senate

Explanatory Memorandum

(Circulated by the authority of the Treasurerthe Hon John Dawkins, M.P.)This Memorandum takes account of amendments made by the House of Representatives to the Bill as introduced.

Chapter 12 PETROLEUM RESOURCE RENT TAX AMENDMENTS

Overview

12.1 This Bill will make four amendments to the Petroleum Resource Rent Tax Assessment Act 1987 (the PRRT Act) to treat transfers of part of a taxpayer's interest in a project in the same way as transfers of a taxpayer's whole interest, to help ensure that the PRRT Act does not delay exploration following changes in interests in projects, and to ease compliance for PRRT payers. The amendments arise out of a Report to Parliament on the operation of the PRRT Act, tabled in Parliament in 1992 by the Minister for Resources.

12.2 Amendment A extends the time for lodgment of a PRRT return. Amendment B deals with the treatment of expenditure, receipts and tax liability on the transfer of a part interest in a petroleum project. Amendments C and D relax the requirements for transfer of exploration expenditure to be offset against receipts from other projects when a person farms into or abandons a petroleum project [Clause 125] .

Summary of the amendments

12.3 This Bill will make four amendments to the Petroleum Resource Rent Tax Assessment Act 1987 (the PRRT Act).

Amendment A: extension of lodgment time

12.4 This amendment will extend the time for lodgment of a PRRT return and of expenditure transfer notices from 21 days to 42 days from the end of the year of tax for a project, commencing from the first year of tax after 1 July 1993. That will be the year of tax ending 30 June 1994, or the first later year in which a taxpayer derives assessable receipts from a petroleum project.

Amendment B: treatment of expenditure of a person who transfers part of their interest in a petroleum project to another person

12.5 If a person enters into a transaction which transfers their whole interest in a petroleum project to another person, the PRRT Act operates to place the purchaser in the same position as the vendor. It treats the purchaser as if they had derived the assessable receipts, incurred the deductible expenditure and paid the tax instalments of the vendor up to the time of the transaction, and treats the vendor as not having done so. [Section 48] .

12.6 However, if a person enters into a transaction to transfer only part of their interest in a project to another person, all expenditure, receipts and tax derived, incurred or paid up to the time of the transaction remain with the vendor.

12.7 This amendment will treat transactions entered into on or after 1 July 1993 which transfer a partial interest in a project in the same way as transactions which transfer an entire interest. The purchaser will be placed in the shoes of the vendor by being treated as if they had derived, incurred or paid amounts of receipts, expenditure and tax derived, incurred or paid by the vendor before the transaction, proportionate to the share of the vendor's interest transferred [Clause 129] .

Amendment C: transfer of exploration expenditure incurred after farm-in to a petroleum project

12.8 Currently, a taxpayer who farms into an existing petroleum project and subsequently incurs exploration expenditure on the project in that financial year cannot transfer that expenditure to be offset against their assessable receipts, or the receipts derived by another member of the same wholly-owned company group, from another project.

12.9 This amendment ensures that exploration expenditure incurred on or after 1 July 1990 on a project the taxpayer had already farmed into will be offset against their assessable receipts from another project. This will apply as long as the taxpayer, or the wholly-owned company group, retains an interest in both projects at the end of the farm-in year.

Amendment D: transfer of exploration expenditure on the abandonment of an entire interest in a petroleum project

12.10 Currently, a participant in a petroleum project who abandons their entire interest in the project before the end of a financial year cannot transfer exploration expenditure incurred on the project in that year to be offset against receipts from another project. This exploration expenditure will not be deductible by anyone.

12.11 This amendment will ensure that a person who abandons their interest in a project on or after 1 July 1993 will retain all expenditure they incurred before they abandoned the project. Their exploration expenditure will be transferable to be offset against receipts from other concurrent projects. This is similar to the treatment of expenditure when a project is abandoned by all participants.

Background to the legislation

12.12 Petroleum Resource Rent Tax (PRRT) is a tax on profits from petroleum projects. It is assessed on a project basis; the liability to pay PRRT is imposed on a person, in relation to their interest in the project. This liability is based on any profit received by the person from the project after taking into account their receipts and indexed expenditure in relation to the project, and allowing a minimum rate of return on most expenditure.

12.13 PRRT is levied at the rate of 40% and is assessed on the basis of an annual return. Three quarterly instalments are paid before the final instalment and annual return. The taxable profit of a PRRT payer is the excess of assessable receipts over deductible expenditure in a financial year. Deductible expenditure may be either capital or revenue in nature, and may be:

•

exploration expenditure;

•

general project expenditure; or

•

closing down expenditure.

12.14 Taxpayers carry forward all their exploration and general project expenditure on a petroleum project in which they have an interest until it is absorbed by their assessable receipts from the project. It may be carried forward at the augmented bond rate (the long-term bond rate plus 5%) or the Gross Domestic Product (GDP) factor rate. Expenditure incurred more than 5 years before a project commences is carried forward at the GDP factor rate, while more recent expenditure is carried forward at the augmented bond rate. Closing down expenditure may also be absorbed against taxable profits of earlier years of the project, if assessable receipts of the same year are inadequate.

12.15 Because real expenditure on a project is carried forward on an indexed basis, financing costs are not part of deductible expenditure.

