House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 1 - Mining rights and information

Outline of chapter

1.1 Schedule 1 to this Bill amends the capital allowance provisions in Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997). The amendments limit the scope of the immediate deduction for expenditure on mining, quarrying or prospecting rights (mining rights) and mining, quarrying or prospecting information (mining information) first used in exploration. The limitation better targets the immediate deduction to genuine exploration activities.

Context of amendments

1.2 Australia's income tax system supports the exploration for resources by allowing an immediate deduction for the cost of depreciating assets that are first used in exploration. This is an important concession, which recognises resources exploration is a vital activity that has spill over benefits to the economy.

1.3 Concerns have emerged in recent years that the immediate deduction is being claimed in circumstances that go beyond the policy intent of supporting exploration activity. This integrity concern arises where the immediate deduction is claimed for the cost of acquiring mining rights and information, where the price paid reflects the value of resources that have already been discovered. The growing number of claims being made is presenting base erosion concerns, and is undermining the sustainability of this tax concession.

1.4 To address these integrity concerns, the tax concession will be tightened to better target genuine exploration activity. Mining rights and information that are first used for exploration but no longer immediately deductible will be depreciated over their effective life, or 15 years if this is shorter.

Summary of new law

1.5 In the Treasurer and Assistant Treasurer's joint Media Release of 6 November 2013 titled, the Commonwealth Government announced that it will better target the immediate deduction for exploration to genuine exploration activity as previously announced by the former Government.

1.6 The capital allowance provisions will be changed so that the cost of mining rights and mining information first used for exploration will no longer be immediately deductible except in limited circumstances.

1.7 The costs of mining rights and mining information will continue to be immediately deductible if acquired directly from a Commonwealth, State or Territory government body.

1.8 Expenditure incurred on generating new mining information will continue to be immediately deductible.

1.9 Expenditure incurred in obtaining geological and geophysical information data packages from specified providers will continue to be immediately deductible.

1.10 All other mining rights and mining information costs that would currently benefit from the immediate deduction that are excluded by the operation of this measure will be depreciable over either 15 years from the time the rights or information are first used, or their effective lives, whichever is the shorter period.

1.11 Where exploration on a particular tenement ceases, the taxpayer can choose to immediately deduct any remaining undepreciated value of the related mining rights and mining information. If the taxpayer then recommences exploration on the tenement, they will be subject to a clawback of what would have been the residual value of the mining rights or mining information had the taxpayer not chosen an immediate deduction.

Comparison of key features of new law and current law

Detailed explanation of new law

1.12 Schedule 1 to this Bill amends Division 40 of the ITAA 1997 to limit the immediate deductibility of mining rights and mining information to better target the deduction to genuine exploration activities.

1.13 An immediate deduction is available for mining rights and mining information acquired directly from an Australian government body.

1.14 Expenditure incurred on generating new mining information continues to be immediately deductible.

1.15 Expenditure incurred on obtaining off the shelf geological and geophysical information such as data packages and survey results acquired from private providers will continue to be immediately deductible under certain circumstances.

1.16 All other mining rights and mining information costs that would benefit from the current immediate deduction provisions that are excluded by the operation of this new measure will be depreciable over either 15 years from the time the depreciating assets are first used or their effective lives, whichever is the shorter period.

1.17 Where exploration is unsuccessful and ceases, the taxpayer may choose to immediately deduct any remaining undepreciated value. If the taxpayer recommences exploration or production activities on the tenement, a clawback amount may be included in assessable income.

Immediate deduction

1.18 An immediate deduction for the cost of mining rights and mining information still applies in three cases. These are broadly:

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where the right or information has been acquired from an Australian Government agency or entity;

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where the information has been provided from a private supplier of geological data of a technical nature - that is, someone whose primary business is to provide geological data; or

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where the information has been created by the taxpayer itself - either directly or through hiring a contractor to generate the information.

1.19 These cases are not considered to present a significant integrity risk, as their cost does not significantly reflect the value of known resources.

1.20 In each case, eligibility for the immediate deduction is still dependant on meeting all the qualifying criteria in subsection 40-80(1), not just the provisions inserted by this Schedule.

Rights and information acquired from the Commonwealth, State or Territory Government

1.21 Mining rights are issued by the State, Territory or Commonwealth, depending on the geographical location to which the rights apply. Expenditure incurred in acquiring a mining right from the issuing body (an Australian Government agency or Government entity) remains immediately deductible. This includes where a right has been acquired from an Australian Government authority through a cash bidding process.

