House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 1 - Overview of the Petroleum Resource Rent Tax

Outline of chapter

1.1 This chapter provides:

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an outline of the Petroleum Resource Rent Tax Assessment Amendment Bill 2011 (Main Bill);

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an outline of the three Petroleum Resource Rent Tax (PRRT) imposition Bills - specifically:

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the Petroleum Resource Rent Tax (Imposition - Excise) Bill 2011 (PRRT excise imposition Bill);

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the Petroleum Resource Rent Tax (Imposition - Customs) Bill 2011 (PRRT customs imposition Bill); and

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the Petroleum Resource Rent Tax (Imposition - General) Bill 2011 (PRRT general imposition Bill); and

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an overview of the existing Petroleum Resource Rent Tax Act 1987 and the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA 1987). It explains the basic operation of the tax.

The extension of the Petroleum Resource Rent Tax

1.2 The Main Bill amends the PRRTAA 1987 to expand its coverage to onshore projects and the North West Shelf. From 1 July 2012, the PRRT will be extended to apply to petroleum production, including coal seam gas and shale oil, sourced from petroleum projects located onshore and in territorial waters, as well as from the North West Shelf project area. The PRRT will not apply to the Joint Petroleum Development Area in the Timor Sea.

Outline of the Bill

1.3 The Main Bill amends the existing PRRTAA 1987 to expand its application to onshore projects and the North West Shelf project. It is divided into six Schedules:

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Schedule 1 includes provisions to:

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extend the PRRT to apply to onshore oil and gas projects, as well as the North West Shelf project;

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apply the PRRT to shale oil and coal seam gas, but not to those resources which are subject to the Minerals Resource Rent Tax (MRRT); and

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take account of the different characteristics of onshore petroleum projects in relation to them being combined.

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Schedule 2 includes provisions to:

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ensure that petroleum projects transitioning to the PRRT will be able to derive assessable receipts from 1 July 2012; and

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include as assessable, those receipts derived from the sale of incidental products, or the provision of a service relating to carbon capture and storage that are produced by the petroleum project.

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Schedule 3 includes provisions to:

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clarify the deductibility of environmental expenditure incurred in relation to the petroleum project;

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allow for the payment of other resource taxes to be grossed up and deductible for PRRT purposes so as to avoid double taxation; and

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ensure that native title payments under the Native Title Act 1993 are deductible for PRRT purposes.

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Schedule 4 includes provisions to:

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provide those persons who held an interest in a transitioning exploration permit, retention lease or production licence with a starting base, or alternatively allow them to take account of expenditures incurred prior to 1 July 2012, in recognition of past investments.

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Schedule 5 includes provisions to:

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allow consolidated or multiple entry consolidated (MEC) group companies that are consolidated for income tax purposes the option of having their interests held in an onshore petroleum project treated as a single interest.

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Schedule 6 includes provisions to:

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amend the PRRTAA 1987 to reflect the Clean Energy Future package;

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repeal the Petroleum Resource Rent Tax Act 1987 ; and

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make various consequential amendments.

Imposition Bills for the PRRT

1.4 The PRRT was imposed by the Petroleum Resource Rent Tax Act 1987 . That Act imposes the tax in respect of the taxable profit of a person of a year from a petroleum project. The Petroleum Resource Rent Tax Act 1987 will be repealed as part of the Main Bill and replaced by the three separate imposition Bills:

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the PRRT excise imposition Bill;

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the PRRT customs imposition Bill; and

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the PRRT general imposition Bill.

1.5 The three additional imposition Bills impose the PRRT to the extent that it is a duty of customs [section 4 of the PRRT customs imposition Bill] ; to the extent that it is a duty of excise [section 4 of the PRRT excise imposition Bill] ; and to the extent that it is neither a duty of customs nor one of excise [section 4 of the PRRT general imposition Bill] . All three imposition Bills set the rate with respect to the taxable profits of a person of a year of tax in relation to a petroleum project at 40 per cent, consistent with the original imposition Act [section 5 of the PRRT customs imposition Bill; section 5 of the PRRT excise imposition Bill; section 5 of the PRRT general imposition Bill] .

1.6 The constitutional validity of the PRRT is not in question. However, the three imposition Bills are being introduced to avoid the possibility of constitutional irregularities arising in the future. A similar approach has been adopted for the Minerals Resource Rent Tax (MRRT).

