The Australian Taxation Office (“ATO”) have recently issued Taxation Ruling TR 2017/1 to provide guidance on the application of both section 8-1 and section 40-730 of the Income Tax Assessment Act 1997 (“ITAA1997”).
The Ruling deals with what constitutes mining and petroleum exploration for income tax purposes and the availability of deductions for exploration and prospecting expenditure.
Division 40 – Not a ‘Code’
A key point of the Ruling is that taxpayers cannot use Division 40 as an encompassing code for deductions for exploration expenditure. Instead, taxpayers must determine whether an immediate deduction is be available under the general deduction provisions section 8-1 or under section 40-730.
These provisions provide alternative bases for deductions however the same amount cannot be claimed as a deduction twice. If both provisions potentially provide a deduction for exploration expenditure, the provision which provides the largest deduction shall be used.
Exploration or Prospecting
To be deductible under section 40-730, exploration must be incurred on exploration or prospecting activities. The Ruling clarifies ‘exploration or prospecting’ (“EorP”) to take its ordinary meaning, which is restricted to:
“the discovery and identification of the existence, extent and nature of minerals and includes searching in order to discover the resource, as well as the process of ascertaining the size of the discovery and appraising its physical characteristics”
The Ruling acknowledges the difficulty in determining the nature of the expenditure for the purposes of section 8-1 or section 40-730, adding that the mere point in time at which the expenditure is incurred does not determine its character or nature.
Availability of Immediate Deductions
Whether expenditure satisfies legislative requirements for an immediate deduction will depend on the facts and circumstances of the taxpayer.
Emphasised in the Ruling is that certain expenditure incurred while the project is still being evaluated will not satisfy the immediate deduction requirements under section 8-1 or section 40-730. Importantly, there is no “bright line” test in determining the character or nature of expenditure for the purposes of section 8-1 or section 40-730. This means that the Final Investment Decision (“FID”) or the Decision to Mine (“DtM”) cannot be used for the purposes of classifying expenditure. The Ruling identifies the following expenditure as not qualifying as deductible under section 8-1 or section 40-730:
- The cost of long-lead assets; and
- The costs of early development activities such as detailed executable engineering and design work commissioned for the purpose of planning the proposed development from which project assets can be designed or constructed (design going beyond determining the economic feasibility of the project)
Other Key Matters
Other key items covered in the Ruling include:
- There is no presumption that exploration expenditure is capital or revenue, even if information is produced;
- It is essential to determine the nature or character of the advantage sought, rather than any advantage ultimately obtained;
- When economic feasibility studies are of revenue or capital nature.
The Ruling provides an extensive list of examples which illustrate the ATO’s view.
Date of effect
The Ruling applies to years of income commencing both before and after its date of issue.
The Ruling replaces Taxation Ruling TR 98/23 which was withdrawn from 28 October 2015.
Practical Compliance Guidelines PCG 2016/17
The ATO have also recently issues PCG 2016/17. This deals with how the ATO will administer the law and Ruling, and sets out three areas of focus:
- Assessing the quality of a taxpayers governance policies for projects and how a taxpayer categorises tax decisions;
- Identifying whether the taxpayer has kept adequate analysis and evidence that can easily substantiate the taxpayers exploration deductions; and
- Identify and explain expenditure that is viewed as high risk by the ATO.
As the PCG sets out the factors that the ATO will consider when assessing the risk of non-compliance and therefore how likely the ATO will review exploration expenditure claims, we would strongly recommend that a review of tax policy and procedures be undertaken to ensure compliance with TR 2017/1 and PCG 2016/17.
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