12.16 As PRRT is project-based, most expenditure and receipts must stay with the project. In 1991, limited wider deductibility of exploration expenditure incurred on or after 1 July 1990 was introduced. Each year, exploration expenditure actually incurred by a taxpayer on a project which is not absorbed then against assessable receipts from the project will be transferred to the extent it can be offset against excess assessable receipts of the taxpayer, or other members of the same wholly-owned company group, from other projects.

12.17 The rules for wider deductibility are contained in the Schedule to the PRRT Act. Expenditure incurred on an exploration right or a petroleum project must be transferred to a project, and the taxpayer who incurred the expenditure must hold interests in both transferring entity and receiving project concurrently.

12.18 The taxable profit of a taxpayer in a year of tax in relation to a project is the excess of their assessable receipts from that project over the sum of:

•

deductible expenditure of the project;

•

amounts of exploration expenditure transferred to the project from other projects held by the taxpayer; and

•

(if the taxpayer is a company in a wholly-owned group) amounts of exploration expenditure transferred to the project from projects held by other companies in the group.

12.19 In November 1992, a Report on the operation of the PRRT Act was tabled in Parliament by the Minister for Resources. The Report flagged a number of matters for further consideration. The amendments in this Bill arise out of further consideration of these matters and consultation with industry.

Amendment A: Extension of time to lodge a PRRT return

Background

12.20 Under the PRRT Act, a tax return must be lodged for each petroleum project for each financial year, called a year of tax , in which the taxpayer derives assessable receipts from that project. The first year of tax may be a year in which tax is not yet payable in relation to the project, because not all expenditure of the taxpayer has been absorbed by receipts. [Section 59]

12.21 A PRRT return must be lodged with the Commissioner of Taxation within 21 days of the end of the year of tax in which the taxpayer derives receipts from the project. The Commissioner has a discretion to allow more time for lodgment of returns if he considers it necessary. [Subsection 59(1)]

12.22 A taxpayer who has incurred exploration expenditure on projects or exploration rights able to be offset against receipts from other projects transfers the expenditure by completing and lodging a transfer notice with the Commissioner. The notice must be lodged within 21 days of the end of the financial year in which the transfer is made, or longer if the Commissioner allows. Transfer notices may allow the taxpayer to choose between several possible projects against which transferable expenditure can be claimed. In default, the Commissioner can transfer the expenditure. [Sections 45A, 45B and 45C] .

12.23 Until a transfer notice is completed for every transfer of expenditure made by a taxpayer for a financial year, a taxpayer cannot lodge their final return for the year of tax in relation to those projects on which they have derived assessable receipts. This is because they cannot calculate their taxable profit, if any, in relation to each project, or the amounts of expenditure to be carried forward to a later year.

12.24 Industry groups have submitted that 21 days is insufficient time to lodge returns and that the lodgment period should be extended. The Commissioner has received several applications for extension of time to lodge returns. Those applications have commonly sought another seven or fourteen days in which to lodge returns. To ease compliance for PRRT payers, the Government proposes to double to 42 days - 6 weeks - the time to lodge PRRT returns and transfer notices.

Explanation

12.25 This Bill amends the PRRT Act to double the time for lodgment of a PRRT return from 21 days to 42 days from the end of the year of tax in which the taxpayer derives assessable receipts from a project [Subclause 130(1); Subsection 59(1)].

12.26 The amendment will also double the time allowed for lodgment of transfer notices transferring exploration expenditure to be offset against receipts derived by the taxpayer or another group company from another project. Transfer notices will be required to be lodged within 42 days of the end of the financial year in which the transfer is made [Clause 127 and section 45A; Clause 128 and section 45B] .

12.27 The longer period of 42 days will apply to returns and transfer notices for the financial year starting on 1 July 1993 (and ending on 30 June 1994), and for later financial years [Subclauses 127(2), 128(2) and 130(2)].

Amendment B: treatment of expenditure of a person who sells part of their interest in a petroleum project to another person

Background

12.28 The PRRT Act contains rules which apply when a person enters into a transaction which transfers their whole entitlement to assessable receipts from a petroleum project (their entire interest in the project) to another person. These rules determine the positions of the "vendor" and the "purchaser" (as defined by the legislation) of the interest for the purpose of calculating their PRRT liability. They apply even if the transfer is for no consideration. [Section 48]

12.29 Basically, the purchaser of an entire interest in receipts from a project will be placed in the shoes of the vendor in relation to the project. The law treats the purchaser as if they had derived the assessable receipts, incurred the deductible expenditure, and paid the tax instalments of the vendor up to the time the transaction was entered into, and treats the vendor as not having done so. The purchaser is taken to have incurred expenditure that might have been transferable by the vendor under the wider deductibility regime; however, wider deductibility only applies to actual expenditure of a person and so this expenditure is not transferable in the hands of the purchaser.

12.30 By contrast, a vendor who enters into a transaction which transfers only part of their entitlement to assessable receipts from a petroleum project (a partial interest in the project) retains all receipts, expenditure and tax instalments derived, incurred or paid before the time of the transaction. Thus, even if a purchaser buys 90% of a vendor's interest in a petroleum project, leaving the vendor with only a 10% interest, the vendor retains all receipts, expenditure and tax instalments which they had previously derived, incurred or paid in relation to the project. The purchaser is not treated as having derived any part of the receipts, incurred any part of the expenditure or paid any part of the tax instalments before the time the transaction was entered into.

12.31 The only exception to this treatment of a transaction which transfers a partial interest in a project is a transitional measure for agreements entered into before the announcement of PRRT in 1984. Section 49 enables a transfer of expenditure, as agreed by the parties, on a transaction to transfer a partial interest in a project where the transfer occurred before 1 July 1984 and the Commissioner was given a copy of the expenditure agreement within 30 days after the PRRT Act came into operation.

