all necessary data and information to the taxpayer; (iii) appoint the taxpayer as agent; and (iv) provide the taxpayer with any necessary powers of attorney enabling it to act on its behalf with third parties.

440. Clause 5 of the Company A/the taxpayer Service Agreement, "Tariffs", stated:

Service shall be charged to Company A based on the actual costs incurred by the Taxpayer in providing the Services. Such actual costs shall form the Basic Consideration and may be amended by the Supplier from time to time during the currency of this Agreement. In addition, when utilising the services of its affiliates and/or third parties, the Taxpayer shall charge at actual cost to Company A all documented expenses incurred for such services.

441. Clause 6 of the Company A/the taxpayer Service Agreement, "Invoices and Payments", provides:

6.1 Subject to clause 8 [Taxation], the Taxpayer shall submit to Company A itemized invoices on a monthly basis stating all amounts due by Company A to the taxpayer and Company A shall make the corresponding payments within fourteen (14) days from the date of the invoice.

6.2 Any payment to be effected by Company A hereunder shall be made in Australian Dollars by means of a bank remittance to an account nominated by the taxpayer.

442. The term "Services" was defined very broadly in cl 1 of the Company A/the taxpayer Service Agreement to mean: "technical and administrative services including but not limited to the following items [ie (a) to (k)], together with any other similar services customarily provided or received in the international oil and gas industry".

The taxpayer's position

443. The taxpayer submitted that the relevant service agreements in this case were in the nature of "retainers", such that Company A's liability for the relevant expenditure arose not from the retainer but from work requests made by Company A to a related company (ie Company B and the taxpayer) for the performance of specific tasks. The taxpayer's contention is that the taxpayer could equally have made such a request to an external unrelated company and not Company A. The taxpayer submits that the service agreements in this case differ from the general umbrella services agreement at issue before the Full Federal Court in Esso (2012). Further, according to the taxpayer, the present case is factually different to Esso (2012) because no invoices were issued in that case. Whereas, here, Company B and the taxpayer, as relevant, issued Company A with invoices for work done under each particular Job Order.

Commissioner's position

444. The Commissioner submitted that the Company A/the taxpayer Services Agreement is analogous to the general umbrella services agreement that Esso had with EAL in Esso (2012): discussed at [10] to [14] of that decision. The Commissioner submitted that in Esso (2012), the majority (Keane CJ and Edmonds J) rejected the possibility of apportionment of expenditure, so where a liability is directed at more than one thing, and it is partly allowable and partly excluded, all of it constitutes excluded expenditure. The Commissioner relied particularly upon the conclusion of Keane CJ and Edmonds J at [104]:

Where a payment is liable to be made under an agreement, the question of what the payment was for is to be answered "by having regard to the legal agreements entered into": City Link Melbourne Ltd v Federal Commissioner of Taxation (2004) 141 FCR 69 at [44]. The liability incurred by EAR under clause 4 of the Service Agreement was incurred to obtain the promise of EAL's assistance in the broad range of EAR's business activities referred to in clause 1 of the Service Agreement. If one looks at the terms of the Service Agreement to fix the character of the payments under clause 4, one cannot say the payments were made to discharge a liability in carrying on the activities comprising the Bass Strait project. An indivisible liability under clause 4 of the Service Agreement is not within the scope of ss 37 or 38 of the [PRRTA] Act. But it is not necessary to found our conclusion that the cross-appeal must be allowed on this ground. It is sufficient to note that because of the operation of s 41, it is not possible to say of the liability created by the Service Agreement that it does not include excluded expenditure.

445. The Tribunal was informed by Counsel for the Commissioner that where a specific liability could be established, by way of a Job Order specific to the Apple exploration permit WA-000-P, the Commissioner accepted that there would be an identified liability for the purposes of s 41. The question would then become whether the expenditure concerned was s 37 'exploration expenditure' or s 38 'general project expenditure'. However, the Commissioner submitted, the problem faced by the taxpayer was that all of the Job Orders relating to the Company A Direct Expenditure were not specific to Apple in that they were "directed to" more than one exploration permit or project or liability. For example, the Commissioner observed, Job Order AUS 14 had a number of projects where peer review were requested by Company B and it was impossible to ascertain how much of that expenditure related to Apple and how much did not (ie the expenditure has not been 'disaggregated' into liabilities). In such a case, the Commissioner contended, that even if the expenditure concerned was 'exploration expenditure' for s 37 purposes it would not, based on the reasoning of the Full Court in Esso (2012), be allowable.

