Section 41 of the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA) is a deeming provision that only applies to the extent that a payment is made by a procuring entity to procure a service provider to carry on or provide project activities of a kind referred to in sections 37, 38 or 39 of the PRRTAA on the procuring entity's behalf.
The agreement between the parties may specify that some project activities will be provided by the service provider as an agent for the procuring entity in limited circumstances. If a payment is made subject to an agency agreement, section 41 of the PRRTAA does not apply.
If section 41 of the PRRTAA applies, the procuring entity is taken to have carried on the project activities itself. It is also taken to have made the payment or part payment in carrying on those activities.
Section 41 of the PRRTAA also deems that the payment is taken to have certain characteristics before it is tested against the requirements of deductibility (sections 37, 38 and 39 of the PRRTAA) and the excluded expenditure provisions (section 44 of the PRRTAA). These deeming rules differ, depending on whether the procuring entity and the service provider are unrelated or related. If the entities are:
- unrelated – the payment to procure project activities is taken to have the same character and nature as the project activities procured
- related – the payment to procure project activities is taken to have the same character, nature and amount as the actual expenditure incurred by the service provider in carrying on those activities. This is referred to as the look-through approach.
The procuring entity will not need to use the look-through approach to work out the character, nature and amount of expenditure to the extent that a payment is made to a related service provider for the use of property (on which capital expenditure was incurred). Such payments are taken to have the same character and nature as the project activities procured (as if the entities were unrelated).
The look-through approach is not applied to payments made before 1 July 2013.
This may arise, for example, if the service provider is procured to carry on project activities across a number of projects (including proposed projects) or to also provide non-project related activities.
Find out about:
- Reasonable method of apportionment
- When entities are related
- Payments to unrelated entities
- Payments to related entities
- Joint venture and other service agreements
Reasonable method of apportionment
An entity should choose a reasonable basis of apportionment that is supported by documentation. There is no prescribed method to apportion these payments; however, we do not generally consider a notional or arbitrary method of apportionment to be a reasonable basis.
If an entity, for example, makes a payment to procure project activities for a number of projects, we would not generally accept allocating the payment equally across the projects as a reasonable basis of apportionment, unless there is evidence to support that it is appropriate in the circumstances.
We expect that the service agreement between the entities provides information that assists a procuring entity to apportion these payments. If the basis for apportionment is not clear from the terms or operation of the contract or agreement, other documentation may be required.
Other documentation that may assist in working out a reasonable method of apportionment may include:
- exploration work programs
- field development plans
- drilling schedules
- employee time-writing records
- production development plans
- production operation plans.
Once the payment has been apportioned to identify the part of the payment that relates to the procurement of project activities, the deeming rules in section 41 of the PRRTAA are applied to that portion of the payment.
The deeming rules in section 41 of the PRRTAA differ, depending on whether the procuring entity and the service provider are unrelated or related. This means a procuring entity needs to work out if it is related or unrelated to the service provider.
When entities are related
A service provider is related to the procuring entity for the purposes of section 41 if it either:
- holds an interest in the same petroleum project for which it is providing project activities – for example, the service provider is a joint venture participant in and operator of the project
- is connected to the procuring entity if they are tested under section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997).
Broadly, entities are connected with one another if either of the following applies:
- either entity controls the other entity
- both entities are controlled by the same entity.
Control of an entity can be direct or indirect and includes control exercised by an affiliate. An affiliate is an individual or a company that acts, or could reasonably be expected to act, according to the entity’s directions or wishes, or in concert with the entity to control another entity.
An entity (the first entity) directly controls another entity (the controlled entity) if the first entity, its affiliates or both the entity and its affiliates, have the right to receive at least 40% of any distributions of income or capital of the controlled entity. If the controlled entity is a company, control also arises if the first entity, its affiliates or both have shares and other equity interests in the controlled entity that give them at least 40% voting power in the controlled entity.
The indirect control test is designed to look through business structures that include interposed entities – for example, if an entity (the first entity) directly controls a second entity, and the second entity either directly or indirectly controls a third entity, the first entity is taken to control the third entity. However, the indirect control test does not apply if the second entity is a public entity or is a company where the shares are owned by a public entity.
