Decision impact statement

Esso Australia Resources Pty Ltd v Commissioner of Taxation

• This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Venue: Federal Court of Australia
Venue Reference No: M19 of 2012 (HC) & VID 630 of 2011; VID 631 of 2011 (FFC)
Judge Name: Gummow J, Hayne J, Crennan J (HC) Keane CJ, Edmonds J, and Perram J (FFC)
Judgment date: 17 August 2012 (HC); 20 February 2012 (FFC)
Appeals on foot: N/A
Decision Outcome: Taxpayer's special leave to appeal to the High Court was refused & favourable Full Federal Court decision for the Commissioner

Impacted Advice

Relevant Rulings/Determinations:

• Draft Taxation Ruling TR 2010/D4
• Draft Taxation Ruling TR 2010/D5
• Draft Taxation Ruling TR 2010/D6
• Miscellaneous Taxation Ruling MT 93/2

Subject References:
Petroleum Rent Resource Tax
Petroleum Project Expenditure
Deductible Expenditure
Service Agreement
Service Fee
Mutualised Research Costs
Indirect Costs

Précis

Outlines the ATO's response to this case which concerns deductibility under the Petroleum Resource Rent Tax Assessment Act 1987 ("PRRTAA") of various office facility, administrative and accounting expenditures, service fees and mutualised research costs.

Brief summary of facts

Office Facility, Administrative and Accounting Expenditure and Service Fees

Esso Australia Resources Pty Ltd ("EAR") was engaged in a petroleum project ("the Project") in Bass Strait involving exploring for, recovering, treating and selling petroleum and natural gas. The Project was conducted as a joint venture with BHP Billiton Petroleum (Bass Strait) Pty Ltd ("BHP") pursuant to an Operating Agreement. A Service Agreement between EAR and Esso Australia Ltd ("EAL") provided that EAL would make available to EAR trained personnel, equipment and facilities to enable EAR to conduct its petroleum exploration, production and marketing operations in Australia and on the continental shelf.^[1]

Under the Service Agreement, EAR agreed to pay to EAL the costs EAL incurred in providing the agreed services to EAR, a share of EAL's overhead costs proportionate to the services performed, and a fee of 7.5% of EAR's share of the overhead costs (sub-clauses 4(a), (b) and (c) respectively of the agreement).^[2]

In working out, for PRRTAA purposes, its taxable profit from the Project for the 2003 and 2004 income years, EAR claimed as deductible expenditure amounts referable to its liability to EAL under the Service Agreement. An apportionment methodology was used in working out the amount of some of the claims. The Commissioner disallowed some of the claimed amounts that can be broadly described as relating to office facility, administrative and accounting expenditure and service fees (sub-clause 4(b) overhead costs).

The amounts were disallowed because, in the Commissioner's view, it had not been shown that they were a liability incurred to procure the carrying on or providing the things comprising the Project, or, if they were, then, in accordance with section 41 of the PRRTAA, they were excluded expenditure under paragraphs 44(j) and (k).^[3]

The part of the 7.5% fee relating to the disallowed office facilities, administrative and accounting expenditure was also disallowed (sub-clause 4(c) fee).^[4] It was accepted that the deductibility of this expenditure would depend upon the deductibility of the overhead costs from which it derived.^[5]

Mutualised Research Charge ("MRC")

EAR had also entered into an Upstream Cost Sharing Agreement ("the UCSA") with ExxonMobil Upstream Research Company ("URC").^[6] URC operated a Mutualised Research Program which affiliate companies in the ExxonMobil Group could join.

Under the UCSA, EAR obtained access to 'royalty-free' licences over URC's patent rights and other technical information for use in its upstream operations. An associated agreement allowed EAL to access this information, which it used in providing services to EAR under the Service Agreement.^[7]

The UCSA provided that EAR was required to pay a share of the net cost of upstream research.^[8] EAR received monthly invoices from URC comprising an exploration charge and a production charge.^[9]

The MRC was disallowed by the Commissioner on the basis that it was not made in carrying on or providing the operations and facilities of the Project in terms of sections 37 and 38 of the PRRTAA.^[10]

The taxpayer applied to the High Court for special leave to appeal against the decision of the Full Court of the Federal Court, delivered on 20 February 2012. The Full Court had allowed the Commissioner's appeal against the decision of Ryan J at first instance, delivered on 30 May 2011.