12.32 Industry has submitted that the requirement that a vendor of a partial interest in a project retain all their receipts and expenditure in relation to the project for PRRT purposes may significantly affect commercial decisions. In particular, it is said to restrict the ability of the vendor to negotiate anything but a complete disposal of an interest in a project, thus affecting the choice whether to farm out of a project.

12.33 This effect of the PRRT Act may impede the completion of existing projects, particularly where there has been substantial expenditure and an existing venturer lacks funds to continue but wishes to retain some interest in the project. This is especially problematic for more marginal projects. The Government has decided to amend the Act to ensure that where only part of a person's interest in project receipts is transferred to another person, the purchaser is placed in much the same position as the vendor would have been in but for the transfer, to the extent of the proportion of the vendor's interest which is transferred.

Explanation

12.34 This amendment introduces rules covering parties to a transaction which transfers part of a person's entitlement to derive in the future assessable receipts from a project to another person (a transaction which transfers a partial interest in the project). It puts in place a similar regime to that in Section 48 for transactions which transfer an entire interest in a petroleum project [Clause 129; new section 48A] .

12.35 The amendment will apply to farm-in/farm-out arrangements where an existing participant in a petroleum project enters into a transaction on or after 1 July 1993 to transfer part of their entitlement to derive future assessable receipts from the project to one or more incoming participants. It will apply even where there is no consideration for the transfer of entitlement under the transaction. [New subsection 48A(1)]

12.36 The purchaser of a partial interest will be treated as having derived, incurred or paid proportionate amounts of assessable receipts, deductible expenditure and tax instalments of the vendor before the time the transaction is entered into, and the vendor will be taken not to have derived, incurred or paid that proportion of receipts, expenditure and tax instalments. Transferable exploration expenditure of the vendor will be taken to have been incurred by the purchaser, but will not be transferable to other projects by the purchaser.

The structure of the amendment

12.37 New section 48A deals with transactions transferring a partial interest. It uses substantially the same terms as Section 48 (dealing with entire interests), but is set out in a more formally structured way. [Clause 129]

12.38 Subsections (1) to (3) of new section 48A set out the conditions for application of the section, while subsections (5) to (10) describe the effects of the section. New subsection 48A(4) is a drafting provision which ensures that these consequences have effect for all the purposes of the PRRT Act, and which separates the conditions for application from the consequences of application of the section.

Transactions which transfer a partial interest

12.39 A person who enters into a transaction which transfers part of their entitlement to assessable receipts from a project is the vendor , and the person (or each of the persons) who receive the part entitlement is called the purchaser(s) of that entitlement. [New paragraphs 48A(2)(a) and (b)] The time at which such a transaction is entered into is the transfer time , and the financial year in which the transaction occurs is the transfer year . [New paragraphs 48A(2)(c) and (d)]

12.40 A partial interest in a project may be transferred before the first year in which assessable petroleum receipts are derived from the project (before the first year of tax in relation to the project). [New subsection 48A(3)] Such a transaction may be entered into where there is not yet a production licence (and hence a project) in existence on an area, but only an exploration permit or retention lease. Assessable receipts may be derived and deductible expenditure incurred in relation to a petroleum project that has not yet started [sections 31 and 45] , so a person may have an entitlement to assessable receipts from the project at that time, and may transfer either a part of that entitlement, or that entire entitlement, to another person.

12.41 The proportion of a vendor's whole entitlement to assessable receipts which is transferred by a transaction is the transfer percentage of the vendor's entitlement. The effect of new section 48A will be to place the purchaser in the same position as the vendor would have been in relation to the project, but for the transfer, in respect of the transfer percentage of entitlement to assessable receipts.[New paragraph 48A(2)(e)].

12.42 For example, Explorer NL is the sole operator on an exploration permit. No project is yet in existence, and no receipts have been derived, but Explorer NL has incurred $5 million exploration expenditure. As no receipts have yet been derived, Explorer has not yet lodged its first PRRT return in relation to the project. It enters into a transaction to transfer half of its entitlement to assessable receipts in the future to Buyer. The transfer percentage is 50%. New Section 48A will apply to place Buyer in the position in which Explorer would have been in relation to the project, in respect of 50% of the $5 million deductible expenditure incurred by Explorer before the transfer time . Buyer is taken to have incurred $2.5 million exploration expenditure, derived no receipts and paid no tax in relation to the project.

Assessable receipts, expenditure and tax liability

12.43 The purchaser of the transfer percentage of the vendor's entitlement to assessable receipts from a petroleum project will be taken to have:

•

derived the transfer percentage of assessable receipts;

[new paragraph 48A(5)(a)]

•

incurred the transfer percentage of expenditure;

[new paragraphs 48A(5)(b) and (c)] and

•

paid the transfer percentage of liability for tax instalments;

[new paragraph 48A(5)(d)]

which would have been derived or incurred by the vendor in relation to the project in relation to the transfer year, if that year had ended immediately before the transfer time. The transfer of expenditure is dealt with in more detail below.