Tribunal's view

446. Based on its review of the terms of the Company B/Company A Services Agreement, the 2003 Company B/the taxpayer Services Agreement and the 2005 Company B/the taxpayer Services Agreement the Tribunal is of the view that those agreements were, as submitted by the taxpayer, in the nature of retainers, in that Company A's liability for the relevant expenditure arose out of the Request for Services Procedure contained in those agreements pursuant to which work requests were made by Company A to a related company (ie Company B and the taxpayer) for the performance of specific tasks. Further, it is clear that from the Scope of the Agreement clauses in each of those agreements that Company A could equally have made such a request from an external unrelated company. In this sense, those particular service agreements differ from the general "umbrella" services agreement in Esso (2012).

447. We find, as a matter of fact, that in relation to the Company A Direct Expenditure, Company B and the taxpayer (as relevant) issued Company A with intercompany invoices for specific work done under a particular RCE and Job Order. However, some of those specific RCEs and Job Orders involved more than one exploration permit or project. That is, they did not relate exclusively to work done on Apple Exploration Permit WA-000-P.

448. In Esso (2012) Keane CJ and Edmonds J (at [106]) rejected the possibility of apportionment where a liability is directed to more than one operation. Where that applies to the Job Orders relating to the Company A Direct Expenditure, we therefore conclude that none of the expenditure claimed can be allowed.

449. However, that does not apply in the case of all of the claimed expenditure, and where it does not we are of the opinion that the decision in Esso (2012) is distinguishable. The outcome in Esso (2012) was consistent with the fundamental proposition advanced by the Commissioner in that case (at [75]) that:

One cannot reasonably attribute to the Parliament the intention that s 44 of the [PRRTA] Act could be defeated by an operator of a project by the simple expedient of contracting with another person for the carrying on of the operations of the project

and, that such an outcome would be odd. Consistent with that proposition the majority concluded (at [104]) that a service agreement that indivisibly includes excluded expenditure (s 44) with exploration expenditure (s 37) or general expenditure (s 38) is not deductible under s 41 of the PRRTA Act. However, it would be equally odd to attribute to Parliament the intention necessary to support the outcome contended for by the Commissioner. There is nothing in the explanatory material to suggest Parliament intended that s 41 was to apply differently to a situation where, for example, an operator asked a contractor to work on two different projects, and was billed by that contractor for the two projects on the one invoice (albeit with separated invoiced line items, each recording work separately done in connection with exploration for each of the two projects), to a situation where, in the same circumstances, the contractor billed separately for the two projects.

450. We do not read Esso (2012) as requiring the odd result contended for by the Commissioner. In our view the Full Court was not seeking to exclude normal commercial arrangements where properly invoiced accounts distinguishing expenditure between projects could be provided. Its concern was to prevent the exemption being abused. When the decision is read as a whole, in the context of its own facts, we consider that it provides no support for the reading contended by the Commissioner.

451. In Esso (2012) EAR could not establish the necessary connection between the liability and the project: see Esso (2012) [81]. The liability in that case was EAR's liability to pay EAL all direct costs incurred by EAL in performing the full range of services for all of EAR's operations in Australia and the continental shelf pursuant to cl 4 of the relevant service agreement which included things which could not be directly sheeted home to the project concerned (being the Bass Strait project). No invoices were issued by EAL to EAR in respect of EAR's liability to EAL. We are of the opinion that the circumstances of the present case are quite different.

452. In relation to the Company A Direct Expenditure, the Tribunal considers that where the invoices issued by Company B and the taxpayer, respectively, to Company A demonstrate a direct connection between Company A's liability to Company B and the taxpayer and the work done by Company B and the taxpayer under the relevant Job Orders, s 41 is, on the particular facts of this case, enlivened: cf Esso (2012). The question then becomes whether the expenditure concerned falls within s 37. Where any itemised expenditure in the invoices arises as the discharge of an indivisible liability it would not, on the basis of the majority's reasons in Esso (2012), fall within s 41 of the PRRTA Act.

453. The Tribunal makes the following findings (based on the evidence before it) in relation to the disputed Company A Direct Expenditure which was incurred by Company A under the relevant Job Orders:

•: Job Orders AUS 014, AUS 016, AUS 019 & OPG 004 - 2004 - The work done under these Job Orders (as described above in [420] to [428]), with the exception of any 'Travel expenditure' or 'Other expenditure', was 'in connection with' exploration for s 37(1) purposes such that the expenditure on this work is transferable to the taxpayer under s 45B. This work shares a connection with 'exploration' that is, in the Tribunal's opinion, sufficiently relevant and not too remote: HP Mercantile ; and
•: Job Order OPG 008 - 2004 - None of the work done under this Job Order (as described above in [429] and [430]) was 'in connection with' exploration for s 37(1) purposes (and is not transferable to the taxpayer under s 45B) since this work does not appear (based on the evidence before the Tribunal) to share a connection with 'exploration' that is, in the Tribunal's opinion, sufficiently relevant and not too remote: HP Mercantile .

