House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. Josh Frydenberg MP)

Chapter 1 Uplift rates for carried-forward expenditure

Outline of chapter

1.1 Schedule 1 to the Bill amends the Act to reduce the uplift rates that apply to certain categories of carried-forward expenditure.

Context of amendments

1.2 The PRRT is a profit-based tax on petroleum production, designed to ensure the Australian community receives a fair return on the extraction of Australia's finite petroleum resources while minimising disincentives for business to invest in the petroleum industry.

1.3 Section 22 of the Act outlines the formula on which PRRT is payable. A person is subject to tax on the taxable profit they receive for a year of tax in relation to a petroleum project (section 21). The taxable profit is the person's assessable receipts (section 23) less the sum of their deductible expenditure (section 32) and exploration expenditure transferred to the petroleum project (Division 3A of Part V).

1.4 The categories of deductible expenditure are:

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general project expenditure;

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exploration expenditure, which must, in certain circumstances, be transferred between certain petroleum projects and within company groups;

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resource tax expenditure, which is grossed-up by the PRRT rate (40 per cent) to give credit for royalties and excise paid on a petroleum project's output;

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acquired exploration expenditure and starting base expenditure, which recognise investments made in petroleum projects that transitioned to the PRRT regime; and

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closing-down expenditure, which can give rise to a refundable credit to the extent of prior PRRT liabilities.

1.5 PRRT liabilities are calculated on a project basis meaning deductible expenditure can generally only be used to offset assessable receipts from the same petroleum project and generally cannot be transferred to other projects of the taxpayer. Exploration expenditure is an exception to this principle and must be transferred, for example, between projects that satisfy the common interest rule in Clause 22 in Schedule 1 to the Act.

Expenditure uplifts

1.6 Due to their nature, petroleum projects experience periods of negative cash flow during exploration and construction before a project becomes cash flow positive. Taxpayers may carry-forward unutilised expenditure to offset future positive cash-flow periods.

1.7 The PRRT applies an uplift rate to carried-forward expenditure. The uplift rates are specific to different types of expenditure and are generally calculated by reference to either an ABR consisting of the LTBR and a premium, or the GDP factor outlined in section 2A of the Act.

Review of the PRRT

1.8 The Government initiated a Review of the Petroleum Resource Rent Tax, led by Michael Callaghan AM PSM, on 30 November 2016. The Review considered whether the PRRT was operating as it was originally intended and the reasons for a rapid decline of Australia's PRRT revenues.

1.9 The Callaghan Review received significant input from a wide range of industry and other community stakeholders. The Government released the Review on 28 April 2017.

1.10 The Review found that, while the PRRT remained the preferred way to achieve a fair return to the community without discouraging investment, 'changes should be made to PRRT arrangements to make them more compatible with the developments that have taken place in the Australian oil and gas industry.'

1.11 For example, since the PRRT was introduced in 1988, the nature of petroleum production has changed, shifting from crude oil and condensate to a more significant role for LNG. Over the past 30 years, oil and condensate production has nearly halved, and LNG production has increased over sevenfold.

1.12 LNG projects are characterised by a considerably longer development timeline, increasing the delay between an initial investment and positive cash flow. This, in turn, increases the total uplift applied to expenditure over the course of a project.

1.13 In this context, the Review identified that PRRT uplift rates for deductible expenditure are now overly generous.

Government response - tranche one

1.14 On 2 November 2018, the Government released its final response to the Review. The Government's response is available on the Treasury website: www.treasury.gov.au.

1.15 The Government is implementing its response to the Review in two tranches of legislation. The first tranche of legislation is contained in this Bill and will:

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lower the uplift rates that apply to certain categories of carried-forward expenditure; and

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remove onshore petroleum projects from the scope of the PRRT (see Chapter 2).