Issues decided by the court

Issue decided by the High Court

Whether a grant of special leave to the taxpayer to appeal against the decision of the Full Federal Court was warranted

At the special leave hearing the High Court refused to grant special leave to the taxpayer to appeal against the decision of the Full Court of the Federal Court.

It refused the application on the grounds that there were insufficient prospects of success in displacing the order of the Full Court, given the terms in which the provisions of the PRRTAA and the service agreement are expressed. In particular, those terms were considered so intractable as to deny the apportionment of expenditure as contended for by the taxpayer.

Issues decided by the Full Federal Court

Office Facility, Administrative and Accounting Expenditure and Service Fees

No deduction was available for the claims in issue under sections 37 or 38 of the PRRTAA.

The Full Court made a number of general observations about the operation of the PRRTAA.^[11] Two observations about the statutory context of section 41 set the background to the Court's decision.^[12] The first observation is that section 41 is the only basis for obtaining deductions under sections 32, 37, 38 and 39 where a person derives income in relation to a petroleum project but it does not itself (or by an agent) carry on the operations comprising the project. This was the situation in this case.^[13] The second observation was that there is nothing to suggest that a person who engages a contractor to carry on the activities comprising the project should have deductible expenditure that the person would not have obtained if it itself had carried on the activities.

The Full Court held that section 41 of PRRTAA does not permit a deduction for excluded expenditure in section 44 of the PRRTAA (the claims in issue) or for payments which include such expenditure in relation to activities that section 41 deems to have been carried on by EAR.^[14] Further, there was no other basis on which such expenditure could be deducted.

This conclusion was reached without needing to determine if the total amount payable under clause 4 of the Service Agreement was "one indivisible payment" or represented payments of separate liabilities under each of subclauses 4(a), (b) and (c) of the agreement.^[15]

If payments under clause 4 of the Service Agreement are viewed as the payment of an indivisible liability, it seems to the Commissioner that the Court took the view that this is a situation where the payment includes excluded expenditure, and section 41 of the PRRTAA does not permit a deduction.

It appears this was because in terms of section 41 the liability to make such a payment was not wholly to procure another person to carry on or provide the relevant activities that are of a kind referred to in sections 37, 38 or 39 of the PRRTAA.

The services to be provided under the Service Agreement related to EAR's operations in Australia and on the continental shelf. As a result, the relevant liability for payments under the Service Agreement were for activities not confined to the Project, so that the liability was not wholly to procure another person to carry on or provide activities of a kind referred to in sections 37, 38 and 39 of the PRRTAA.^[16] The inference to be drawn is that apportionment of such a liability is not possible for the purposes of sections 37, 38, 39 and 41.

However, if payments under clause 4 of the Service Agreement were payments of liabilities separately created under sub-clauses 4(a), (b) and (c), then the claims under sub-clauses 4(b) and (c) (relating to the claims in issue) were more readily seen to comprise excluded expenditure (paragraphs 44(j) and (k) of the PRRTAA).^[17]

The Full Court's thinking here appears to be that the liability to make the payments was sufficiently divisible so it could be concluded that what was procured in relation to the Project was of a kind referred to in sections 37, 38 or 39 of the PRRTAA. That is, the relevant services procured were confined to the Project. As a result section 41 of the PRRTAA would apply so that EAR is deemed to have carried on or provided the relevant services and sections 37, 38 or 39 (including section 44 of the PRRTAA) would need to be considered to determine the deductibility of the payments.

The Full Court also observed that if the fee payable under clause 4 of the Service Agreement were regarded as one indivisible liability to make a payment, then sections 37 and 38 of the PRRTAA do not cover such a payment. This is because the fee under the Service Agreement cannot be said to be made to discharge a liability in carrying on the activities comprising the Project. The liability to make a payment also relates to services not confined to the Project. The arrangement enabled EAR to conduct its petroleum exploration, production and marketing operations in Australia and on the continental shelf. Again, the inference to be drawn is that apportionment of such a liability is not possible for the purposes of sections 37, 38 and 39 of the PRRTAA.

The Court does not appear to have relied upon this observation to conclude that the claims in issue are not deductible. Rather, they referred to the operation of section 41 as being sufficient for this purpose.^[18]

The 7.5% fee was not deductible on the basis that its treatment was the same as the overhead costs to which it relates.