1.7 The imposition Bills will apply retrospectively from 1 July 1986, consistent with the commencement of the original imposition Act. Replacing the original imposition Act does not alter the operation of the PRRT. [Subsection 4(3) of the PRRT customs imposition Bill; subsection 4(3) of the PRRT excise imposition Bill; subsection 4(3) of the PRRT general imposition Bill]

1.8 The approach of enacting a single assessment Bill with multiple imposition Bills when a tax law could be argued to be a duty of customs, a duty of excise, as well as some other type of tax is not unusual. The same approach was followed for the enactment of the goods and services tax (GST) legislation and the MRRT.

1.9 PRRT is not imposed on property belonging to a State. That ensures that the PRRT complies with section 114 of the Constitution, which prohibits the Commonwealth from imposing a tax of any kind on property of a State. In practice, this will only have an effect to the extent that a State directly recovers its own petroleum resources. In that case, the State will not be subject to PRRT. [Section 6 of the PRRT customs imposition Bill; section 6 of the PRRT excise imposition Bill; section 6 of the PRRT general imposition Bill]

PRRT - a profits based tax

1.10 The PRRT is imposed by the Petroleum Resource Rent Tax Act 1987 , with the PRRTAA 1987 detailing the operation and administration of the tax.

1.11 The PRRT currently applies to offshore petroleum production occurring in Australia's offshore areas beyond coastal waters, with the exception of:

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the North West Shelf project area comprising the area encompassed by the Commonwealth exploration permits known as WA-1-P and WA-28-P (where Commonwealth crude oil excise and royalties apply); and

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the Joint Petroleum Development Area in the waters between Australia and East Timor (which is subject to Production Sharing Contract arrangements under the Timor Sea Treaty ).

1.12 The tax is designed to ensure that the Australian community receives an appropriate return from the development of its non-renewable petroleum resources located offshore. At the same time, it provides companies with an incentive to explore and develop resources by allowing a return to companies commensurate with the risks involved in petroleum exploration and development.

1.13 Unlike royalty and excise regimes, the PRRT applies to the profits derived from a petroleum project and not the volume or value of the petroleum produced. Through providing deductions for all allowable expenditure (whether capital or revenue in nature), together with uplifts for carry forward expenditure, the PRRT taxes the economic rent generated from a petroleum project.

Operation of the PRRT

1.14 The PRRT is applied to taxable profit derived by a person in a financial year from a petroleum project. Taxable profit is calculated by deducting eligible project expenses from the assessable revenues derived from the project.

1.15 Deductible expenditure broadly includes those expenditures, whether capital or revenue in nature, that are directly incurred by a person in relation to the petroleum project.

1.16 Assessable revenue primarily comprises the receipts received by a person from the sale of petroleum, or marketable petroleum commodities produced from the petroleum, recovered from a project. Marketable petroleum commodities include stabilised crude oil, sales gas, condensate, liquefied petroleum gas, and ethane.

1.17 Where a person incurs deductible expenditure that exceeds their assessable revenue in a financial year, the excess expenditure is carried forward and uplifted to be deducted against assessable project receipts derived by the person in future years.

1.18 The PRRT is essentially a project based tax, so excess undeducted expenditure may not generally be offset against income from other projects. The exception is exploration expenditure, which is transferable to other petroleum projects, subject to a number of conditions.

What is a petroleum project?

1.19 Under the PRRTAA 1987, a 'petroleum project' is taken to exist when there is a production licence in force [subsection 19(1) of the PRRTAA 1987] . However, what constitutes a petroleum project can include activities conducted in relation to the project but which physically take place outside the production licence area.

1.20 A petroleum project also includes the operations, facilities and other things required, for the recovery of petroleum and the processing and treatment of recovered petroleum to produce marketable petroleum commodities prior to being sold or becoming an excluded commodity. [Subsection 19(4) of the PRRTAA 1987]

1.21 A single petroleum production licence can form the basis of a petroleum project. In addition, two or more production licences can be combined to form a single project for PRRT purposes in circumstances where the Resources Minister considers the production licences sufficiently related. [Section 20 of the PRRTAA 1987]

Who is liable to pay PRRT?