Government response - tranche two

1.16 The second tranche of amendments will implement the following changes announced in the Government response:

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improved rules will be introduced to identify petroleum projects to ensure the true scope of each project is recognised;

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more corporate groups will be able to access the benefits of grouping, including group lodgement obligations and broader access to functional currency rules;

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greater certainty will be created for deductible expenditure arising before a petroleum project starts to derive assessable receipts by taxpayers being required to lodge annual PRRT returns, and receive assessments, after they start holding an interest in an exploration permit, retention lease or production licence rather than when they start generating assessable receipts from production;

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taxpayers will be able to use a substituted accounting period for PRRT purposes if they have adopted the period for income tax purposes;

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a new power for the Commissioner of Taxation to administratively exempt projects from PRRT obligations where they are clearly unlikely to pay PRRT in the foreseeable future until they start production or PRRT becomes payable;

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the PRRT general anti-avoidance provisions will be strengthened to reflect changes made to Part IVA of the Income Tax Assessment Act 1936.

1.17 The Government intends to progress the second tranche of legislation in 2019. The Government also intends to progress consequential amendments to regulations in 2019.

Review of Gas Transfer Pricing Regulations

1.18 Further to these legislative reforms, the Treasury will commence a review into the regulations that determine the price of gas in integrated LNG projects for PRRT purposes. The Treasury will consult closely with the industry and community. The Treasury will consult and report back to Government within 12 to 18 months (from the date of the November 2018 announcement).

Summary of new law

1.19 Schedule 1 to the Bill amends the Act to reduce the uplift rates that apply to certain categories of carried-forward expenditure.

1.20 For petroleum projects that successfully apply for a production licence from 1 July 2019 (based on the date specified in a production licence notice), the general expenditure uplift rate will be the LTBR+5 percentage points until the financial year ten years after the financial year in which a project first derives assessable petroleum receipts. From that financial year, the uplift rate for remaining deductions will equal the LTBR.

1.21 For exploration expenditure incurred or transferred from 1 July 2019, the uplift rate will be LTBR+5 percentage points until the financial year ten years after the year in which the expenditure was incurred. From that financial year, any remaining amount of exploration expenditure is maintained in real terms by applying the GDP factor until the expenditure is deducted.

1.22 Where exploration expenditure incurred before 1 July 2019 is deducted within a petroleum project, the current uplift rate equal to the LTBR+15 percentage points (if it currently applies) will continue to apply until 1 July 2019. From that date, the uplift rate equal to the LTBR+5 percentage points will apply.

1.23 Lower uplift rates will limit the scope for excessive compounding of deductions. These changes will ensure the production of petroleum resources is taxed appropriately while continuing to support the development of Australia's LNG industry.

Comparison of key features of new law and current law

Detailed explanation of new law

General expenditure uplifts

1.24 General expenditure incurred no more than five years prior to a production licence being applied for (Class 2 ABR general expenditure) is currently subject to an uplift rate equal to the LTBR+5 percentage points (section 34A of the Act).

The amended general expenditure uplift rates

1.25 The uplift rate equal to the LTBR+5 percentage points continues to apply in relation to a new petroleum project before the project derives assessable petroleum receipts and for later financial years until the financial year ten years after the year in which the project first derives assessable petroleum receipts. [Schedule 1, item 4, subsection 34A(4) (paragraph (c) of the definition of 'uplift rate') of the Act]

1.26 After this period elapses, the uplift rate equal to the LTBR begins to apply to the general expenditure that relates to the petroleum project. [Schedule 1, item 4, subsection 34A(4) (paragraphs (a) and (b) of the definition of 'uplift rate') of the Act]

1.27 Carried-forward Class 2 ABR general expenditure is uplifted at the end of each financial year, including the financial year it was actually incurred, and the uplifted amount is deemed to be incurred at the start of the following financial year (subsections 34A(1) and (4)). The amendments ensure general expenditure is capable of being uplifted ten times at the rate equal to the LTBR+5 percentage points following the date the project first derives assessable petroleum receipts: once at the end of that financial year and again at the end of each of the subsequent nine financial years.

