House of Representatives

Explanatory Memorandum

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

Chapter 3 - Assessable receipts

Outline of chapter

3.1 This chapter outlines the provisions in Schedule 2 to the Petroleum Resource Rent Tax Assessment Amendment Bill 2011 (Main Bill) which amends the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA 1987) to ensure:

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the earliest time that an onshore petroleum project and the North West Shelf project can derive assessable receipts is 1 July 2012;

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incidental production receipts that have been generated using the operations, facilities and other things related to a project on which deductible expenditure was incurred are included in the assessable receipts of the project; and

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the sale of 'project natural gas' which is to be used as feedstock in an integrated gas to liquids project have access to the Petroleum Resource Rent Tax Assessment Regulations 2005 .

3.2 All legislative references throughout this chapter are to the Main Bill unless otherwise indicated.

Context of amendments

3.3 Under some circumstances incidental products or provision of services relating to carbon capture and storage may be produced or provided using operations and facilities that are related to the petroleum project. Some examples include: treated water from a coal seam gas project; generation of excess electricity; or use of project facilities to provide carbon storage services.

3.4 Incidental products or carbon capture and storage services can be sold, generating revenue. It is appropriate to include that revenue as assessable receipts to the extent it has been generated using Petroleum Resource Rent Tax (PRRT) deductible expenditure.

3.5 In some circumstances 'project natural gas' to be used as feedstock for an integrated liquefied natural gas (LNG) plant may be sold to a related party prior to being converted to LNG. The amendments ensure that participants are not excluded from accessing the Petroleum Resource Rent Tax Assessment Regulations 2005 in these circumstances.

Comparison of key features of new law and current law

Detailed explanation of new law

Part 1 - Amendments commencing on 1 July 2012

Onshore projects and North West Shelf project: time for deriving assessable receipts

3.6 The PRRT applies to profits from a petroleum project. It is calculated by deducting eligible real expenditure from assessable receipts.

3.7 The PRRT is being extended to onshore projects and the North West Shelf project from 1 July 2012. The time from which assessable receipts can be derived for the North West Shelf project and onshore projects has been set at 1 July 2012 [Schedule 2, items 9 and 10] . This ensures that onshore projects are not taxed on receipts received prior to the PRRT applying onshore. When the look back starting base approach has been adopted certain assessable receipts can be derived prior to 1 July 2012.

3.8 However, any prepayment of assessable receipts is taken to have been derived in the financial year in which the activity is undertaken [Schedule 2, item 13] . This ensures that payment of receipts received before 1 July 2012 for petroleum or marketable petroleum commodities not recovered or produced until after 1 July 2012 is assessable.

Example 3.1: Pre-payment of an assessable tolling receipt

Thorsouth Oil and Gas Limited operate the Whenrangy petroleum project. Thorsouth Oil and Gas Limited entered into a contract on 1 July 2011 with Haskicdoyle Gas Limited to process their gas through the Whenrangy petroleum project's gas processing plant for the next five years. Haskicdoyle Gas Limited prepaid Thorsouth Oil and Gas $15 million on 1 July 2011 ($3 million per year) to undertake this toll processing. The proportion of the activity that was undertaken prior to 1 July 2012 will not generate an assessable tolling receipt for example, $3 million. The proportion of the activity undertaken after 1 July 2012 will generate an assessable tolling receipt when the tolling activity is undertaken of $3 million per year for the next four years.

3.9 For the purposes of the PRRT onshore projects and the North West Shelf project are treated as if eligible real expenditure could be incurred at any time including a time before 1 July 2012 [Schedule 2, item 11] . This allows assessable receipts to be derived from expenditure that was incurred by the petroleum project prior to 1 July 2012.

Refunds of resource tax expenditure

3.10 Resource tax expenditures are creditable against the PRRT liability of a PRRT project. Payments of resource taxes are converted to a deduction equivalent by dividing by the prevailing PRRT rate.

3.11 In some circumstances the holder of an interest in a petroleum project may receive a refund of resource tax expenditure (such as where there has been an overpayment). Such a refund will be grossed up by dividing it by the PRRT rate [Schedule 2, items 3 and 4] and be treated as an assessable miscellaneous compensation receipt under subparagraph 28(b)(ii) of the PRRTAA 1987. Grossing up of the resource tax refund ensures that the correct amount is recognised as an assessable miscellaneous compensation receipt. The refund will be recognised in the year of tax that it is received and not when the resource tax expenditure to which it relates was incurred.