1.22 Cash bidding usually occurs in mature areas where the bidders have some expectation that the geographical area to which the right relates will contain minerals or petroleum, although the precise location of these resources is not known. These costs are considered to be incurred for genuine exploration despite the bid price reflecting the expected presence of resources. [Schedule 1, item 1, paragraph 40-80(1)(d)]

1.23 Similarly, expenditure on mining information acquired from an Australian Government agency or a Government entity, such as Geoscience Australia is immediately deductible. [Schedule 1, item 1, subparagraph 40-80(1)(e)(i)]

Geological and geophysical data packages

1.24 An immediate deduction is allowable for the acquisition of mining information in the nature of a geological or geophysical data package. The taxpayer must acquire the information from an entity whose main business is the provision of mining information to be eligible for the immediate deduction. [Schedule 1, item 1, subparagraph 40-80(1)(e)(ii) and subsection 40-80(1AA)]

1.25 A geological or geophysical data package is a specific subset of mining information. It is general information of a technical nature. It is not mining information that relates to the more precise location of a particular resource. This information tends to be an off the shelf product and is not created in respect of a particular tenement.

1.26 The types of entities who typically provide geological and geophysical data packages include expert geologists and other specialists who speculatively analyse raw geological data. Geological and geophysical data packages may include pre-existing mining information.

Newly created mining information

1.27 An immediate deduction is allowable where the taxpayer creates mining information or an enhancement to mining information already held. [Schedule 1, items 1 and 2, subparagraph 40-80(1)(e)(iii), subparagraph 40-80(1)(e)(iv) and subsection 40-80(1AA)]

1.28 To create information the taxpayer must bring new information into existence.

Mining information may be created directly by the taxpayer using their staff to conduct exploratory or prospecting activities. Accordingly expenditure such as salaries and wages, contractor fees, travel and accommodation, fuels and consumables may form part of the cost of mining information.

1.29 An immediate deduction is also available where the creation of the mining information is outsourced by commissioning through an agency arrangement to an entity that is in the business of providing mining information, including providing services that generate mining information, to explorers or miners. [Schedule 1, items 1 and 2, subparagraphs 40-80(1)(e)(iii) and (iv) and subsection 40-80(1AA)]

1.30 The cost of a mining information asset created for a taxpayer by the holder of an immediately adjacent mining right relating to minerals beneath both tenements is immediately deductible to the taxpayers where they contributed to the cost of its creation. [Schedule 1, item 1, subparagraphs 40-80(1)(e)(iii)]

1.31 A joint venture partner to a mining operation has a percentage interest in an information asset created in respect of the joint venture. The joint venturer will therefore be eligible for the immediate deduction as having created the asset, or caused it to be created directly themselves in respect of their percentage contribution to expenditure incurred for that purpose. [Schedule 1, items 1 and 2, subparagraphs 40-80(1)(e)(iii) and (iv) and subsection 40 80(1AA)]

Application of subsection 40-80(1) qualifying criteria to second element costs

1.32 Expenditure on mining rights and mining information must also satisfy the qualifying criteria in subsection 40-80(1) to be immediately deductible.

1.33 Use of a mining right consisting of a set of rights involves undertaking an activity or taking some action permitted by that set of rights that would be unlawful if the mining right was not held by the taxpayer. For subsection 40-80(1), the nature of that use must then be for exploration or prospecting.

1.34 Further, the taxpayer must satisfy one of the following three tests:

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the taxpayer carried on general mining operations, petroleum mining operations or quarrying operations;

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it would be reasonable to conclude that the taxpayer proposed to carry on such operations; or

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the taxpayer carried on a business of, or a business that included, exploration or prospecting for minerals (including petroleum) or quarry materials obtainable by such operations and the expenditure was necessarily incurred in carrying on that business.

1.35 Similarly, these criteria apply again when an asset is enhanced and a second element cost is incurred. [Schedule 1, item 2, subsection 40-80(1AB)]

1.36 It is typical that a mining information asset is created over time. That is, costs are incurred over a period of time in further developing and enhancing the data that establishes the information asset. The uniform capital allowance provisions operate such that each separate cost component of a depreciating asset is identified and added to the original cost of the asset.

1.37 After each time a mining right or mining information asset is enhanced, the first use of the enhanced asset must be for exploration or prospecting. It cannot be for development drilling for petroleum or operation in the course of working a mine quarry or petroleum field, if the second element cost is to be immediately deductible.

1.38 The mining right or mining information asset is independently retested against all of the relevant subsection 40-80(1) qualifying criteria in this way, regardless of whether or not the asset previously satisfied the qualifying criteria. Only the amount of the enhancement is immediately deductible if the criteria are satisfied. Other previously undeducted costs continue to decline in value over the effective life of the asset.