Example 1.1 General expenditure uplift rates

Project Omega incurs $100 million of general expenditure in 2027-28. The project is granted a production licence in 2028-29 and first derives assessable petroleum receipts in 2029-30.

Project Omega's carried-forward general expenditure can be uplifted at the following rates:

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the LTBR+5 percentage points at the end of the financial years 2027-28 to 2038-39 (inclusive);

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the LTBR at the end of the 2039-40 financial year and future financial years.

The higher uplift rate applies twelve times, including ten times after the date the project first derived assessable petroleum receipts.

New petroleum projects

1.28 A petroleum project is generally a new project subject to the amended general expenditure uplift rates if:

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there is a production licence notice for the project and the notice specifies a date on or after 1 July 2019; or

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if there is no production licence notice, the production licence was granted on or after 1 July 2019.

[Schedule 1, items 4 and 5, subsection 34A(4) (subparagraphs (a)(i) and (ii) of the definition of 'uplift rate') and subsection 34A(5) (definition of 'post-June 2019 licence') of the Act]

1.29 A production licence notice specifies the day sufficient information has been provided to support an application for a production licence (subsection 258(7) of the Offshore Petroleum and Greenhouse Gas Storage Act 2006). As such, the date specified in the notice is often referred to as the application date, even if an incomplete application was made at an earlier date. [Schedule 1, items 1 and 5, subsection 34A(5) (paragraph (a) of the definition of 'post-June 2019 licence') of the Act and the note to subsection 258(7) of the Offshore Petroleum and Greenhouse Gas Storage Act 2006]

1.30 Similar principles are relevant for determining whether general expenditure was incurred more than five years prior to the application for the production licence (paragraph 34A(1)(a) of the Act).

New combined projects

1.31 Petroleum projects may be combined under project combination certificates issued by the Minister for Resources if the projects are sufficiently related (subsection 20(1) of the Act). All of the production licences relating to the Bass Strait exploration permit are taken to be a single petroleum project, as are the licences relating to the North West Shelf exploration permits (subsection 19(1A) and 19(1B) of the Act).

1.32 A combined petroleum project is a new project subject to the amended general expenditure uplift rates if one or more of the production licences that make up the combined project:

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is subject to a production licence notice and the notice specifies a date on or after 1 July 2019; or

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if there is no production licence notice, the production licence was granted on or after 1 July 2019.

[Schedule 1, items 4 and 5, subsection 34A(4) (subparagraphs (b)(i) and (ii) of the definition of 'uplift rate') and subsection 34A(5) (definition of 'post-June 2019 licence') of the Act]

1.33 Petroleum projects and combined projects that are not new projects are not subject to the amendments to the general expenditure uplift rates. Class 2 ABR general expenditure incurred in relation to these petroleum projects continues to be uplifted at the rate equal to the LTBR+5 percentage points. [Schedule 1, item 4, subsection 34A(4) (paragraph (c) of the definition of 'uplift rate') of the Act]

Derivation of assessable petroleum receipts

1.34 The ten-year period for the uplift rate equal to the LTBR+5 percentage points begins when a project first derives assessable petroleum receipts. It does not matter who derives the assessable petroleum receipts as the test applies on a project basis.

1.35 For combined projects, the ten-year period during which the current uplift rate continues to apply begins when:

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a new combined project first derives assessable petroleum receipts; or

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a pre-combination project that relates to one of the post-June 2019 production licences in the combined project first derived assessable petroleum receipts after the grant of the first post-June 2019 production licence.

[Schedule 1, item 4, subsection 34A(4) (subparagraphs (b)(iii) and (iv) of the definition of 'uplift rate') of the Act]

1.36 Where a pre-combination project was itself a combined project, the provisions apply in a recursive manner.

Example 1.2 Combined projects

Project Alpha was granted a production licence in 2010, with production commencing in 2015. Following successful drilling, a second production licence is granted in 2020 for an adjacent gas field.