3.12 Onshore projects and the North West Shelf project may also receive a refund of a resource tax after 1 July 2012 that relates to petroleum extracted prior to 1 July 2012. This refund would be considered an assessable miscellaneous compensation receipt under subparagraph 28(b)(ii) of the PRRTAA 1987. A transitional provision has been inserted to ensure that refunds of resource taxes that relate to petroleum extracted prior to 1 July 2012 are not included as assessable receipts. [Schedule 2, item 13]

Example 3.2: Refund of a resource tax

Tinni Oil and Gas Company pre-paid $1.5 million in royalty to the Western Australian Government for petroleum extracted between 1 June 2012 and 30 June 2012. During June a cyclone disrupted production and only $1 million in royalties was payable by Tinni Oil and Gas Company to the Western Australian Government. On 3 July 2012, Tinni Oil and Gas Company received a $0.5 million refund of the royalties paid. The refund of the royalties would not give rise to an assessable receipt because it is related to petroleum extracted prior to 1 July 2012.

Assessable incidental production receipts

3.13 In some circumstances products other than petroleum or marketable petroleum commodities will be recovered, extracted or produced using operations and facilities that are related to the petroleum project and for which deductible expenditure was incurred. Examples include treated water from a coal seam gas project or excess electricity generated from the project. These incidental products or carbon capture and storage services could then be sold, effectively reducing the net costs of the operations and facilities in relation to the petroleum project.

3.14 This measure includes revenue received from the sale of incidental products or carbon capture and storage services as an assessable receipt for the calculation of taxable PRRT profit [Schedule 2, items 1, 2 and 5, section 29A] . The consideration receivable is reduced by any expenses whether of a capital or revenue nature related to the sale to the extent they were not eligible real expenditure under the PRRT and incurred in deriving the assessable incidental production receipts [Schedule 2, item 5, subsection 29A(2)] .

3.15 Assessable incidental production receipts will only be derived when the product or service in relation to carbon capture and storage is:

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sold;

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recovered, extracted, provided or produced in carrying on operations, facilities and other things in relation to the project;

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not petroleum or a marketable petroleum commodity; and

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related to eligible real expenditure incurred by the person in relation to the petroleum project, including the combined project or any pre-combination project.

Example 3.3: A coal seam gas water treatment facility

Ayda Resources Limited, Llumens Petroleum Limited and Warlygas Limited are participants in the Micknnell coal seam gas project. The petroleum project produces sales gas, a portion of which will be sold in the domestic gas market and the remainder converted into liquefied natural gas (LNG) for export.

A necessary and integral part of the Micknnell project is a water treatment facility that processes the water recovered as part of the petroleum project. The project is subject to comprehensive environmental conditions which include requirements to treat waste water and to monitor the environmental impact of water production.

The Micknnell project decides that following the processing of the water into a resource it will be:

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sold to the Crawford distillery; and

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provided to the local football club to assist them to irrigate the football oval.

The receipts from the sale of the water to the Crawford distillery are assessable incidental production receipts as the water has been produced using operations, facilities or other things comprising the petroleum project and the costs associated with processing and treating the water have been claimed as deductible expenditure.

The provision of the water to the local football club to irrigate the football oval was not sold and no consideration was received. Consequently no assessable incidental production receipts would be generated with respect to this water.

Example 3.4: Remote use of products

The Chofields coal seam gas project is owned and operated by Lotjoo Petroleum Limited that has a water monitoring and management plan which uses the processed waste water for irrigation of timber. The timber is being grown to provide a method of disposing of the water produced from the Chofields project. The expenses associated with the processing of the water to ensure it is suitable for irrigation is deductible expenditure for Lotjoo Petroleum Limited.

The timber is being grown by Lotjoo Petroleum Limited and Robwn Woodchips Limited. The water is not sold to Robwn Woodchips Limited.