Example: Working out whether entities are connected
Company A has a 60% shareholding in Company B (which is not a public company). Company B has a 50% shareholding in Company C. This means:
- Company A is connected with Company B because it directly controls Company B
- Company B is connected with Company C because it directly controls Company C.
Company A is connected with Company C because it indirectly controls Company C (as Company A directly controls Company B, and Company B directly controls Company C).
End of examplePayments to unrelated entities
If the entities are unrelated, the procuring entity's payment to the service provider is taken to have the same character and nature as the project activities procured. The payment is then tested against the requirements of deductibility (sections 37, 38 or 39 of the PRRTAA) and the excluded expenditure provisions (section 44 of the PRRTAA).
The payment or part payment to procure the project activities is deductible if the requirements of deductibility are met and the activities procured do not constitute an item of excluded expenditure.
The underlying expenditure incurred by the service provider in providing the activities procured is not used to work out the character and nature of the payment if the entities are unrelated.
For the procuring entity to meet its record-keeping obligations, we expect that it would have (or have access to) documentation to show the character and the nature of the project activities procured from the unrelated service provider.
We expect that a key source document is the contract or service agreement between the procuring entity and the unrelated service provider. Other source documents that explain the setting, context and purpose of the transaction or arrangement may also be relevant, including any tender discussions, ongoing reviews of the provision of project activities, and reports commissioned under the arrangement.
Example: Payments made to procure petroleum project activities
Tidus Ltd (the procuring entity) has an interest in four offshore petroleum exploration permits known as the Alpha, Beta, Gamma and Delta exploration permits.
Tidus Ltd procures an unrelated service provider, Auron Ltd, to undertake seismic survey activities across all the exploration permit areas (which are of various sizes) under a single contract and at a fixed cost of $40 million.
Because each exploration permit is recognised as a separate petroleum interest for PRRT purposes, the $40 million payment that relates to the procurement of project activities needs to be apportioned among the four exploration permits. However, the contract between the parties does not specify how much of the fixed cost of $40 million is attributable to each exploration permit and does not require Auron Ltd to provide Tidus Ltd with such information.
In view of the different sizes of the exploration permit areas, Tidus Ltd works out that the payment should be apportioned based on the area (km2) covered by the survey shoot in each exploration permit area, as opposed to arbitrarily apportioning $10 million to each exploration permit. In the absence of any evidence to the contrary, this approach is considered a reasonable basis of apportionment.
The area of the survey shoot conducted by Auron Ltd in the Alpha exploration permit represents 50% of the total area covered. As a consequence, 50% of the project activities Auron Ltd undertakes are attributable to this exploration permit – the other 50% is non-project activities in relation to this exploration permit.
Because the survey activities procured are project activities of a kind referred to in section 37 of the PRRTAA (exploration expenditure) and do not constitute an item of excluded expenditure, the whole $40 million payment is potentially deductible to Tidus Ltd. As a result, $20 million of the payment made to Auron Ltd is potentially deductible in relation to the Alpha exploration permit. The apportionment of the payment for the other exploration permits is dependent on the areas covered by the survey shoot in their respective exploration permit areas.
Because the entities are unrelated, the payment made by Tidus Ltd is taken to have the same character and nature as the project activities procured. As a consequence, there is no requirement for it to look through the payment to the underlying expenditure incurred by Auron Ltd in providing those activities.
No further apportionment of the amount of the payment that is attributable to the Alpha exploration permit (or the amounts of the payment attributable to the other exploration permits) is required, and the amount Tidus Ltd can claim as deductible expenditure in relation to each exploration permit is not reduced.
End of examplePayments to related entities
If the entities are related, the payment or part payment to procure project activities is taken to have the same character, nature and amount as the actual expenditure incurred by the service provider in carrying on the activities procured.
However, to the extent a payment to a related service provider is for the use of property (on which capital expenditure has been incurred) the payment or part payment is taken to have the same character and nature as the project activities procured.
The deeming in section 41 of the PRRTAA operates in the same manner as payments made by a procuring entity to an unrelated service provider. As a result, a procuring entity is only required to look through to the expenditure incurred by the related service provider to the extent the payment does not involve the use of property.
