7 February 2023
In brief
The Australian Taxation Office (ATO) released a draft decision impact statement (DIS) on 31 January 2023 in response to the Full Federal Court’s decision in Commissioner of Taxation v Shell Energy Holdings Australia Limited [2022] FCAFC 2 (Shell).
Despite the Shell case being a dispute as to the availability of a deduction under section 40-80 of the Income Tax Assessment Act 1997 which, until 2013, had allowed an immediate deduction for depreciating assets, including mining, quarrying and prospecting rights (MQPRs), that are first used for exploration, the case will be of ongoing relevance in relation to:
- the important transitional rule in section 40-77 of the Income Tax (Transitional Provisions) Act 1997 which governs whether a MQPR is a depreciating asset or capital gains tax (CGT) asset;
- what constitutes “exploration” for tax purposes; and
- when an intangible asset is considered held for “first use”, which governs from when depreciating deductions under Division 40 are available.
Accordingly, the DIS will be of interest both for taxpayers in the resources sector and taxpayers generally who hold intangible assets.
In detail
Background facts
- Shell Energy Australia Holdings Limited (Shell) is the head company of a tax consolidated group which undertakes oil and gas exploration, development and production activities in Australia;
- Shell participated in an unincorporated joint venture (the Browse Project) with various other oil and gas companies;
- The participants in the Browse Project were together the holders of an exploration permit and six retention leases issued variously under State or Commonwealth legislation;
- The Browse Project joint venture was organised into two separate joint ventures (West and East Browse) but they were governed by substantially similar joint venture agreements;
- In August 2012, Shell entered into an Asset Exchange Agreement (AEA) under which Shell agreed to purchase another party’s participating interest in the Project. The total of the appraised value of the purchased interests was $2.3 billion;
- Prior to entry into the AEA, Shell’s interests in the Browse Project comprised an exploration permit (acquired in August 1998) and six retention leases which related to areas which had been covered by exploration permits in respect of which Shell, and other joint venturers, had been a holder of prior to 1 July 2001 (this is relevant to the transitional rule); and
- The interests assigned under the AEA occurred on the Completion Date, with effect from an earlier Effective Date, but with the proviso that each provision of the agreement that was a dealing as defined in the relevant legislation 'is of no force until it has been approved and registered'. The Effective Date was 1 June 2012. The relevant dealings were registered under the governing legislation in early November 2012.
The relevant depreciating asset
Central to the first instance judgment, and the ATO’s unsuccessful High Court special leave application, was an analysis of what was the relevant depreciating asset.
Shell is a good example of the importance of considering the underlying legislation and contractual arrangements that govern an intangible asset, in this case the MQPR. In the first instance decision, Colvin J held:
“The statutory proprietary rights conferred upon the holders of the Statutory Titles remained undivided. The joint venture was merely an association that governed how those undivided rights would be exercised by the holders, not who would hold them. The character of the statutory right was an undivided interest and the parties could not alter that character by allocating percentages or proportions to those undivided statutory interests.
Nevertheless, a proportional interest in those undivided rights could arise, and did arise, from the conferral of proportionate rights upon each of the venturers including by submitting the exercise of the rights associated with the Statutory Titles to decisions of the Venture Committee under each of the joint ventures. In consequence, each of the venturers came to hold a proportional interest in the Statutory Titles, such interest being an intangible asset. It was that proportional interest (not the whole of the proportionate interest in the joint venture) that was the relevant intangible asset for present purposes.”
That is, for income tax purposes, Shell acquired an additional proportional interest in the statutory titles - as will be seen, this is critical in establishing that Shell acquired an asset for “first use” under section 40-80 and was not subject to the transitional rule in section 40-77.
The Full Federal Court observed that the “primary judge correctly reasoned [that] the Commissioner’s contention conflates two distinct rights: the statutory titles and the proportional interest in the statutory titles arising from the terms of the joint venture agreed between the holders of the statutory titles”.
However, it seems that this is not the end of the matter for the ATO, given its approach in its unsuccessful High Court special leave application. The DIS notes that as the special leave application was refused on procedural grounds:
“... whether or not an interest in joint venture property arises merely by virtue of the acquisition of a participating interest in the joint venture remains an open question. The Commissioner's view on this issue is that whether, and to what extent, a venturer has an interest in joint venture property and the nature of any such interest will depend on the facts and circumstances of each case (and may be affected by the joint venture agreement or by statute).”
First use
The concept of “first use” was relevant to the application of section 40-80 and identifying the relevant “start time”, but the findings of the Full Federal Court are relevant more broadly.