454. Further, the Tribunal considers that none of the Company A Direct Expenditure which is classified as 'Travel expenditure' falls within s 37(1) for the reason that it, instead, constitutes 'excluded expenditure' under s 44(j) as it represents a work cost "incurred indirectly in carrying on or providing operations, facilities or other things of a kind referred to in sections 37 [and] 38." On the evidence before it, the Tribunal is unable to ascertain whether the Company A Direct Expenditure, categorised as 'Other expenditure', is 'in connection with' exploration or not, for the purpose of s 37(1). As such, it cannot be transferred to the taxpayer under s 45B.

Allocated Expenditure

Relevant Facts & Evidence

455. Allocated Expenditure was described in the witness statements of Ms C and Mr A. Broadly, the disputed Allocated Expenditure comprised expenditure allocated by the taxpayer to Company A in respect of the staff costs of "business development".

456. Ms C, as the Chief Accountant for the taxpayer, was familiar with the taxpayer's accounting systems and procedures, including those used to allocate expenditure by the taxpayer to projects carried on by the taxpayer on its own behalf, and on behalf of Company A, in Australia. In her witness statement (dated 31 October 2012) Ms C explained (at [9]) that, in relation to the Apple Project:

Company A did not have any employees in Australia at the relevant time. Nor did it operate offices of its own. Under a service agreement between Company A and the taxpayer , the taxpayer provided Company A with all the necessary services and facilities Company A required to carry out its operations in Australia in respect of Company A's interest in the [Apple exploration] Permit. [Emphasis added]

457. The service agreement between Company A and the taxpayer, referred to by Ms C above, is the Company A/the taxpayer Service Agreement (see Company A Direct Expenditure above at [433] to [442]).

458. According to Ms C, the services and facilities provided by the taxpayer to Company A in respect of Apple Exploration Permit WA-000-P (and other permits) were in the nature of:

(a): information technology equipment and resources, offices facilities and utilities (including telephone and electricity) and office equipment;
(b): services provided by non-technical staff (ie financial/accounting, legal and human resources staff) in support of the activities carried on by the taxpayer for Company A;
(c): training and specific equipment utilised by the taxpayer's staff to carry out the work required; and
(d): direct labour costs of technical staff (engineers, project managers and business analysts) that worked on the Permit and were employed by the taxpayer.

459. Ms C stated that the taxpayer's costs of performing those services and providing those facilities were allocated and charged to Company A by the taxpayer by way of intercompany invoice on a monthly basis. The amounts of expenditure in dispute fell into three broad categories, comprising:

•: Business development - systems allocation;
•: Business development - direct labour; and
•: Other charges for the years ended 30 June 2003 and 30 June 2004.

460. Ms C explained the taxpayer's procedure or methodology for allocating costs to Company A as comprising the following three phases:

•: Phase 1 - Involved allocating overhead costs of information technology and general administration costs (ie rent, telephone and utilities etc) to each "department". There were four "departments", comprising: (i) "administration" (sometime referred to as "JV alloc" and "non JV alloc"); (ii) "exploration"; (iii) "operations"; and (iv) "business development" (sometimes referred to as "commercial");
•: Phase 2 - Involved allocating each department's costs (based on its "average" time recorded) to a specific permit or project (also known as "job centre"). These costs included: (i) the department's share of the phase 1 allocation; (ii) the department's specific costs (including costs for training and equipment specific to that department; and (iii) labour costs for non-technical staff (ie management, legal, human resources and finance); and
•: Phase 3 - Involved allocating labour costs for technical staff (ie project managers, engineers and business analysts) to a specific permit or project (also known as a "job centre").

461. Ms C said that the expression "business development" was a reference to the taxpayer's commercial department (one of its four departments referred to immediately above under Phase 1) and the expressions "systems allocation" and "direct labour" were references to both the type of costs concerned and the method of allocating those costs. She said that "other charges" were simply charges that did not relate to the allocation process described above.