Where the look-through approach applies, any mark-up charged on the expenditure incurred by the related service provider in carrying on the project activities is not deemed to be incurred by the procuring entity. This is because the payment made by the procuring entity is taken to be the same as the actual expenditure incurred by the related service provider in carrying on the activities procured.
Also, any expenditure incurred by the related service provider that would constitute an item of excluded expenditure retains that character and nature when it is used to work out the character, nature and amount of the payment made by the procuring entity.
The procuring entity needs details of the expenditure incurred by the related service provider in order to look through to this expenditure. The level of detail required is similar to the information the procuring entity would need if it had incurred the expenditure itself and it was required to work out if the expenditure met the deductibility requirements. Support for this is found in the Explanatory MemorandumExternal Link that accompanied the Tax Laws Amendment (2013 Measures No. 2) Bill 2013 where it states [at 6.19]:
Requiring PRRT taxpayers to apply a look-through approach to third party payments would require the third party to provide details of all the expenditure incurred in providing the service, including commercial-in-confidence information, in order for the taxpayer to determine the extent to which the payment was deductible.
After the deeming in section 41 of the PRRTAA has been applied to the payment, it is then tested against the requirements of deductibility (sections 37, 38 or 39 of the PRRTAA) and the excluded expenditure provisions (section 44 of the PRRTAA).
For the procuring entity to meet its record-keeping obligations, we expect that it would have (or have access to) documentation to show how the expenditure incurred by the related entity meets the requirements of deductibility and is not excluded expenditure.
This means the procuring entity may need to obtain or access other source documents apart from the contract or service agreement between the entities that may originate from the related service provider. These other source documents are similar to those a procuring entity would maintain if it had incurred the expenditure itself, including job orders and invoices, job descriptions and other relevant cost information.
Example: Project activities procured from a related entity include the use of property
Assume the same facts as example 1 above except that Auron Ltd is related to Tidus Ltd. Also assume that some of the activities procured under the contract relate to the use of property by Auron Ltd.
In the absence of any evidence to the contrary, the apportionment of the payment based on the area (km2) covered by the survey shoot in each permit area continues to be considered a reasonable basis of apportionment. However, further apportionment is required to establish the extent that the payment relates to the use of property on which capital expenditure was incurred. If the payment relates to the use of property, it is deemed to have the same character and nature as the project activities procured.
The remaining portion of the payment made by Tidus Ltd is taken to have the same character, nature and amount as the expenditure incurred by Auron Ltd in carrying on the activities procured.
Tidus Ltd obtains documentation from Auron Ltd that shows that $10 million of the $40 million fixed charge related to project activities involving the use of property. This amount continues to be deductible to Tidus Ltd.
In relation to the remaining $30 million of the payment, the documentation requested shows that Auron Ltd only incurred $27 million of expenditure in providing the project activities, with $3 million representing a mark-up of that expenditure. The documentation also shows that $1 million of this expenditure would be considered as excluded expenditure had Tidus Ltd incurred that expenditure. As a consequence, only $26 million continues to be deductible to Tidus Ltd.
The amount of the payment to be apportioned across the four exploration permits is $36 million (the $40 million payment, less the $3 million mark-up, less the $1 million excluded expenditure).
As a result, $18 million of the payment made to Auron Ltd is deductible in relation to the Alpha exploration permit. Similar reductions occur in relation to the other exploration permits on a proportional basis due to the exclusion of the mark-up and the excluded expenditure.
End of exampleSee also:
Joint venture and other service agreements
We acknowledge that the vast majority of petroleum projects in Australia are carried out by joint ventures under a joint venture operating agreement (JVOA).
If the operator under the JVOA carries on or provides project activities in relation to a petroleum project on behalf of the joint venture participants, the operator and the participants are related for the purposes of section 41 of the PRRTAA.
As a result, each joint venture participant’s proportionate share of the amounts payable under the JVOA are taken to have the same character, nature and amount as the operator’s expenditure incurred in carrying on the project activities.