The joint venture applies for and is granted a project combination certificate for the project. Because one of the production licences was granted after 1 July 2019, the ten-year period will commence at the end of the financial year the combined project first derives assessable petroleum receipts after the date specified in the production licence notice for the second licence.

Example 1.3 Additional combinations

Further to Example 1.2, a third production licence is combined with the project in 2023. There is no change to the ten-year period because it was already triggered by the first post-June 2019 licence.

1.37 Once a combined project is subject to the amendments and the uplift rate equal to the LTBR begins to apply to the project, the project is always subject to this uplift rate. If one or more, but not all, of the production licences cease, the combined project is taken to continue (subsection 19(3) of the Act).

1.38 The continuing combined project will continue to be a new project subject to the new uplift rate even if the remaining production licences were issued prior to 1 July 2019 or had not derived assessable petroleum receipts before that time.

Example 1.4 Combined project where a production licence ceases

Further to Example 1.2, but disregarding Example 1.3, the second production licence ceases in 2025. In 2028, a third production licence is granted and is combined with the first production licence. There is no change to the ten-year period that commenced at the end of the financial year the combined project first derived assessable petroleum receipts.

Class 1 GDP factor expenditure

1.39 General expenditure incurred more than five years prior to a production licence being applied for (Class 1 GDP factor expenditure) is not subject to the amendments and remains subject to an uplift rate equal to the GDP factor (section 35 of the Act).

Exploration expenditure uplifts

1.40 Exploration expenditure incurred no more than five years prior to a production licence being applied for (Class 2 ABR exploration expenditure) is currently subject to an uplift rate equal to the LTBR+15 percentage points (section 35A of the Act and clause 8 in Schedule 1 to the Act).

1.41 Exploration expenditure incurred more than five years prior to a production licence being applied for (Class 2 GDP factor exploration expenditure) is currently subject to an uplift rate equal to the GDP factor (section 35B of the Act and clause 12 in Schedule 1 to the Act).

Exploration expenditure incurred before 1 July 2019 and retained in the same petroleum project

1.42 Class 2 ABR exploration expenditure incurred before 1 July 2019 and retained within the same petroleum project continues to be subject to an uplift rate equal to the LTBR+15 percentage points until 1 July 2019. [Schedule 1, item 44, subparagraph 8(3)(a)(i) and paragraph 8(3)(b) (subparagraph (i) of the definition of 'uplift rate') in Schedule 1 to the Act]

1.43 From 1 July 2019, the exploration expenditure is subject to an uplift rate equal to the LTBR+5 percentage points indefinitely. [Schedule 1, item 44, paragraph 8(3)(b) (subparagraph (ii) of the definition of 'uplift rate') in Schedule 1 to the Act]

Example 1.5 Exploration expenditure incurred before 1 July 2019

Project Beta was granted a production licence in the 2010-11 financial year. Its sole operator incurred total exploration costs of $500 million in the 2007-08 financial year.

Project Beta starts to derive assessable petroleum receipts and is entitled to deduct the exploration expenditure in the 2021-22 financial year. The uplift rate equal to the LTBR+15 percentage points applies up to and including the 2018-19 financial year because the exploration expenditure was incurred after June 1990 and no more than five years before the production licence came into effect.

From the 2019-20 financial year, the uplift rate equal to the LTBR+5 percentage points applies.

1.44 Class 2 GDP factor exploration expenditure incurred before 1 July 2019 continues to be uplifted at the rate equal to the GDP factor indefinitely.

Example 1.6 Class 2 GDP factor exploration expenditure

Project Gamma was granted a production licence in the 2010-11 financial year. Its sole operator incurred total exploration costs of $500 million in the 2000-01 financial year.

Project Gamma starts to derive assessable petroleum receipts and is entitled to deduct the exploration expenditure in the 2021-22 financial year.