1.39 These second element costs, which could include certain wages and other incidental expenditure, are not deductible under section 40-730 where they form part of the cost of a depreciating asset. Mining rights and mining information first used for exploration but no longer immediately deductible

1.40 Mining rights and mining information that are first used for exploration and whose costs are not eligible for the immediate deduction because of the amendments in this Schedule are to be depreciated over 15 years or their effective life, whichever is shorter. [Schedule 1, item 3, subsection 40-95(10A)]

1.41 Mining rights and mining information that do not satisfy the first use for exploration or prospecting continue to have their costs depreciated over the effective life of the rights and information. The effective life of mining rights and mining information is determined by reference to the life of any mine or proposed mine to which it relates. If there is more than one mine or proposed mine, the life of the mine that has the longest estimated life is used. [Schedule 1, item 3, subsection 40-95(10)]

1.42 The effective life of mining rights and mining information that relate to a petroleum field or quarry are similarly calculated. [Schedule 1, item 3, subsection 40-95(10)]

1.43 If no such mine or proposed mine exists, the right or information will be depreciated over 15 years, regardless of whether or not the first use criteria are met. [Schedule 1, item 5, subsection 40-95(12)]

1.44 The taxpayer may choose to recalculate the effective life of the right or information asset where the effective life is no longer accurate due to a change in circumstances - including where a related mine or proposed mine or petroleum field has subsequently come into existence, or ceased to exist. [Schedule 1, item 8, subsection 40-110(3B)]

Balancing adjustment provisions

1.45 A new balancing adjustment has been added to the capital allowance provisions. The balancing adjustment only applies to a mining right or mining information first used for exploration or prospecting that was not immediately deductible only because it did not satisfy the requirements in subparagraphs 40-80(1)(d) or (e). It applies when exploration has been unsuccessful. [Schedule 1, item 14, paragraph 40-295(1A)(a) and (b)]

1.46 Exploration may be unsuccessful at a particular point if no resource body has been discovered on the tenement. It also may be unsuccessful because it is not commercially viable to develop any known resource body at that time. In either case, it is not industry practice to hand back the tenement to the issuing authority but to retain the tenement in the hope a tenement may be explored more successfully later or the resource body may become commercially viable to exploit later by virtue of changes in technology or commodity prices.

1.47 The taxpayer may choose for the balancing adjustment event to occur for a mining right or mining information asset if it has not budgeted or planned to incur expenditure that relates to the tenement to which the asset relates that is in excess of the minimum expenditure required to maintain the tenement. [Schedule 1, item 14, paragraph 40-295(1A)(b) and (c)]

1.48 The minimum expenditure necessary to satisfy the conditions for being allowed to continue to hold a mining right will vary and will depend on the conditions of the mining right and jurisdiction in which the minerals lie. The taxpayer must have not budgeted or planned to incur more expenditure than the minimum required to satisfy those conditions in order to choose for the balancing adjustment event to operate.

1.49 One common example of where this balancing adjustment event may apply is after:

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activities authorised by the mining right have generated mining information sufficient that a commercial quantity of minerals has been discovered and delineated; and

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subsequent economic study has determined it is not presently commercially viable to extract the minerals but extraction is expected to become commercially viable in a timeframe designated by the issuer (the relevant State or Commonwealth Minister) of the mining, quarrying or prospecting right relevant to the tenement. The designated timeframe is such that the issuer allows the explorer or miner to continue to hold a mining right, without having to move to commence operations by which minerals would be extracted for commercial exploitation, subject to conditions.

1.50 The conditions required to be met to retain the mining right will vary from right to right. The expenditure incurred in meeting those conditions is the minimum expenditure required to retain the tenement.

1.51 The amount that is deductible because of the balancing event is the adjustable value of the depreciating asset at the time the choice to apply the balancing adjustment is made. The adjustable value of a depreciating asset is so much of the cost of the asset at a particular time as not yet previously depreciated.

Clawback in the form of a balancing adjustment

1.52 The policy rationale for the clawback in the form of a balancing adjustment is that the valuation of mining rights and mining information is inherently uncertain and will change as resource prices change and in light of technological developments. If the valuation of any asset subsequently increases after a write down, and hence exploration recommences, it is appropriate to correct the earlier write down in the form of a balancing adjustment, albeit the original write down was in good faith.

1.53 If the conditions that allow the taxpayer to choose to apply a subsection 40-295(1A) balancing adjustment event are no longer met, the taxpayer must include a clawback in their assessable income. [Schedule 1, item 14, paragraph 40-295(1B)]

1.54 The amount of the clawback is dependent on the time at which the conditions for the subsection 40-295(1A) balancing adjustment event are no longer satisfied. The clawback amount is what the adjustable value of the mining right or mining information would have been at that time if the taxpayer had not previously applied the balancing adjustment event.