1.22 The PRRT is levied on a person in a financial year in relation to a petroleum project at a rate of 40 per cent of the taxable profit. That is the profit after all eligible expenses incurred by the person have been deducted from the assessable receipts derived.

1.23 Each person who earns a taxable profit in relation to a petroleum project in a year of tax is liable to pay PRRT [section 21 of the PRRTAA 1987] . Partnerships or unincorporated associations are taken to be a person for the purposes of the PRRT [sections 12 and 13 of the PRRTAA 1987] . Where participation in a petroleum project is through a trust, the trustee is liable for the PRRT rather than the individual beneficiaries [section 109 of the PRRTAA 1987] . The parties in a joint venture are assessed on an individual basis.

1.24 A person has a PRRT taxable profit in a year of tax in relation to a petroleum project if their assessable receipts exceed their deductible expenditures. Diagram 1.1 illustrates the basic framework for calculating PRRT liability.

Diagram 1.1: Calculating PRRT Liability

1.25 PRRT payments are deductible for income tax purposes.

Assessable receipts

1.26 There are six types of receipts that may constitute assessable receipts derived by a person in relation to a petroleum project under the PRRTAA 1987 [section 23 of the PRRTAA 1987] . These can be divided into two broad categories, namely:

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'assessable petroleum and exploration recovery receipts' derived from the sale of petroleum, or marketable petroleum commodities produced from petroleum recovered from the project's eligible exploration or recovery area; and

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other receipts that may be derived in relation to a petroleum project such as through the disposal or hiring out of project assets.

1.27 'Assessable petroleum receipts' result from the sale of petroleum prior to a marketable petroleum commodity being produced, or from marketable petroleum commodities that become an 'excluded commodity' via sale. Where a marketable petroleum commodity becomes an excluded commodity other than by sale (for instance moved away from its place of production other than to adjacent storage, or further processed), the market value of a marketable petroleum commodity immediately before it became an excluded commodity is treated as an assessable receipt for PRRT purposes. [Section 24 of the PRRTAA 1987]

1.28 Special provisions apply to calculating the assessable receipts associated with sales gas produced in integrated gas-to-liquids projects such as liquefied natural gas projects. These provisions are contained in the Petroleum Resource Rent Tax Assessment Regulations 2005 .

1.29 Receipts that effectively recoup deductible project expenditure, or which compensate for the loss or destruction of petroleum or marketable petroleum commodities from the project, such as insurance payments or rebates, are taken to be assessable receipts [paragraph 28(b) of the PRRTAA 1987] . A person may also derive assessable receipts in relation to a petroleum project in other forms, including:

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payments received in exchange for utilising project assets and/or operations to process petroleum from another project [section 24A of the PRRTAA 1987] ;

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amounts received in respect of the disposal, loss or destruction of property for which PRRT deductible expenditure had been incurred or other payments in relation to such property [section 27 of the PRRTAA 1987] ; and

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payments received in respect of employee amenities for which deductible expenditure was incurred [section 29 of the PRRTAA 1987] .

1.30 These receipts are taken to be assessable for PRRT purposes to ensure that only the 'net' expenditure incurred by a person in relation to a petroleum project is deductible for PRRT purposes.

1.31 Assessable receipts do not include amounts received as loans, or in respect of loans made, receipts of interest and capital repayments received from borrowers. They also do not include share capital received as shareholders' funds, dividends or bonus shares received from associated companies or private royalty income.

Eligible real expenditure

1.32 Under the PRRT, expenditure of both a capital and revenue nature which is incurred by a person in relation to the petroleum project (eligible real expenditure) is deductible against assessable receipts in the year that it is incurred.

1.33 Eligible real expenditure is categorised as general project expenditure, exploration expenditure or closing-down expenditure, depending on its nature and purpose. [Sections 37 to 39 of the PRRTAA 1987]

1.34 Where capital expenditure is incurred in respect of assets or property that is to be used only partly in relation to a petroleum project, only that portion of the expenditure related to petroleum project use is deductible for PRRT purposes. [Section 42 of the PRRTAA 1987]

Exploration expenditure

1.35 Exploration expenditure comprises expenditure incurred in relation to exploration for petroleum that relates to an eligible exploration or recovery area [section 37 of the PRRTAA 1987] . The characterisation of expenditure incurred by a person holding an interest in an exploration permit (or a retention lease) is a question of fact to be determined in light of all the circumstances. It is not determined simply by reference to the fact that the person holds an exploration permit (or a retention lease).