Water provided to Robwn Woodchips Limited is not sold, therefore no assessable incidental production receipts have been derived by Lotjoo Petroleum Limited. The timber production of Robwn Woodchips Limited is not associated with the operations, facilities and other things comprising the petroleum project and as such, the costs of the timber production of Robwn Woodchips Limited are not deductible. In addition any proceeds from the sale of the timber in Robwn Woodchips Limited will not constitute assessable incidental production receipts as the timber has not been recovered, extracted or produced in carrying on the petroleum project.

Lotjoo Petroleum Limited is required to dispose of the water not provided to Robwn Woodchips Limited and grows trees using this water. Lotjoo Petroleum Limited has claimed the expenses associated with the timber production as eligible real expenditure because the disposal of the water and associated timber production is related to the operations, facilities and other things comprising the petroleum project. The proceeds from the sale of the timber by Lotjoo Petroleum Limited will result in assessable incidental production receipts as the timber has been recovered, extracted or produced in carrying on the petroleum project because deductible expenditure associated with the timber production was claimed by Lotjoo Petroleum Limited in relation to its petroleum project.

Example 3.5: Excess electricity generation

Zellanne Petroleum Limited operates a petroleum project. Zellanne Petroleum Limited has installed as part of the petroleum project some electricity generation capacity that uses petroleum from the project. While the electricity is generated for use by the operations and facilities of the petroleum project, at times excess electricity is produced to maintain security of supply because of fluctuating demand. Any excess electricity produced is sold to the national electricity market and a local uranium mine operated by Maarchette Limited. The sale of excess electricity is considered a product under section 29A. The consideration received by Zellanne Petroleum Limited from the sale of the excess electricity would generate assessable incidental production receipts.

Zellanne Petroleum Limited incurred expenditure for a power line to connect its electricity generators to the national electricity market. This cost was not deductible in relation to the petroleum project. Consequently the consideration received from the sale of the electricity under paragraph 29A(2)(b) will be reduced by the sum of any expenditure (whether of a capital or revenue nature) to the extent it was incurred in deriving the assessable incidental petroleum receipts and is not eligible real expenditure in relation to the petroleum project.

Example 3.6: Carbon capture and storage for a power station

Viicator Oil Company operates a petroleum project with associated carbon capture and storage facility which is a necessary and integral part of the petroleum project. VoltaBilly Limited operates a coal power station and has contracted Viicator Oil Company to sequester the carbon dioxide produced from the power station. Viicator Oil Company receives payment for the carbon capture and storage service provided to VoltaBilly Limited. This payment would be considered an assessable incidental production receipt because the service provided is using operations, facilities and other things that comprise the petroleum project.

Example 3.7: Assessable incidental production receipts from the sale of carbon emission units

At the beginning of the year, Tanner Robe Oil Company estimates that it will have an upstream emissions liability of 5,000 tonnes of CO2 for that year. The company pays $125,000 to purchase these units on the market at $25/unit and deducts this expenditure as environmental expenditure related to the petroleum project.

At the end of the year, Tanner Robe Oil Company finds out that it only needed to surrender 4,000 emission units. It sells 1,000 units at $30/unit and surrenders the rest to meet its emissions liability. Tanner Robe Oil Company will recognise the $30,000 it received from the sale of the excess units as an assessable incidental production receipt.

Example 3.8: Unrelated product

Raymurj Limited, a LNG producer, is a co-venturer in, and operator of, a major LNG project, Strike-It-Lucky. Raymurj Limited has in place a corporate risk management policy which involves Raymurj Limited taking out hedges to minimise risks associated with fluctuations in gas prices, interest rates and foreign exchange. These hedging arrangements are not embedded within the sales arrangements for gas.By undertaking this hedge program, Raymurj Limited has effectively locked in the gas price for its share of the Strike-It-Lucky output for the duration of the hedging contracts.

Even though the hedging program is aligned to Raymurj Limited's share of production, any gain on the hedge is not consideration receivable in relation to the sale of a product or the provision of a carbon capture and storage service and therefore does not comprise assessable incidental production receipts.