This may mean operators that provide expenditure statements to joint venture participants are required to provide a more detailed breakdown of expenditure than may have been previously required for participants to meet their PRRT obligations. Billing statements may need to identify circumstances where participants are not charged on a cost recovery basis, because participants are only able to claim payments to the extent that they are equal to the actual expenditure incurred by the operator in carrying on the activities procured.
If an operator engages another entity that it is connected with (a connected third entity) to carry on activities of the project, the joint venture participants in the project may need details of the connected third entity's expenditure in providing these activities to meet their PRRT obligations.
Other service agreements between group entities
An entity that is either a participant in a joint venture or has the sole interest in a petroleum project may also enter into an agreement to engage a group entity to undertake project activities on its behalf.
If the procuring entity and its group entity are related for the purposes of section 41 of the PRRTAA, the procuring entity's payment is taken to be of the same character, nature and amount as the expenditure of the group entity. In these circumstances, a related group entity may be required to provide a more detailed breakdown of its expenditure than may have been previously required for the procuring entity to meet its PRRT obligations.
If the related group entity engages another entity that it is connected with (a connected third entity) to carry on activities of the project, the procuring entity may need details of the connected third entity's expenditure in providing these activities to meet its PRRT obligations.
Connected third entities engaged by a service provider
If a service provider is related to the procuring entity and it engages another entity that it is connected with (a connected third entity) to carry on or provide project activities on behalf of the procuring entity, the connected third entity is also related to the procuring entity.
This means that the payment or part payment that relates to the project activities provided by the connected third entity is taken to have the same character, nature and amount as the actual expenditure incurred by the connected third entity in carrying on the activities procured.
Therefore, a procuring entity is required to look through to the expenditure incurred by the connected third entity to the extent the payment does not involve the use of property.
Example: Service provider engages a connected third entity to provide project activities
Juno Limited holds a 30% interest in a petroleum project. The remaining interest is held by Vesta Limited, an unconnected entity which is also the joint venture operator responsible for project operations.
Juno Limited makes payments to Vesta Limited for its proportionate share of the project activities carried out by Vesta Limited. Juno Limited and Vesta Limited are related entities for the purposes of section 41.
Vesta Limited makes payments to Ceres Pty Ltd, a wholly owned subsidiary, to carry out all of the project activities in relation to the project.
Because Vesta Limited is procuring project activities from a connected third entity (Ceres Pty Ltd) on behalf of a related entity (Juno Limited), the payments made by Juno Limited to Vesta Limited have the same character, nature and amount as the actual expenditure incurred by Ceres Pty Ltd in carrying on the activities procured.
End of exampleExpenditure exceeding payment
If a related service provider, or an entity connected with the service provider, incurs more expenditure than the payment it receives for carrying on project activities (and which does not relate to the use of property), the amount of its expenditure is taken not to exceed the procuring entity’s payment. This means the service provider or connected entity's expenditure is capped to the amount of the procuring entity's payment.
Sections 37, 38, 39 and 44 also apply in relation to that expenditure as if it were reduced to the same extent.
Example: Reduction of expenditure on a proportionate basis
Hestia Pty Ltd makes a payment of $100,000 to a related entity, Artemis Pty Ltd, to procure project activities other than in relation to the use of property. Artemis Pty Ltd incurs $125,000 in carrying on the project activities – $12,500 of this expenditure is excluded expenditure under section 44.
The amount of the payment under section 41 is capped to $100,000 because this is how much Hestia Pty Ltd actually paid Artemis Pty Ltd. In addition, as excluded expenditure accounted for 10% of the $125,000 incurred by Artemis Pty Ltd, Hestia Pty Ltd removes excluded expenditure from the payment it made to the same extent (10%). It works out the amount of excluded expenditure from the payment as follows:
- $12,500 ÷ $125,000 × 100% = 10%
- 10% × $100,000 = $10,000
$10,000 of the amount of the $100,000 is taken to be excluded expenditure (section 44).
Hestia Pty Ltd similarly reduces the expenditure deductible under sections 37, 38 and 39 – for example, if 50% of the $125,000 of expenditure incurred by Artemis Pty Ltd is deductible under section 37, Hestia Pty Ltd can only include 50% of the $90,000 payment as deductible expenditure.
End of example