1.36 Exploration expenditure is deductible against assessable receipts of the project but if there are insufficient receipts, exploration expenditure can be transferred to other projects if certain conditions are satisfied.

General project expenditure

1.37 General project expenditure comprises expenditure (other than excluded expenditure, exploration expenditure or closing-down expenditure) incurred in relation to carrying on or providing the operations, facilities and other things in relation to a petroleum project.

1.38 It includes expenditure related to the recovery of petroleum recovered from the production licence area, processing to produce marketable petroleum commodities, as well as storage, services and employee amenities related to the project. [Section 38 of the PRRTAA 1987]

1.39 Examples of general project expenditure include expenditure on production platforms, drilling plant and equipment, pipelines to transport petroleum from the well head to a reception point, payments to contractors, and the wage costs of project employees.

Closing-down expenditure

1.40 Closing-down expenditure comprises all expenditure related to closing-down a petroleum project, including expenditure on environmental restoration of the petroleum project area and the removal of drilling platforms (but not the cost of relocating them elsewhere). [Section 39 of the PRRTAA 1987]

1.41 In cases where a person derives insufficient assessable receipts for a year against which to deduct closing-down expenditure incurred for the year, a tax credit of 40 per cent of the excess expenditure is provided subject to the tax credit not exceeding the cumulative PRRT previously paid. [Section 46 of the PRRTAA 1987]

1.42 The provision of a tax credit ensures that a person is able to recover the eligible project expenditure incurred, notwithstanding that production from the project may have ceased, in cases where PRRT on the project has previously been paid.

Excluded expenditure

1.43 Project financing costs, certain indirect payments and certain payments in respect of administration and accounting activities are specifically not taken into account in ascertaining amounts of exploration, general project and closing-down expenditure in relation to a project. Excluded expenditure includes:

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financing costs, including interest payments and repayments of principal in respect of borrowings;

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dividend payments, share issue costs, and equity capital repayments;

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payments to acquire an interest in an exploration permit, retention lease or production licence (including to acquire interests in petroleum project profits, receipts or expenditures) other than in relation to the grant of the permit, lease, licence or authority;

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private override royalties;

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payments of income tax and GST; and

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indirect administration costs and payments in respect of land and buildings related to administration.

[Section 44 of the PRRTAA 1987]

Deductible expenditure

1.44 Where a person's eligible real expenditure in relation to a project exceeds their assessable receipts in a year, the excess is 'carried forward' and augmented on a yearly basis until it can be absorbed against assessable receipts from the project, or transferred to another project.

1.45 The uplift rate applied to augment undeducted expenditure depends on whether it is exploration or general project expenditure, and the time at which it is incurred.

1.46 General project and exploration expenditure is further categorised into 'Class 1' and 'Class 2' expenditure. Whether expenditure is Class 1 or Class 2 largely relates to whether it was incurred before or after 1 July 1990. The exception is that general project expenditure is treated as Class 1 gross domestic product (GDP) factor expenditure where it was incurred more than five years before a production licence came into force, regardless of the year it was incurred.

1.47 Table 1.1 summarises the different deductible expenditure categories.

Exploration expenditure is transferable

1.48 A person who has undeducted Class 2 augmented bond rate exploration expenditure or class 2 GDP factor expenditure in relation to a petroleum project in a financial year, must if they are able to do so, transfer that expenditure.

1.49 The rules governing the transferability of exploration expenditure are within the Schedule to the PRRTAA 1987, and for a transfer between projects of the same taxpayer, they include requirements that:

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the taxpayer must hold an interest in both the transferring petroleum project (or the exploration right) and the receiving petroleum project from the time the transferable expenditure was incurred up until the time of transfer;

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the receiving petroleum project must have a taxable profit, and the transferred expenditure cannot exceed that amount;

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the exploration expenditure must be transferred first to the petroleum project that has the most recent production licence; and

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transfers must be made in the following order:

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Class 2 augmented bond rate exploration expenditure uplifted at the LTBR + 15 per cent, starting with the oldest expenditure; and

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Class 2 GDP factor expenditure uplifted at the GDP factor starting with the oldest expenditure first.