12.44 The vendor is taken not to have derived, incurred or paid the transfer percentage of assessable receipts, expenditure or tax instalments. The vendor retains receipts, expenditure and tax liability only to the extent that they retain an interest in receipts of the project. [New subsection 48A(6)]

12.45 If there is more than one purchaser, each will have acquired a part of the transfer percentage of the vendor's interest in the project. The transfer percentage of assessable receipts, expenditure and tax instalments will be distributed between the purchasers in proportion to their acquired entitlement to the partial interest transferred. [New subsection 48B(5)].

12.46 For example, if X Co agrees to transfer 50% of its interest in a project to Y Co and Z Co in equal shares, the transfer percentage is 50%. However, the acquired entitlement of each of Y Co and Z Co is only 25% of X Co's assessable receipts. Y Co and Z Co will each taken to have derived, incurred or paid 25% of receipts, expenditure and tax which was derived, incurred or paid by X Co before the transfer time. X Co will be taken not to have derived, incurred or paid 50% of its former receipts, expenditure and tax instalments.

12.47 The approach taken in new Section 48A requires that the amounts of receipts, expenditure and tax liability of the vendor be calculated in the same way as if there has been a transfer of the vendor's entire interest in the project. Then, as only the transfer percentage of the vendor's interest is transferred, the amounts actually taken to be derived or incurred by the purchaser are calculated by taking the transfer percentage of those entire amounts. This amount is fixed. The vendor and purchaser cannot agree on whether expenditure can be transferred, and what amount will be transferred, as they could in the transitional period under section 49.

Treatment of expenditure

12.48 When a vendor enters into a transaction which transfers their entire interest in a project, their expenditure is taken to be incurred by the purchaser in two different ways under Section 48. Deductible expenditure which is not transferable is taken to be incurred by the purchaser in the transfer year, after it has been compounded in the hands of the vendor using either the GDP factor, or the augmented bond rate. This includes "inherited" expenditure taken to be incurred by vendor as a result of previous Section 48 or new Section 48A transactions. [Paragraph 48(1)(a)(i)]

12.49 However, transferable exploration expenditure is treated differently because of the operation of the wider deductibility regime. Transferable exploration expenditure is either class 2 augmented bond rate exploration expenditure, or class 2 GDP factor expenditure. It is calculated under the Schedule and is based on actual exploration expenditure incurred by the person plus any amounts previously taken to have been incurred by the person under Section 48. These form the incurred exploration expenditure amount of the person [ Clause 1 , Parts 2 and 3 of the Schedule].

12.50 A technical result of the calculation of transferable exploration expenditure of the vendor is that some amounts are deemed not to have been incurred by the vendor until they can be utilised. This renders these amounts "invisible" for the purposes of a Section 48 transaction. To avoid this problem, Section 48 simply takes the purchaser to have incurred expenditure that would have been included in the incurred exploration expenditure amount of the vendor in relation to the project before the transfer time. The purchaser is taken to have incurred this expenditure at the time the vendor actually incurred it, and the expenditure is compounded in the hands of the purchaser, not the vendor. [Paragraph 48(1)(a)(ia) and subsection 48(2) . A more detailed explanation, with an example, can be found in the Explanatory Memorandum to Taxation Laws Amendment Act (No. 5) 1992.]

12.51 A similar approach to expenditure is taken in new Section 48A for transactions which transfer part of a person's interest in assessable receipts from a project. The purchaser of a partial interest will be taken to have incurred, in the transfer year, the transfer percentage of deductible expenditure of the vendor which is not transferable, as compounded by the Schedule in the hands of the vendor. As with Section 48, deductible expenditure of the vendor in relation to the project includes "inherited" expenditure of the vendor as a result of previous Section 48 or new Section 48A transactions. [New paragraph 48A(5)(b)]

12.52 In addition, the purchaser of a partial interest will be taken to have incurred the transfer percentage of amounts of expenditure which would have been included in the incurred exploration expenditure amount in relation to the vendor and the project, as if the transfer year had ended immediately before the transfer time. [New paragraph 48A(5)(c)] .

12.53 The purchaser will be taken to have incurred these amounts in the year in which they were actually incurred by the vendor, and they will be compounded under the Schedule to become class 2 augmented bond rate exploration expenditure or class 2 GDP factor exploration expenditure in the hands of the purchaser .[New subsection 48A(7)]

12.54 Amendments have been made to the definition of incurred exploration expenditure amount in the Schedule to the Act, to ensure that, like transferable exploration expenditure taken to be incurred by a purchaser of an entire interest in a project, transferable exploration expenditure taken to be incurred by a purchaser of a partial interest under new paragraph 48A(5)(c) is included in the incurred exploration expenditure amount of the purchaser [ Clause 131; clause 1 of the Schedule, subparagraphs (a)(ii), (b)(ii) and (b)(iii) of the definition].

12.55 Expenditure which would be transferable to other projects in the hands of the vendor will not be transferable in the hands of the purchaser. Wider deductibility is intended only to apply to expenditure actually incurred by a taxpayer. Consequently, while both Section 48 and new Section 48A have the result that exploration expenditure which is transferable in the hands of the vendor is in the nature of transferable exploration expenditure in the hands of the purchaser, this expenditure will not in fact be able to be transferred by the purchaser because the purchaser had no interest in the project when the expenditure was incurred.

Transfer of property in relation to the transaction

12.56 A transaction which transfers a partial interest in a project may involve the transfer from the vendor to the purchaser of a partial interest in property being used in relation to the project at the transfer time. The vendor may derive receipts and the purchaser may incur expenditure because of a transfer of property in relation to the transaction.