1.55 Consequently, if the conditions for the subsection 40-295(1A) balancing adjustment event are no longer satisfied at a time after the end of the effective life of the asset (by reference to the original start time), and no second element costs have been incurred, the adjustable value of the mining right or mining information at that time will be zero. That is, in this circumstance there will be no clawback.

Example 1.1

Exploration Co purchases an exploration licence on a green field's tenement for $150 million from XYZ Mining Co (a private mining company). As granted under the exploration licence, they first use the exploration licence to commence exploration activity on the tenement.

Exploration Co depreciates the $150m cost of the exploration licence over 15 years on a prime cost basis. After five years Exploration Co discovers an ore body on the tenement but concludes that it is not commercially viable to develop the deposit and decides to discontinue further exploration on the tenement. At this point, the adjustable value of the exploration licence is $100 million, with Exploration Co having claimed depreciation deductions of $10 million a year over the five preceding years. Exploration Co does not plan or budget for further expenditure on the land in excess of what is required to maintain the exploration licence. Exploration Co chooses to write down the remaining adjustable value of the tenement to $0.

After owning the exploration licence for 10 years, Exploration Co concludes that, because of a change in commodity prices, it will recommence exploration of the tenement. The adjustable value of the exploration licence, had it not elected the balancing adjustment in year 5, and had not incurred any second element costs, would now be $50 million. If Exploration Co had not elected the balancing adjustment in year five it would have claimed depreciation deductions of $10 million a year over 10 years, leading to a write down of the exploration licence of $100 million. When $100 million is deducted from the initial cost of the exploration licence of $150 million, this leads to an adjustable value of $50 million.

Therefore, the balancing adjustment amount added to Exploration Co's assessable income as a result of triggering the subsection 40-295(1B) balancing adjustment event in year 10 is $50 million. This is the difference between the written down value of the exploration licence, that is $0, and what would have been the adjustable value had Exploration Co not chosen to apply the subsection 40-295 (1A) balancing adjustment event.

$50 million becomes the new adjustable value of the exploration licence at the beginning of year 10 and Exploration Co may deduct $10million a year in relation to the exploration licence over the next five years (assuming Exploration Co has not chosen to use a different estimated effective life of the exploration licence under subsection 40-110(3B)).

If at the beginning of year 10 Exploration Co had a proposed mine with an effective life of four years to which the exploration licence relates, and it chooses to use the re-estimated effective life under subsection 40-110(3B), the Exploration Co would be able to depreciate the remaining cost of the exploration licence at $12.5 million a year on a prime cost basis.

The clawback would apply similarly if the exploration licence was depreciated using the diminishing value method.

Consequential amendments

1.56 Consequential amendments were required to the effective life, cost and balancing adjustment provisions. [Schedule 1, items 4, 6, 7, 10, 11, 12, 13 and 15, paragraph 40-95(11)(a), paragraph 40-105(4)(c), subsection 40-110(3A), subsection 40-180(1), table in subsection 40-180(2,) subsection 40-285(4), note in subsection 40-285(4) and table in subsection 40-300(2)]

Application and transitional provisions

1.57 In order to ensure that this measure does not distort commercial activity, it applies to acquisitions of mining rights and mining information that occur after the announcement of the measure at 7.30 pm Australian Eastern Standard Time, 14 May 2013.

1.58 However, the amendments in this Schedule do not apply to mining rights or mining information you begin to hold after that time if you did so by virtue of an arrangement you had entered into before the announcement. [Schedule 1, Part 2, items 1 and 2]

1.59 The arrangement involving the acquisition right must have been in place continuously from the time before the announcement until the time you become the holder of the mining right or mining information. All terms and conditions of the arrangement, including the consideration for the right or information, must have been agreed prior to the time of the announcement.

1.60 The fact that the arrangement is contingent upon the exercising of an acquisition right, option or other condition does not prevent it from satisfying these criteria.

1.61 For example, if the taxpayer entered into an option to acquire a mining right at a particular price before the announcement but had not exercised it until after the announcement, the taxpayer is still entitled to the immediate deduction for the cost of the mining right (exercise price) when the taxpayer exercised the option subject to satisfying subsection 40-80(1) in its form prior to these amendments.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Mining rights and information

1.62 Schedule 1 to this Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

1.63 This Schedule amends the ITAA 1997 to limit the immediate deductibility of expenditure on mining rights and mining information first used in exploration. The limitation better targets the immediate deduction to genuine exploration activities.

Human rights implications

1.64 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

1.65 This Schedule is compatible with human rights as it does not raise any human rights issues.