A depreciation deduction can only be claimed from an asset’s “start time”, which is when you first use the asset or have it “installed ready for use”. The Full Federal Court stated that:
“While “install” implies the putting in place of something, neither the thing being installed nor the place of instalment need be a tangible use. The expression is capable of bringing within its scope Shell’s acquisition of the additional proportional interest (once approved and registered) by reading “installed” as encompassing “putting in place”, whether in a tangible or intangible sense. In practice, that means that a bundle of rights is installed ready for use once held for use.”
In the DIS, the ATO notes that whether other intangible assets will likewise have a start time when once they are held for use will depend on:
- the nature of the relevant asset; and
- the operation of any relevant legislation that governs the use of that asset.
The ATO has also withdrawn Taxation Determination 2019/1, as the ATO’s view that you 'first use' an MQPR when you do something that the MQPR permits or authorises and that merely holding an MQPR does not constitute a 'use' of it can no longer be sustained.
What constitutes “exploration”?
The debate between the taxpayer and the ATO was whether “exploration” was limited to activities that related to the discovery of a resource, or also extended to determining the commercial viability of that resource.
The Full Federal Court reached the same conclusion as Colvin J in the first instance decision that “there is nothing in the statutory history or in the enactment in the Commonwealth to suggest that Parliament intended that “exploration for petroleum” should be limited to the discovery of petroleum and not include activities directed to investigating the commercial recoverability of petroleum.”
The Chief Justice observed that “the notion that the words “explore” and “exploration” should be limited to finding the existence of some petroleum; and that any steps thereafter to find or discover its extent, worth or commercial feasibility for exploitation are not exploration or exploratory cannot be accepted and must be rejected.”
The ATO does seem to suggest in the DIS that the more expansive view of what constitutes exploration discussed above may not apply in all cases - noting that a more limited definition may apply to the defined term of “exploration and prospecting” for the purpose of s.40-730(4).
Whilst not addressed in the DIS, the ATO has already espoused the view on its website that Shell is limited to considering what constitutes exploration for income tax purposes and it does not decide the meaning of ‘exploration for petroleum’ for the purposes of the Petroleum Resource Rent Tax Assessment Act 1987.
Application of the transitional rule
The relevant transitional rule in section 40-77 provides:
(1) Division 40 of the new Act does not apply to a mining, quarrying or prospecting right that you started to hold before 1 July 2001.
(1A) Division 40 of the new Act does not apply to a renewal or extension of a mining, quarrying or prospecting right that you started to hold before 1 July 2001.
(1B) Subsection (1) applies to a mining, quarrying or prospecting right (the new right) that you start to hold after 1 July 2001 as if you had started to hold the new right before that day if:
(a) you started to hold another mining, quarrying or prospecting right before that day; and
(b) the other right ends on or after that day; and
(c) the new right and the other right relate to the same area, or any difference in area is not significant.
That is, a MQPR that is subject to the transitional rule is not depreciable under Division 40, but rather remains subject to the CGT provisions.
The ATO ran a number of arguments as to why the transitional rule applied to the MQPR in question, all of which were rejected at first instance and on appeal. In addition to the argument that Shell did not acquire a new depreciating asset from another party (which as noted above has not been dropped by the ATO), the ATO asserted that because the geographical area of the retention leases (granted after 1 July 2001) was a subset of the area the subject of the original exploration permits (granted before 2001), the new right related to the “same area” for the purpose of section 40-77(1B)(c).
This argument was rejected by the Full Federal Court on the basis that the word “same” means “identical” and a right does not cover the same area as another right if the area is different in size, even if it is merely a subset of the area covered by that other right.
Despite the Full Federal Court’s finding, the ATO has flagged that the debate will now move to the second condition associated with section 40-77(1B)(c), being whether any difference in area between a renewed MQPR and the old right is “not significant” such that the transitional rule is engaged.
The Takeaway
The key takeaway is the potential limiting of the scope of the transitional rule where a production license is granted on or after 1 July 2001 in respect of a subset of an area the subject of an exploration permit granted before 1 July 2001.
Further, despite the outcome of Shell, the ATO is keeping open an argument that when a taxpayer acquires an additional interest in an unincorporated mining joint venture for value, then depending on the underlying statutory and contractual arrangements, the taxpayer may not acquire a new depreciating asset.
Comments are due on the draft DIS by 3 March 2023.
James O'Reilly
Ryan Jones
kathryn Utting
Jayde Thompson
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