3.16 In circumstances where assessable incidental production receipts are derived using property that is only being partially used in relation to the petroleum project. The assessable incidental production receipts derived are apportioned in accordance with the amount of eligible real expenditure incurred in relation to the project. [Schedule 2, item 6]

Example 3.9: Partial use of a water treatment facility

Derpin Resources Limited operates a petroleum project and a gold project. Both the petroleum and gold projects require the removal and treatment of water. The water treatment facility is used equally between the petroleum and gold project. Only 50 per cent of the expenditure associated with the water treatment facility is eligible real expenditure under section 42 of the PRRTAA 1987 because only 50 per cent of the water treatment facility is used in relation to the petroleum project.

All the water from the water treatment facility is sold to Roffcath Soft Drink Limited. Only 50 per cent of the revenue received by Derpin Resources Limited from the sale of the water would be an assessable incidental receipt under the PRRTAA 1987 because only 50 per cent of the expenditure constituted eligible real expenditure.

3.17 Assessable incidental production receipts can be generated in relation to the petroleum project prior to the commencement of a petroleum project and are included in the calculation of PRRT taxable profit. [Schedule 2, items 7 and 8]

3.18 Where an assessable receipt could be categorised under multiple assessable receipt provisions it will only be assessed once.

3.19 In circumstances when a person derives assessable receipts, section 57 of the PRRTAA 1987 allows the Commissioner of Taxation to consider whether a particular transaction is non-arm's length having regard to the connection between the parties. The scope of this section has been expanded to include the new assessable incidental production receipts and assessable tolling receipts. [Schedule 2, item 12]

3.20 The transfer of carbon emission units where the costs of the units were included as eligible real expenditure in relation to the project will be treated as a non-arm's length sale, with the market value of the units included as an incidental receipt derived in relation to the project.

Example 3.10: Purchase and sale of carbon emission units

Marchette Resources, a wholly owned subsidiary of The Marchette Group operates a petroleum project. Marchette Resources purchases 10,000 carbon emission units at the beginning of the year in line with its estimates for the offset it will need against its future carbon emissions liability for its upstream operations during the year. It claims the expenditure as eligible real expenditure in the first quarter.

At the end of the year the actual emissions liability for Marchette Resources was found to be 7,000 carbon emission units, as production slowed due to some unforeseen circumstances. Marchette Resources surrenders 7,000 carbon emission units and transfers 3,000 units to Marchette Gold which is another subsidiary of the Marchette Group. The transfer of the carbon emission units is treated as a non-arm's length sale and the market value of the carbon emission units being transferred is recognised as assessable incidental production receipts in the final quarter of the financial year.

Part 2 - Amendments commencing on proclamation

Sale of project natural gas

3.21 Due to the operational and commercial arrangements of the onshore coal seam gas industry, holders of interests in coal seam gas sometimes sell the coal seam gas produced from their numerous projects to a separate, special purpose entity (an 'aggregator'). The aggregator performs a number of functions including:

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sourcing sufficient volumes of coal seam gas from various production licences;

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streamlining of gas processing services and gas sales contracts;

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allowing the sharing of infrastructure; and

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streamlining the transportation of gas using a common network of gas transmission pipelines.

3.22 In some circumstances a sale of natural gas to the aggregator may occur prior to a marketable petroleum commodity being produced. Amendments are made to the PRRTAA 1987 to ensure that, where such circumstances arise in the context of an onshore integrated gas to liquids operation, the interest holders are able to access the PRRT regulations. The PRRT regulations provide a methodology to determine the assessable petroleum receipts relating to that gas used as feedstock in a gas-to-liquids operation (project natural gas). [Schedule 2, items 14 to 16]

3.23 These amendments will commence on a single day to be set by proclamation or six months from the day these Bills receive Royal Assent.

3.24 The current PRRT regulations will be reviewed following the passage of the Main Bill to ensure they operate appropriately in the coal seam gas context.

Example 3.11: Sale of project natural gas

Touricet Limited operates an onshore coal seam gas to LNG facility in Tasmania. As part of their sourcing of natural gas from multiple petroleum licences Touricet Limited operate a 100 per cent owned 'aggregator'. For a number of commercial reasons the project natural gas is sold from licences held by Touricet Limited to the aggregator at a non- arm's length price. The aggregator collates the gas and it is then sent to Touricet's LNG facility.

The sale of project natural gas is referred to the PRRT regulations through paragraph 24(1)(f). The amount of assessable receipts to be included from the sale of the project natural gas is calculated in accordance with the PRRT regulations.