12.57 Assessable property receipts are receipts derived by a person in relation to a petroleum project, in relation to property used on the project in respect of which the person has incurred project expenditure at the exploration, general or closing-down stages of the project. They include the sale price of property; insurance receivable or its value if property is lost or destroyed; its value at the time its use on a project is ended; amounts gained from hiring out or granting rights to use property; and amounts received for the provision of information. [Section 27]

12.58 Although a transaction which transfers a partial interest in a project may lead to a change of interests in property used on the project, in relation to the project, the property has not been disposed of, lost, destroyed, hired out or its use terminated as a result of the transaction. Therefore, any receipts derived by the vendor, or expenditure incurred by the purchaser, because of a transfer of property in relation to the transaction will not be treated as assessable property receipts of the vendor or eligible real expenditure of the purchaser.

12.59 Where there is a transfer of property in relation to the transaction, new subsection 48A(8) will apply to:

•

deem the vendor not to have derived any assessable property receipts in relation to the transaction; [paragraph 48A(8)(a)] and

•

deem the purchaser(s) not to have incurred any eligible real expenditure in relation to the transaction [paragraph 48A(8)(b)]

because of the transfer of the property.

12.60 This follows the treatment of transfers of property where a taxpayer's whole interest in a project is transferred. It ensures that PRRT liability is based on expenditure incurred by the taxpayer which makes the property available to the project, and on receipts derived by the taxpayer from use of the property outside the project, or its sale, loss, destruction or termination of use on the project. PRRT liability is not affected by the amount of consideration on a farm-in.

Property, miscellaneous compensation and employee amenities receipts

12.61 As a result of a transaction which transfers the transfer percentage of the vendor's entitlement to assessable receipts from a project, the purchaser holds a percentage interest in the project and may hold an interest in property used on the project. The interest of the purchaser as a percentage of the whole of the project will not be the same as the transfer percentage if the vendor is not the only other participant in the project.

12.62 After the transfer time, the purchaser should derive the transfer percentage of any project receipts which would have been derived by the vendor but for the transfer, including assessable property receipts, assessable miscellaneous compensation receipts and assessable employee amenities receipts. The vendor will derive the remaining percentage of these receipts.

12.63 Assessable property, miscellaneous compensation and employee amenities receipts derived by a person are defined in terms of eligible real expenditure of the person. [Sections 27, 28 and 29 respectively] This is project expenditure of the person incurred at exploration, general or closing-down stages of the project. [Section 2]

12.64 To ensure that the purchaser is taken to receive the transfer percentage of assessable property, miscellaneous compensation and employee amenities receipts after the transfer time, the purchaser will be taken to have incurred the transfer percentage of any eligible real expenditure incurred by the vendor in relation to the project. This is the same approach as is taken in paragraph 48(1)(e) in relation to transfers of entire interests. [New subsection 48A(9)]

12.65 After the transfer of a partial interest, property in which the vendor, purchaser and other project participants have an interest may be sold and generate assessable property receipts. The purchaser of the partial interest is taken by new Section 48A to have incurred the transfer percentage of the expenditure incurred by the vendor on the property. Section 27 will then apply correctly and the purchaser will derive the percentage of the assessable property receipts proportionate to its interest in the whole project.

Bad Debts

12.66 Bad debts which arise after the transfer time in relation to a transaction which transfers a partial interest will be treated in the same way as they are treated by paragraph 48(1)(f) in relation to a transfer of an entire interest. [New subsection 48A(10)]

12.67 Bad debts in relation to a project are deductible to a taxpayer as exploration, general project or closing down expenditure, depending on the stage at which they are written off. [Section 40]

12.68 A bad debt of a purchaser of a partial interest may relate to receipts owing to the vendor of the partial interest before the transfer time. The purchaser is taken to have brought to account receipts which were owing to the vendor in the transfer year. In order to calculate a bad debt to be treated as expenditure of the purchaser which relates to receipts owing to the vendor before the transfer year, the purchaser will be taken to have brought to account the transfer percentage of any debt brought to account by the vendor as assessable petroleum, exploration recovery, property, compensation, or employee amenities receipts. [New subsection 48A(10)]

Amendment C: Transfer of exploration expenditure incurred after farm-in to a petroleum project

Background

12.69 Under the wider deductibility regime in the PRRT Act, some exploration expenditure incurred on a project is transferable on a mandatory basis to be offset against excess assessable receipts derived from other projects. Wider deductibility delays PRRT liability until exploration expenditure is absorbed by receipts from all projects in which a taxpayer (or another member of the same wholly-owned company group) has an interest.

12.70 Transferable expenditure is either class 2 augmented bond rate exploration expenditure or class 2 GDP factor expenditure. Unused transferable exploration expenditure incurred by a taxpayer on or after 1 July 1990 in relation to a project will be transferred to the extent to which it can be offset against their assessable receipts, or against receipts derived by another company in the same wholly owned group, from another project. The rules for the wider deductibility of exploration expenditure are set out in the Schedule to the PRRT Act. Part 5 deals with transfer of expenditure between projects held by the same taxpayer, while Part 6 deals with transfer of expenditure between projects held by different group companies.

12.71 A taxpayer must first transfer unused exploration expenditure to the extent to which it can be be offset against their own receipts from other projects. If any transferable expenditure remains after these transfers, a taxpayer who is a member of a wholly-owned company group must transfer this expenditure to the extent to which it can be offset against any receipts derived from other projects by other companies in the group. The taxpayer must make the transfer by completing a transfer notice and giving it to the Commissioner at the end of the financial year in which the transfer is made. Transfer notices may allow the taxpayer to choose between several possible projects against which transferable expenditure can be claimed. In default, the Commissioner can transfer the expenditure. [Sections 45A, 45B and 45C] .

