Taxation Ruling TR 2017/1 (the Ruling) provides our views on deductions for mining and petroleum exploration expenditure under section 8-1 and section 40-730 of the Income Tax Assessment Act 1997 (ITAA 1997). The reference to ‘exploration expenditure’ covers exploration/prospecting expenditure within its ordinary meaning and also within the statutory extension in subsection 40-730(4).
On 22 February 2017, we published the ATO compliance approach – exploration expenditure deductions Practical Compliance Guideline 2016/17 (the Guideline). The Guideline outlines how we will administer the law and the Ruling to ensure deductions for exploration expenditure are correctly claimed and how we will apply its compliance resources to assure exploration expenditure deduction claims. Taxpayers can use the Guideline to increase their confidence that deductions are claimed correctly.
The self-assessment procedures are intended to help you practically assess and show whether your governance framework meets the principles set out in Part A of the Guideline.
If you can demonstrate your governance framework meets these principles, this will help us obtain assurance for a large portion of the claims for exploration expenditure deductions. We are then able to tailor any further compliance activity and focus on the high risk areas as set out in Part C of the Guideline.
The issue is the potential for inaccurate or inappropriate exploration expenditure claims by taxpayers arising from deficiencies in taxpayers’ governance frameworks (including substantiation).
The risk is that incorrect exploration expenditure deduction claims by taxpayers, resulting in an overstatement of deductions claimed and corresponding understatement of taxable income.
See also
- Taxation Ruling TR 2017/1
- ATO compliance approach – exploration expenditure deductions Practical Compliance Guideline 2016/17
Who can use these self-assessment procedures
These self-assessment procedures can be used by multiple stakeholders.
- You can use this guide when performing a self-assessment of your project and tax governance framework by comparing the principles in Part A of the Guideline.
- ATO Client Engagement teams can use this guide when they review your exploration expenditure claims.
The intention is to create certainty about our procedures and provide guidance to facilitate self-assessment. If you complete the self-assessment process prior to our review and provide your report to us, this may decrease our time spent on review activities.
Interaction with the Tax Risk Management and Governance Review Guide
The self-assessment procedures are designed to assist with the assurance of exploration expenditure claims using the best practice principles set out in Part A of the Guideline.
See also
How you should use the self-assessment procedures
The self-assessment procedures provide a 'best practice' framework.
We recognise that the best practice examples provided below may not exactly align with the actual project and tax governance framework in place for all entities, particularly those with simple tax affairs. The internal project and tax governance frameworks that exist should be ‘fit for purpose’ and we encourage you to adopt elements of what we consider to be best practices applicable to your circumstances. You can find more information on the best practice governance principles in relation to exploration expenditure claims in Part A of the Guideline.
When reviewing exploration expenditure, you are encouraged to describe your compensating controls to demonstrate how tax risks are managed to the extent your governance framework varies from the ATO best practice and document why these elements might not apply to your circumstances.
To facilitate this process, refer to the tables in Dealing with observations identified by the self-assessment procedures. Complete the tables when applying the self-assessment procedures in instances where your project and tax governance frameworks do not align with best practices.
The self-assessment procedures are not intended to become form over substance, nor should users necessarily attempt to comply with every element. The self-assessment procedures provide the opportunity to contrast your governance framework against the ATO better practice and adopt an ‘if not why not’ approach to elements where better practice elements are not present.
We suggest you perform an initial gap analysis, and then look to leverage existing processes or identify compensating controls where best practice elements are either not present or partially present, with an ‘if not, why not approach’ for remaining items. For example, an entity might legitimately elect not to adopt a better practice element where the risk is deemed to be low (with reference to an internal risk matrix or materiality), or that the cost of compliance might exceed the benefit.
Not replicating the exact better practice element outlined in the guide should not imply a failure but rather prompt discussion about how that risk is managed.
Exploration expenditure claims
Elements of a governance framework to be confirmed
Project level governance
Identify the existence of a project level governance framework. Step one seeks to identify policies and procedures that apply to the project that the exploration claim is in relation to. This is by contrast to the policies and procedures that relate to the operation of the ordinary business and commercial governance frameworks that are typically more general in nature.
Procedure and report inclusions
Include specific detail of procedures completed or not completed, factual findings including dates, amounts and any errors, observations or exceptions identified and any proposed or undertaken action by the taxpayer to correct the issue/s (if any).
Step 1
For each project that the exploration claims relate to, provide:
- the project name
- phase of the project
- a summary of the project level governance framework and process that details how a project progresses through the various phases of the project life-cycle or stage-gate
- the summary should cover both documented/undocumented and formal/informal processes. Processes or procedures supported by written policies should be clearly referenced in the summary and relevant details provided
- any identified difference from standard policies and procedures needs to be outlined
- a summary of processes relied upon to assess adherence to project level governance framework
If the policies and procedures relate to multiple projects it is sufficient to provide this detail once together with a list of projects to which they relate noting any differences between projects.