Mutualised Research Charge ("MRC")

No deduction is available for the MRC under sections 37 or 38 of the PRRTAA.

The work conducted by URC that EAR contributed to by the MRC was not conducted in carrying on the activities comprising the Project.^[19] The URC's work may have been used for the benefit of the Project, but URC cannot be said to have carried on or provided any of the operations, facilities or things comprising the Project

Further observations of the Full Federal Court

The Full Court made a number of observations about the operation of the PRRTAA throughout their judgments. Some of these observations are outlined in what follows.

A number of additional observations were made by Keane CJ and Edmonds J at paragraphs [116] to [121] of their judgment. They note that they addressed the arguments put by the Commissioner and the taxpayer in their decision and decided the matters accordingly. However, they considered that the premise upon which the Commissioner's amended assessments were predicated was wrong and took the opportunity to outline their views.^[20]

The premise was that the consideration paid by EAR to EAL under the Service Agreement, which was not disallowed by the Commissioner, is deductible expenditure.^[21] Although it is not clear, it appears that the observations are made on the basis that the liability under which the payments were made was indivisible.

The first observation is that the terms of the Service Agreement are such that it cannot be said that the consideration paid by EAR to EAL qualifies as being incurred by EAR in relation to the Project, in terms of section 37 or 38 of the PRRTAA.^[22] That is, EAR cannot be said to have itself (or by an agent) carried on the operations comprising the Project and incurred the expenditure.^[23]

Secondly, the services to be provided by EAL to EAR under the Service Agreement are not confined to the Project so they are not of a kind referred to in sections 37, 38 and 39 of the PRRTAA, and as a result section 41 of the PRRTAA is not engaged. The inference to be drawn is that apportionment of such a liability is not possible for the purposes of sections 37, 38, 39 and 41.

A number of observations are then made about how section 41 of the PRRTAA would operate if it applied to the Service Agreement relationship between EAR and EAL (contrary to the view above).

The application of section 41 of the PRRTAA is 'described shortly as working a statutory agency as between EAL and EAR for the purposes of ss 32, 37, 38 and 39 of the Act'. The effect of paragraph 41(a) of the PRRTAA in the context of the Service Agreement is stated by the Full Court to be that the operations, facilities and other things comprising the project are taken to have been carried on or provided by EAR. Paragraph 41(b) of the PRRTAA takes the liability of EAR under the Service Agreement to be incurred in carrying on or providing the same things comprising the project that paragraph 41(a) of the PRRTAA takes EAR to have done.^[24]

The further point is made that the consideration paid by EAR under the Service Agreement is attributed with the same characteristics as the various components of EAL's expenditure. This means that if a component of EAL's expenditure is excluded expenditure under section 44 of the PRRTAA, then the equivalent proportion of the consideration paid by EAR will be excluded expenditure. The effect of this is that such expenditure will be denied deductibility.

ATO view of Decision

The orders of the Full Court were those sought by the Commissioner in the proceedings.

Many aspects of the decision are consistent with the Commissioner's views on the operation of the deductible expenditure provisions in the PRRTAA.

Given the considered views of the Full Court about the operation of the PRRTAA in its additional observations, the Commissioner is of the respectful opinion that he should have regard to these observations in administering the law in this area.

On the basis of the Full Court's decision and observations it seems that a number of propositions can be drawn:

•

Sections 37, 38 and 39 of the PRRTAA do not allow for apportionment of expenditure where the liability to make a payment is not confined to the carrying on or providing of the operations, facilities and other things comprising the petroleum project

•

Section 41 of the PRRTAA does not allow for apportionment of expenditure where the liability to make a payment is not confined to procuring the carrying on or providing of operations, facilities or other things of a kind referred to in sections 37, 38 or 39 of the PRRTAA

•

Section 41 of the PRRTAA impresses the character of the contractor's expenditure onto the liability to pay of the eligible person in terms of what it procures. This can include the relevant proportion of an expenditure of a particular character relative to other expenditure.

The first two dot points above effectively mean that an indivisible liability to make a payment (including such a liability that is a component of a divisible liability) must be wholly confined to the relevant things comprising the petroleum project in terms of sections 37, 38 or 39 of the PRRTAA before the application of those sections (and section 41 of the PRRTAA) can be considered.

Administrative Treatment

The ATO will now apply the law in accordance with its views of the Full Federal Court's decision and observations when it determines assessments, rulings, objections and appeals.