12.72 The wider deductibility regime allows some spreading of exploration expenditure across projects. However, trading in expenditure is not allowed. A person cannot buy up a PRRT-liable project to receive expenditure from a failed exploration project, or buy up a failed project in order to transfer expenditure to a PRRT-liable project, even during the financial year in which expenditure is transferred. This is ensured by the common interest rule in the Schedule, in relation to projects held by a single taxpayer, and projects held by group companies.

12.73 The common interest rule for transfer of expenditure between project interests of the same taxpayer requires that before expenditure can be transferred, the taxpayer must hold a continuous interest in both:

•

the project on which the expenditure was incurred, and from which it is transferred (the transferring entity ); and

•

the project to which the expenditure is transferred (the receiving project )

from the beginning of the financial year in which the expenditure was incurred to the end of the financial year for which it is transferred. [Subclause 22(1) of the Schedule]

12.74 Transferable expenditure may be incurred on and transferred from either a petroleum project which is the subject of an eligible production licence or an exploration right, and so this is defined as the transferring entity . However, it can only be transferred to a petroleum project, so this is termed the receiving project . The year in which the expenditure is transferred is known as the transfer year . [Clauses 20 and 29 of the Schedule]

12.75 A similar rule applies to wholly-owned group companies (not other groups: Section 2B ). The company which incurs and transfers the expenditure must have held an interest in the transferring entity continuously from the beginning of the financial year in which the expenditure was incurred to the end of the year in which it is transferred. The company which receives the expenditure to be offset against its receipts from the receiving project must have held an interest in that project over the same period of time. Both companies must have been members in the same group in that time. The company which transfers the expenditure is the loss company , while the company which receives the expenditure is the profit company . These terms do not imply that either company is making a profit or a loss for income tax or accounting purposes. [Clause 28 and subclause 31(1) of the Schedule]

12.76 If a taxpayer farms into a petroleum project during a financial year and incurs expenditure on the project in that year, the common interest rule prevents the transfer of this expenditure to other projects held by the taxpayer or by another company in the same group. This is because the taxpayer has not held an interest in the transferring entity (the project the taxpayer has farmed into) from the beginning of the financial year in which the taxpayer incurred the expenditure.

12.77 Following industry submissions, the Government has decided to remove this consequence of the common interest rule because it may lead taxpayers to delay incurring exploration expenditure until the financial year following farm-in. It is not the intention of the PRRT Act to delay exploration.

Explanation

12.78 This Bill amends the common interest rule in relation to the transferring entity so that a taxpayer who farms into a petroleum project during a financial year can transfer exploration expenditure incurred on the project in that year. This expenditure must be transferred if it satisfies the other conditions for transferability in the Schedule.

12.79 As transfers between projects of the same taxpayer and of group companies are treated separately by the common interest rule, these amendments are in separate clauses in the Bill and will be dealt with separately below. The Bill amends clause 22 of the Schedule in relation to transfers of expenditure between projects in which the same taxpayer has an interest [Clause 132; new subclause 22(2AA) of the Schedule] and clause 31 of the Schedule in relation to transfers of expenditure between projects in which different group companies have an interest. [Clause 133; new subclause 31(2AA) of the Schedule]

Commencement and application

12.80 The amendments will commence on 1 July 1991, the date of commencement of the wider deductibility regime for exploration expenditure contained in the Schedule to the PRRT Act. They will apply, as does the Schedule, to exploration expenditure incurred on or after 1 July 1990. [Clause 2(2)]

Transfers between projects held by the same taxpayer

12.81 A person who farms into a project gains an entitlement to assessable petroleum receipts from the project at the time of entering into the transaction. This is an interest in the project. A person may gain an interest in a project before any assessable receipts are derived from it, and before a production licence comes into force. [Sections 31 and 45; clauses 2 and 3 of the Schedule]

12.82 The farm-in time is the time at which the person starts to hold an interest in relation to the project which is the transferring entity. A taxpayer may farm in to gain an interest in receipts from a project during a financial year, and then farm in again to increase their interest. The first time the taxpayer farms in will be the farm-in time . [New subclause 22(2AA)(b)] .

12.83 This amendment will ensure that where a person farms into the transferring entity during a financial year and then incurs transferable exploration expenditure in relation to the project in that year, the common interest rule will not require the person to have held an interest before the farm-in time. When the other requirements for transfer are met, that expenditure will be transferable to be offset against that person's receipts from other projects. [New subclause 22(2AA)] .

12.84 The amendment does not change the requirements of the common interest rule in relation to the receiving project . The taxpayer must hold an interest in the receiving project from the beginning of the financial year in which the expenditure is incurred (the beginning of the year the taxpayer farmed into the transferring entity) to the end of the year in which the expenditure is transferred. [Subclause 22(1) of the Schedule]

12.85

Example 1

Co and B Co each have a 50% interest in an exploration joint venture and each hold a 50% interest in an exploration permit. On 1 September 1993, X Co farms into the joint venture by purchasing half of A Co's interest for $5 million. A Co now holds a 25% interest, B Co holds a 50% interest and X Co holds a 25% interest in the project. The farm-in time is 1 September 1993.