Step 2
If the documents in step 1 are in draft you need to:
- provide reasons
- document response
- raise an observation in the report.
Step 3
If no written documents are in place in response to step 1, raise an observation.
Note: If there is no participation in joint venture (JV) projects, skip steps 4-7.
Step 4
Where the project is operated as a JV, identify and list the following:
- agreements governing the operation of the project of the JV (for example, JV operating agreements)
- agreements governing cost sharing arrangements
- agreements in respect of the types and detail of information to be provided by project operators to participants in order to facilitate decision making
- agreements and guidelines as to the information to be provided to allow participants to correctly identify and characterise exploration expenditure, including details of any tax advice procured (or to be procured) on participants behalf including any amendments.
Step 5
Provide details of the most recent JV audit of the operator’s financial records (including external audit engagements) conducted as part of the program of assurance.
Step 6
If the documents in step 4 are in draft you need to:
- provide reasons
- document their response
- raise an observation in the report.
Step 7
If no written documents are in place in response to step 4, raise an observation and describe in writing the policies and procedures applied to the specific project.
Tax governance
Identify and substantiate the existence of a tax governance framework with respect to exploration expenditure claims.
Procedure and report inclusions
Include specific detail of procedures completed or not completed, factual findings including dates, amounts and any errors, observations or exceptions identified and any proposed or undertaken action by the taxpayer to correct the issue/s (if any).
Step 8
Identify, list and summarise the local/domestic policies and procedures that relate to the tax characterisation process.
Step 9
The summary should include details of:
- the accounting policies and procedures for the recording of the expenditure
- the information systems (and any manual interventions) that are used throughout the process from recording the expenditure through to population and lodgement of the tax return, internal controls and the process for testing of the controls
- the process used by the taxpayer to identify and verify the character and quantum of the expenditure (including when and how this process is undertaken)
- whether and to the extent analysis and documentation is required to support and evidence the basis for exploration claims
- details of processes applied to confirm adherence to the tax characterisation process.
Note: If the above items are not documented or are only partially documented in the tax characterisation process, provide reasons, document response and raise an observation.
Step 10
If the documents in step 8 are in draft:
- provide reasons
- document response
- raise an observation in the report.
Step 11
If no written documents are in place in response to step 8, raise an observation and describe in writing the actual or expected processes applied to the specific project.
Step 12
Obtain a copy of the schedule/schedules that include the following details for the relevant year:
- all exploration expenditure claims (whether claimed under section 8-1, Division 40 of the ITAA 1997, or some other provision)
- a description of the project expenditure and the activities to which each claim relates
- all project expenditure that has been reviewed and assessed as not being exploration expenditure (for example, the cost of long lead assets) and the project to which they relate.
Step 13
List key details of each schedule to include:
- file name
- date prepared
- total number of claims
- total amount deducted under each provision for each project.
Step 14
If no written documents are in place in response to step 12, raise an observation.
Note: If there is no participation in JV projects, skip steps 15 and 16.
Step 15
If there is participation in a JV project, check that part of the tax characterisation process includes:
- accounting policies and procedures for the recording of expenditure, including the process undertaken to review JV statements and AFEs to verify the character and quantum of the expenditure and how these expenditures are then captured in the accounting system
- the approach as to how expenditure recorded in the accounts is identified as exploration expenditure and treated for tax purposes.
Note: If the above items are not documented or are only partially documented in the tax characterisation process, provide reasons, document response and raise an observation.
Step 16
For JV projects, ascertain whether the operator has provided information for participants to use in preparing tax returns and such information has been used as part of the tax characterisation process (for example JV tax packs).
If so, describe the type of information received including key details of each relevant document such as:
- file name
- date prepared
- total number of claims
- total amount deducted under each provision for each JV project.
If not, raise an observation.
Sampling
An example of better practice is testing the application of the project level and tax governance frameworks.
Procedure and report inclusions
Include specific detail of procedures completed or not completed, factual findings including dates, amounts and any errors, observations or exceptions identified and any proposed or undertaken action by the taxpayer to correct the issue/s (if any).
Step 17
Obtain a sample from the schedule referred to at step 12.1.
For each project in the ‘Select’, ‘Define’ or later phase, select and identify the largest item with the description containing ‘FEED’, ‘feasibility’, ‘Pre-FEED’ or ‘pre-feasibility’. Where no items with these descriptions exist, select the largest item.
Alternatively where no projects have reached the 'Select', 'Define' or later phases, select the largest item of exploration expenditure from any project. However, if these projects apply a distinctly different governance framework, a sample from a project under each framework should be selected.