The GDP factor uplift applies indefinitely as the exploration expenditure was incurred after June 1990 and more than five years before the production licence came into effect. There is no change in the uplift from 1 July 2019.

Exploration expenditure incurred from 1 July 2019

1.45 From 1 July 2019, there is no distinction drawn between exploration expenditure incurred more than five years prior to a production licence application being made and expenditure incurred at a later time. [Schedule 1, items 34, 35 and 36, clause 1 (definitions of 'ABR expenditure year', 'GDP expenditure year' and 'standard uplift expenditure year') in Schedule 1 to the Act]

1.46 All exploration expenditure incurred on or after 1 July 2019 is subject to the following uplift rates:

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until the financial year ten years after the year in which the exploration expenditure is incurred - an uplift rate equal to the LTBR+5 percentage points; [Schedule 1, item 44, subparagraph 8(3)(a)(ii) and paragraph 8(3)(b) (subparagraph (iv) of the definition of 'uplift rate') in Schedule 1 to the Act]

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then - an uplift rate equal to the GDP factor. [Schedule 1, item 44, paragraph 8(3)(b) (subparagraph (iii) of the definition of 'uplift rate') in Schedule 1 to the Act]

Exploration expenditure transferred before 1 July 2019

1.47 Exploration expenditure transferred before 1 July 2019 continues to be transferred subject to the following existing uplift rates:

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for expenditure incurred by the transferring entity no more than five years prior to the date specified in the receiving project's production licence notice (or the date of the grant if there is no notice) - an uplift rate equal to the LTBR+15 percentage points; [Schedule 1, item 73, clause 37 in Schedule 1 to the Act]

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for expenditure incurred by the transferring entity more than five years prior to the date specified in the receiving project's production licence notice (or the date of the grant if there is no notice) - an uplift rate equal to the GDP factor. [Schedule 1, items 74 to 77, clause 38 in Schedule 1 to the Act]

Exploration expenditure transferred from 1 July 2019

1.48 All exploration expenditure transferred from 1 July 2019 is subject to the amended uplift rates, regardless of when the expenditure was incurred. [Schedule 1, item 73, clause 36A in Schedule 1 to the Act]

1.49 All exploration expenditure transferred on or after 1 July 2019 is transferred subject to the following uplift rates:

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until the financial year ten years after the year in which the exploration expenditure is incurred - an uplift rate equal to the LTBR+5 percentage points; [Schedule 1, item 73, subsections 36A(1) and (2), and paragraph 36A(3)(a) (subparagraph (ii) of the definition of 'uplift rate') in Schedule 1 to the Act]

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then - an uplift rate equal to the GDP factor. [Schedule 1, item 73, subsection 36A(1) and paragraph 36A(3)(a) (subparagraph (i) of the definition of 'uplift rate') in Schedule 1 to the Act]

Example 1.7 Exploration expenditure transferred from 1 July 2019

Project Delta was granted a production licence in the 2010-11 financial year. Its sole operator incurred total exploration costs of $500 million in the 2007-08 financial year, which are never deducted within the project.

The operator also has an interest (that satisfies clause 22 in Schedule 1 to the Act) in Project Theta that has a notional taxable profit and, without transferred exploration expenditure, would pay PRRT in 2020-21.

The operator is required to transfer its exploration expenditure from Project Delta to Project Theta. The uplift rate equal to the LTBR+5 percentage points applies at the end of each of the ten financial years from 2007-08 to 2016-17 (inclusive). At the end of each of the financial years from 2017-18 to 2019-20 (inclusive), the augmented total is uplifted at the rate equal to the GDP factor.

1.50 It would not change the outcome in Example 1.7 if the production licence for Project Theta was granted within five years of the 2007-08 financial year in which the exploration expenditure was incurred or at a later time.