462. Consistent with Ms C's evidence, Mr A stated that the Allocated Expenditure comprised three broad categories, being: (i) "business development - systems allocation expenditure"; (ii) "business development - direct labour expenditure"; and (iii) "other expenditure". In relation specifically to the "business development - direct labour expenditure" category, Mr A stated that during the relevant period time was recorded by staff to three separate "job codes", being: (i) WA-000-P exploration (which expenditure has been allowed by the Commissioner); (ii) WA-000-P re-evaluation (which expenditure has been allowed by the Commissioner); and (iii) WA-000-P appraisal feasibility (which expenditure remains in dispute).

463. Mr A held the position of Business Development and Commercial Manager throughout the relevant period, and he explained the processes by which he and the staff reporting to him recorded the time that they spent working on the Apple Project. He also described, in general terms, the activities undertaken by him and his staff on a quarterly basis from the first quarter of 2003 to the second quarter of 2005. Mr A's evidence on this issue was consistent with the evidence of Ms C.

The Taxpayer's position

464. The taxpayer's position in relation to the Allocated Expenditure is broadly the same as that put forward by it in relation to the Company A Direct Expenditure: refer to [443] above.

465. The taxpayer accepted, in relation to the Allocated Expenditure specifically, that there was some "blurring" of expenditures in the earlier invoices issued by the taxpayer to Company A (ie they did not specifically identify which exploration permit/project the expenditure concerned related to), but submitted that the later invoices contained "line items" recording which particular exploration permit/project the invoiced expenditure related to. In relation to the earlier invoices (relating to the Allocated Expenditure) which did not contain line items, the exploration permit/project to which the expenditure related could, in any event, be determined by reference to the "back documents".

Commissioner's position

466. According to the Commissioner, the activities described by Mr A that gave rise to the Allocated Expenditure are similar to those denoted by the category of Company C Billed Expenditure headed "commercial" (described in [208] and [209]) in that the activities entailed the negotiation with Company F of the terms of a HOA following the execution of the LOI, the JSA and the Company F Gas Sales Agreement. The Commissioner submitted that the evidence of Mr A and Ms C concerning the Allocated Expenditure does not provide a basis for treating that expenditure as either exploration or in connection with exploration for the purposes of s 37(1).

467. The Commissioner also submitted that some of the amounts of disputed Allocated Expenditure (such as rent, administrative overheads and the like) clearly constituted 'excluded expenditure' under s 44 and that they have not been excised, with any precision, from the Allocated Expenditure claimed by the taxpayer. Consistently with Esso (2012) such expenditure cannot be deductible.

Tribunal's view

468. The Tribunal considers that the Company A/the taxpayer Service Agreement pursuant to which the taxpayer carried on "Services" for Company A in return for a "Tariff" was a general umbrella services agreement similar to that at issue in Esso (2012). Under the Company A/the taxpayer Service Agreement the taxpayer was required, each month, to provide Company A with "itemised invoices" based on the actual costs incurred by the taxpayer in providing the "Services".

469. Although there was some blurring of the expenditure in the early invoices issued by the taxpayer to Company A (with respect to the Allocated Expenditure), the later invoices issued by the taxpayer to Company A (at least from about March 2003) provided "line items" indicating which particular exploration permit (or project) the invoiced expenditure related to. Even in relation to the earlier invoices, it appears from the evidence before the Tribunal that the genesis of the Allocated Expenditure can be determined by reference to the "back documents".

470. The Tribunal concludes that all Allocated Expenditure which represents an undifferentiated mix where the underlying liability is indivisible does not fall within s 41 and cannot, therefore, be claimed by the taxpayer. However, where the invoices issued by the taxpayer to Company A evidence a direct association between Company A's liability and the taxpayer's work s 41 should apply. The question is then whether the Allocated Expenditure concerned falls within s 37(1).

471. It follows from the Tribunal's findings in relation to the Company C Billed Expenditure (above at [401] to [411]) that the Allocated Expenditure which was categorised as "Business development - systems allocation" and "Other charges" does not share the relevant connection with 'exploration' to come within s 37(1) as it was not sufficiently relevant to and was too remote from 'exploration': HP Mercantile .

472. In relation to the final part of the category referred to as "Business development - direct labour expenditure" which remains in dispute (being "WA-000-P appraisal feasibility"), the Tribunal has insufficient evidence before it whether that particular expenditure shares the necessary connection with exploration to fall within s 37. As such it cannot be transferred to the taxpayer: s 45B. However, if the Commissioner could be satisfied that that particular expenditure related to operations of the kind found by the Tribunal as being 'in connection with' exploration for s 37(1) purposes under Company C Billed Expenditure (refer to [405], [408] and [411] above) then such expenditure would, based on the Tribunal's earlier reasoning, be allowable to the taxpayer as being sufficiently relevant to and not too remote from 'exploration': HP Mercantile .

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