Note: For example, participation in a particular joint venture project may require its own governance framework, separate and distinct to the governance framework that the taxpayer would ordinarily apply to projects. In such circumstances, the sample under step 17 would involve one sample for the particular joint venture (assuming it is not already provided in step 17), and one sample for the taxpayer’s other projects. If taxpayers are uncertain as to whether different governance frameworks apply, in such cases taxpayers are encouraged to select a sample from each of these projects where potentially different governance frameworks apply.
Next step
By reference to this sample, ‘walk-through’ and put in writing the application of the project level governance policies and procedures, and tax characterisation process. As part of the ‘walk-through’, provide a step-by-step description of the application of the governance policies and procedures, and tax characterisation process, evidenced by relevant documents and system records to demonstrate that the relevant policies and procedures are followed.
Step 18
When completing the 'walk-through' in step 17, you should provide the reasons and document the response whilst raising an observation in the report if you identify that:
- elements of the project level governance policies and procedures outlined at step 1 have not been followed
- elements of the tax characterisation process outlined in step 10 have not been followed
- the documentation and analysis as part of the tax characterisation process was not in accordance with the process described in step 8
- the tax characterisation process was not accompanied by obtaining evidence in the form of primary documents.
Dealing with observations identified by the self-assessment procedures
The tables below may help management to self-assess potential instances where their project level and tax governance frameworks do not align with better practices. It includes the option to state that an element is not applicable for all observations identified as a result of this work plan.
As you apply the self-assessment procedures, complete the table for observations/ratings made.
Where observations are made, an initial assessment should be made as to its potential impact on the existence or operation of the applicable governance framework.
Outline any details of compensating control or reasons why best practice element might not be adopted including cost of compliance, materiality and low risk (for example seismic surveys or exploration drilling).
If there are compensating controls or explanations in respect of these observations and then a 'final assessment' of the impact of these controls/explanations on the existence or operation of the applicable governance frameworks should follow. Refer to the examples set out below.
Observation/Rating Scale |
There are only draft documents in relation to project level governance policies and procedures |
|---|---|
Initial assessment |
Absence of project level governance framework |
Detail of compensating control and/or explanation/details |
Draft documents regarding project level governance policies and procedures considered sufficient as the only exploration activities as demonstrated by investment proposal is for seismic surveys and exploration drilling and therefore activities relate to initial phase of project life cycle |
Final assessment |
Demonstrates practically that documented project level governance framework operates |
Observation/Rating Scale |
There are no written local/domestic policies in place that relate to the tax characterisation process (as reliance in placed on global policies) |
|---|---|
Initial assessment |
Demonstrates existence of a tax governance framework |
Detail of compensating control and/or explanation/details |
As a compensating control, a description of the actual process that is undertaken with regards to identifying and analysing exploration expenditure has been recorded. The application of this process is evidenced by the walk-through sample. |
Final assessment |
Demonstrates practically that a documented tax governance framework operates |
We will also use this to make similar assessments.
How we use the self-assessment procedures
We use these procedures to assess the robustness of a taxpayer’s governance framework (including both project level and tax governance) against what is better practice and will tailor the compliance approach to reviewing exploration expenditure.
The table below outlines the approach we take in reviewing exploration expenditure after its initial assessment of the relevant frameworks.
Assessment |
Risk Rating |
Compliance Approach |
|---|---|---|
Demonstrates practically that a documented governance framework operates |
Low Risk |
Compliance activity will generally be limited to sample testing of your exploration expenditure claims in the high risk areas identified in Part C of the Guideline. |
Demonstrates existence of a governance framework in operation |
Moderate Risk |
In addition to sample testing of your exploration expenditure claims in the high risk areas identified in Part C of the Guideline, we may seek to review a cross section of your claims beyond those areas. The scope and intensity will be tailored depending on the assessment of the robustness of your governance frameworks. |
Absence of a governance framework |
High Risk |
We may conduct a detailed review of all of your exploration expenditure claims. |
Definitions
Demonstrates practically that a documented governance framework operates
You have documented governance (including both project and tax) policies and processes in place which support the tax characterisation of exploration expenditure and have demonstrated the operation of this process via a sampled walkthrough of exploration expenditure claims.
Demonstrates existence of a governance framework in operation
While not all the procedures in the ‘best practice’ framework have been demonstrated, you have shown that specific procedures are either not necessary or you have a compensating control and this is reflected in the sampled walkthrough of exploration expenditure claims.
Absence of governance framework
You do not have a formalised governance framework or policy and cannot demonstrate the operation of a governance process in relation to your exploration expenditure claims.
How the ATO administers the law and the Ruling to assure deductions claimed for 'exploration expenditure'.