Project combination certificates

1.51 Amendments are made to the project combination rules to prevent the Resources Minister unilaterally combining petroleum projects.

1.52 The Resources Minister may only combine related petroleum projects where an application is made by a relevant person [Schedule 1, items 78 and 80 to 83, subsections 20(1), (4) and (10), and paragraphs 20(9)(b) and (12)(b) of the Act]

1.53 Consistent with the current law, an application may be made by a person (or a group of persons collectively) entitled to receive at least half of the receipts from the sale of petroleum or marketable petroleum commodities produced in relation to each of the petroleum projects to be combined. [Schedule 1, item 80, subsection 20(4) of the Act]

1.54 Applications for a project combination certificate must be made within 90 days of the most recent production licence coming into force, or within a longer period allowed by the Resources Minister. [Schedule 1, item 80, subsection 20(4A) of the Act]

1.55 The Resources Minister has 90 days to consider an application, subject to the Minister's ability to determine a further period where necessary. If the Minister determines a longer period, the Minister must notify the applicant. [Schedule 1, items 79 and 80, subsections 20(2), (4B) and (4C) of the Act]

1.56 If the Resources Minister does not make a decision in relation to an application before the end of the 90-day period - or a longer period determined by the Minister - the Minister is taken to have refused the application. This would entitle the applicant to seek merits review of the decision in the Administrative Appeals Tribunal. [Schedule 1, item 80, subsection 20(4B) of the Act]

1.57 These amendments provide certainty to project participants that petroleum projects will not be unilaterally combined where the combination could have adverse tax consequences for the participant.

Consequential amendments

1.58 Class 2 ABR general expenditure is relabelled Class 2 uplifted general expenditure. This reflects the change of the uplift rate to incorporate the unaugmented LTBR for some financial years. Similarly, Class 2 ABR exploration expenditure is relabelled Class 2 uplifted exploration expenditure. This reflects that this class applies to all exploration expenditure incurred on or after 1 July 2019. [Schedule 1, items 2, 3, 6 to 34, 37, 38, 39, 41, 44, 47, 50, 51, 52, 54, 56 and 61, the formula and the definition of 'augmented bond rate' in subsection 34A(4), sections 34A, 35A, paragraphs 32(c), 32(e), 35(3)(c), 35C(5)(c), 35C(5)(e), 35E(3)(c), 35E(3)(e), 48A(5)(b), 58K(2)(a) and 58M(2)(a), subparagraphs 48(1)(a)(i), 58K(1)(b)(iii), 58M(1)(c)(iii), the notes to section 36A, subsection 36B(1), paragraph 48A(5)(c) and subparagraph 48(1)(a)(ia), and the headings to subsections 58K(2) and 58M(2) of the Act, and clause 1 (definition of 'augmented bond rate'), clause 5 (paragraph (a) of the definition of 'notional taxable profit'), subclauses 8(3) to (7), and paragraphs 6(1)(a) and 7(a) in Schedule 1 to the Act]

1.59 The concept of an ABR expenditure year in Schedule 1 to the Act is relabelled a standard uplift expenditure year. This incorporates the 2019-20 financial year and future financial years. [Schedule 1, items 34, 35 36, 40, 42 to 46, 48, 49, 51, 53, 55, 57 to 60, 62 to 73, clause 1 (definitions of 'ABR expenditure year', 'GDP expenditure year' and 'standard uplift expenditure year') clauses 24, 33 and 37, subclauses 8(3) to (7), paragraphs 6(1)(b) and 7(b), and subparagraphs 25(c)(i) and 34(c)(i) in Schedule 1 to the Act]

Application provisions

1.60 The amendments commence on 1 July 2019. [Clause 2 of the Bill]

1.61 The amendments in Schedule 1 to the Bill generally apply from 1 July 2019. The application of the amendments to expenditure incurred prior to that date and petroleum projects that were the subject of a production licence notice that specifies an earlier date are discussed earlier in this Chapter.