X Co incurs $10 million exploration expenditure on the permit before December 1993. Currently, this expenditure cannot be offset against assessable receipts derived by X Co in relation to other projects it holds at the time. This amendment will enable X Co's transferable exploration expenditure to be offset against its receipts from other projects, provided other requirements for transfer are met.

On 1 January 1994, X Co enters into another agreement with A Co to earn a further 20% of A Co's interest on condition that X Co incur $2 million exploration expenditure by 1 March 1994. The further $2 million exploration expenditure incurred by X Co will also be transferable to other projects under the proposed amendment, provided other requirements are met.

Section 48 or 48A expenditure

The intention of the wider deductibility regime is that a taxpayer is only able to offset exploration expenditure actually incurred by them against their receipts from other projects. This results from the requirement that the person hold an interest in relation to the transferring entity from the beginning of the financial year in which the expenditure was incurred.

When a taxpayer farms into a project by purchasing the interest or part of the interest of another participant, they will be placed in the shoes of the vendor by the operation of Section 48 or new Section 48A. Under these provisions, the taxpayer is taken to have incurred, and effectively "inherits", all or part of any transferable exploration expenditure of the vendor. This "inherited" expenditure is not incurred after the farm-in time and so cannot be transferred to another project. [New paragraph 22(2AA)(b)]

If the taxpayer farms in a second time in the financial year to gain an increased interest in the project, and does so by again purchasing the interest or part of the interest of another participant, Section 48 or new Section 48A will apply again. In this situation, there is the possibility that the taxpayer will be taken to have incurred some of the expenditure actually incurred by that other participant after the farm-in time .

This amendment ensures that the taxpayer will only be able to transfer exploration expenditure which they have actually incurred, and not which they have been taken by section 48 or new section 48A to have incurred. Therefore, a taxpayer who has "inherited" expenditure because of the application of those sections cannot transfer that expenditure to other projects. [Subclause 22(2AA)(c)]

12.86

Example 2

P Co farms into a project on 1 April 1995 by purchasing Q Co's entire interest (leaving P Co and R Co holding a 50% interest each in the project). The farm-in time is 1 April 1995. Section 48 operates to take P Co to have incurred $4 million exploration expenditure incurred by Q Co earlier in the financial year. P Co also incurs $1 million expenditure on drilling an exploration well. At the same time, R Co incurs $1 million on seismic testing.

12.87

In May, P Co gains a further 10% interest in relation to the project by purchasing 20% of R Co's interest. P Co is taken by new section 48A to have incurred 20% of the transferable exploration expenditure of R Co at the time it is incurred by R Co. Consequently, P Co will be taken to have incurred $0.2 million exploration expenditure after the farm-in time, in addition to the $1 million actually incurred by P Co. Only the expenditure actually incurred by P Co after the farm-in time ($1 million) can be transferred to other projects.

Transfer of expenditure between group companies

12.88 Where a taxpayer who is a group company has unused transferable exploration expenditure, after expenditure has been transferred to other projects held by the taxpayer, the unused expenditure may be able to be transferred to be offset against assessable receipts of another group company from another project. [Section 45B]

12.89 The taxpayer with unused expenditure is a loss company . The expenditure can only be transferred to offset assessable receipts derived by another company in the group with an interest in a project which has taxable profits: a profit company . The loss company must transfer as much of its unused transferable exploration expenditure to profit companies in the group as the latter can absorb.

12.90 This Bill amends the common interest rule in relation to the loss company and the transferring entity only. It ensures that a group company which farms into a petroleum project in a financial year and then incurs exploration expenditure in relation to the project which remains unused at the end of that year, can transfer that expenditure to be offset against receipts derived by a profit company in the group from another project. [Clause 133; new subclause 31(2AA) of the Schedule]

12.91 The amendment does not affect the rule that the profit company must hold an interest in relation to the receiving project continuously from the beginning of the financial year in which the expenditure was incurred to the end of the transfer year. [Subclause 31(1) of the Schedule]

12.92 The farm-in time is the time at which the loss company started to hold an interest in relation to the petroleum project. [New subclauses 31(2AA)(a) and (b)] . The amendment will remove the requirement of the common interest rule that the loss company have held an interest in relation to the transferring entity (the project which the company farmed into) before the farm-in time. [New subclause 31(2AA)]

12.93 The restrictions regarding expenditure "inherited" under section 48 or 48A, discussed above for transfers between project interests held by the same taxpayers, also apply to transfers between project interests held by different group companies. Only expenditure actually incurred by the loss company can be transferred to other projects. [New subclause 31(2AA)(c)]

12.94

Example

A Co is a new subsidiary in the Expol Group, owned by Ex Holdings Co. On 1 August 1992, A Co earned a 25% interest in an existing petroleum project by incurring $2 million exploration expenditure and $10 million general project expenditure. This is A Co's only petroleum interest, and it derives no assessable petroleum receipts in the 1993-94 financial year. The farm-in time is 1 August 1993. At the end of the year, A Co is a loss company because it has unused exploration expenditure.

This amendment will enable A Co's $2 million exploration expenditure to be transferred to be offset against receipts derived by another company in the group which has profitable petroleum interests.

Amendment D: transfer of exploration expenditure on the abandonment of an entire interest in a petroleum project

Background

12.95 A person with an interest in receipts from a petroleum project and who has incurred expenditure in relation to the project (whether on an exploration right or production licence) may later decide to leave the project because of its low prospectivity or for other commercial reasons. The person may either:

•

enter into a transaction which transfers their interest in the project to another person; or

•

abandon or "walk away" from their interest in the project.