The ATO accepts it has administered the PRRTAA in this area in a manner which is consistent with the views expressed in the Draft Taxation Rulings (TR 2010/D4, TR 2010/D5 & TR 2010/D6) for a number of years. Therefore, the ATO will generally not seek to disturb assessments for the 2012 financial year and earlier years where taxpayers have self assessed on the basis of:

•

Apportioning an amount of expenditure for the purposes of section 37, 38 or 39 of PRRTAA in a manner that is consistent with the Draft Taxation Rulings.

•

Apportioning an amount for the purposes of section 41 of the PRRTAA where the liability to make a payment is not confined to procuring the carrying on or providing of the operations, facilities or other things of a kind referred to in section 37, 38 or 39 in a manner that is consistent with the Draft Taxation Rulings.

•

The views expressed in the Draft Taxation Rulings about the operation of section 41 to the effect that:

-

A liability to make a payment to a contractor will be apportioned if the taxpayer procures the contractor to provide a number of services and some of those services are items covered by the excluded expenditure provision in section 44 of the PRRTAA or those services are not directly related to the project as outlined in the Draft Taxation Rulings.

-

A payment to a third party contractor may be fully deductible in some circumstances. This may be the case where a taxpayer procures a contractor to provide a specific service, that is directly related to the project and is not an item covered by the excluded expenditure provision (e.g. a drilling service), and the contractor spends some of the money on items of excluded expenditure that would not be deductible in the hands of the taxpayer had they incurred them as expressed in TR 2010/D6.

However, our information indicates some taxpayers may have self-assessed amounts of deductible expenditure in the 2012 financial year and earlier years on a basis that is not consistent with the Draft Taxation Rulings. The ATO is currently considering what action (if any) it may take in relation to these taxpayers.

Implications for ATO precedential documents (Public Rulings & Determinations etc)

The following ATO precedential documents will be withdrawn as a result of the Full Federal Court decision.

•

Draft Taxation Ruling TR2010/D4

•

Draft Taxation Ruling TR 2010/D5

•

Draft Taxation Ruling TR 2010/D6

•

Miscellaneous Taxation Ruling MT 93/2

The ATO is not proposing to issue a public ruling on the implications of the Full Federal Court decision as amendments were made to the PRRTAA on 30 July 2013 to provide certainty to industry following the court decision (see Tax Laws Amendment (2013 Measures No 2) Act 2013). The ATO in consultation with Industry has issued practical guidance on apportioning expenditure and will continue with its practice of consulting with Industry to prioritise and work through issues that may arise over time from the new measures or from withdrawing the Draft Taxation Rulings and MT 93/2.

Implications for Law Administration Practice Statements

N/A

Court citation:
[2012] HCATrans 194
[2012] FCAFC 5
(2012) 200 FCR 100
(2012) 87 ATR 124

Footnotes

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 2-3.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 3.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 4 and 29-31.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 31.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 31.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 32.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 34-37.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 33.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 37.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 37.

For example, Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 92 and 116-121.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 99.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 76-78 and 118.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 110 and 123.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 110.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 104 and 119.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 107.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 104.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 112.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 117.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 116.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 118.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 76-78.

Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5 at 121.

Legislative References:
Fringe Benefits Tax Assessment Act 1986 (Cth)
The Act

Income Tax Assessment Act 1936 (Cth)
The Act

Income Tax Assessment Act 1997 (Cth)
The Act

Petroleum Resource Rent Tax Act 1987 (Cth)
The Act

Petroleum Resource Rent Tax Assessment Act 1987 (Cth)
37
38
41
44
The Act

Petroleum (Submerged Lands) Act 1967 (Cth)
The Act

Taxation Laws Amendment Act (No.3) 2002 (Cth)
The Act

Case References:
City Link Melbourne Ltd v Commissioner of Taxation
[2004] FCAFC 272
141 FCR 69
2004 ATC 4945
57 ATR 316

Commissioner of Taxation v Mount Isa Mines Ltd
(1991) 28 FCR 269
21 ATR 1294
91 ATC 4154

Esso Australia Resources Pty Ltd v Commissioner of Taxation
[2011] FCAFC 154

Esso Australia Resources Pty Ltd v The Commissioner of Taxation
[2011] FCA 565

Ronpibon Tin NL v Federal Commissioner of Taxation
[1949] HCA 15
(1949) 78 CLR 47