12.96 Under the first option, all assessable receipts, deductible expenditure and tax instalments derived, incurred or paid by the person before the transfer time are taken to be derived, incurred or paid by the purchaser of the interest, and the person is taken not to have derived, incurred or paid them. All expenditure is therefore deductible to the purchaser in relation to the project. [Section 48]

12.97 Under the second option, as the law stands, the person retains all expenditure they incurred before "walk away". In walking away from the project, they give up their interest in assessable receipts from the project they abandoned, so the expenditure cannot be offset against receipts from that project. This means that non-transferable expenditure of the person cannot be absorbed against any expenditure. This consequence is not affected by this amendment. However, participants are less likely to walk away once a project enters the production phase.

12.98 It may be possible for the person who walks away from a project to offset any transferable exploration expenditure which they incurred on the project before abandonment against their receipts, or receipts derived by other companies in the same wholly-owned group, from other projects. This depends on the operation of the common interest rule in the Schedule, described in detail in the Background to Amendment C above. As the expenditure is to be transferred from the project the person abandons, the rules relating to the project from which expenditure is to be transferred (the transferring entity) must be considered. [Clauses 22 and 31 of the Schedule]

12.99 The common interest rule requires that the person hold an interest in relation to the project from which expenditure is to be transferred from the beginning of the financial year in which the expenditure is incurred to the end of the year for which it is transferred. The person will satisfy this rule with respect to transferable exploration expenditure which they incurred in a financial year before the "walk away" year.

12.100 However, the person will generally fail this test in relation to transferable exploration expenditure incurred on the project during the year in which the person walks away . Such expenditure can only be offset against receipts from other projects in two situations:

•

If the person who walks away is the sole participant in the project, the exploration right or production licence will lapse as a result of abandonment. The common interest rule does not preclude the person transferring from a project expenditure incurred in the year in which it lapses. [Subclauses 22(2A) and 31(2A)]

•

If there is more than one participant in the project, and all the participants abandon it during the same financial year, then the right or licence will lapse as described above. Each participant can offset transferable expenditure incurred in that year against receipts from other projects, if other requirements are satisfied.

12.101 However, as the law stands, if other participants remain on the project which the person abandons, that person cannot transfer their expenditure to other projects in which they hold an interest; nor can it be deducted by the remaining participants in the project.

12.102 The Government has decided to amend the common interest rule to ensure that a person who "walks away" from a petroleum project is not precluded from transferring exploration expenditure incurred in the "walk away" year to be offset against assessable receipts derived by them, or by another company in the same group, from other projects. This will reduce the chances of such expenditure being lost completely, and is consistent with the treatment where a project lapses.

Explanation

12.103 This amendment modifies the common interest rule relating to transfers between projects held by the same person. The amendment will ensure that a person who ceases to hold an interest in the transferring entity in the financial year in which expenditure is to be transferred, is not precluded from transferring eligible expenditure to be offset against their receipts from other projects under wider deductibility. [Clause 132 ; new subclause 22(2AB)]

12.104 It also modifies the common interest rule relating to transfers between group companies so that a group company with unused exploration expenditure who ceases to hold an interest in the transferring entity in the transfer year, is not precluded from transferring this expenditure to be offset against receipts derived by another group company from other projects. [Clause 133; new subclause 31(2AB) of the Schedule]

12.105 The amendment does not affect the common interest rule in relation to the receiving project (to which the expenditure is transferred). The person, or the profit company, will still be required to hold an interest in the receiving project from the beginning of the financial year in which the expenditure is incurred to the end of the transfer year. [Subclauses 22(1) and 31(1) of the Schedule]

12.106 The amendment will apply where a person has ceased to hold an interest in the transferring entity on or after 1 July 1993. The time at which the person ceases to hold an interest is the cessation time . [New paragraphs 22(2AB)(a) and 31(2AB)(a) of the Schedule]

12.107 It will not apply where the person who ceases to hold the interest does so not by abandoning the project, but by entering into a transaction which transfers their whole interest to another person. Section 48 will apply in this situation. [New paragraphs 22(2AB)(b) and 31(2AB)(b) of the Schedule]

12.108

Example

A Co, B Co and C Co are joint venture participants involved in exploration work on permit P1. The permit is up for renewal on 29 June 1994. The participants will be required to commit themselves to further exploration expenditure in order to renew the permit. B Co and C Co wish to renew the permit even though it is only marginally prospective, but A Co wishes to concentrate on other, more profitable projects in which it has an interest. It tries to farm out its interest but the remaining participants do not wish to buy it, and it can find no external buyers. A Co abandons its interest in receipts derived from the sale of petroleum found on P1 on 1 May 1994.

A Co has incurred $2 million transferable exploration expenditure on P1 between 1 July 1993 and 1 May 1994. Currently, A Co cannot transfer this expenditure to be offset against its receipts from other projects, nor is it deductible to the remaining participants on P1. This amendment will ensure that A Co can transfer this expenditure to be offset against excess assessable receipts from other projects which A Co has held from the start of the 1993-94 financial year, as long as it retains its interest in these projects for the whole financial year.

If A Co derives no excess assessable receipts from those other projects in the 1993/94 financial year (that is, if deductible expenditure of A Co on those projects exceeds assessable receipts from them), exploration expenditure incurred by A Co on P1 will be deductible in a future year against excess assessable receipts from one of those projects.