House of Representatives

Petroleum Resource Rent Tax Assessment Amendment Bill 2006

Petroleum Resource Rent Tax (Instalment Transfer Interest Charge Imposition) Bill 2006

Petroleum Resource Rent Tax (Instalment Transfer Interest Charge Imposition) Act 2006

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 3 - Infrastructure licences and closing down costs

Outline of chapter

3.1 Petroleum projects are likely to have substantial expenditures on closing down the project, including associated environmental restoration costs. These costs are part of deductible expenditure for Petroleum Resource Rent Tax (PRRT) purposes. However, some project facilities may go on to non-project use under an infrastructure licence. When project facilities stop being used for the project, but remain in use, any later costs of closing down their use under the infrastructure licence are currently not recognised (either directly or indirectly) for PRRT purposes.

3.2 Schedule 3 to this Bill amends the Petroleum Resource Rent Tax Assessment Act 1987 (PRRT Act) to allow the present value of expected future expenditures associated with closing down petroleum project assets that continue to be used under an infrastructure licence to be deductible against the PRRT receipts of this project. This change is made so far as these costs are currently not recognised for PRRT purposes. This change was announced by the Treasurer and Minister for Industry, Tourism and Resources in a joint press release dated 10 May 2005.

Context of amendments

3.3 The PRRT is a profits based tax. It applies when project revenue from the sale of petroleum products in a financial year exceeds accumulated undeducted expenditures, including expenditure on plant, as augmented to maintain their real value and ordinarily to provide a minimum rate of return.

3.4 'Closing down expenditure' is one kind of deductible expenditure for PRRT purposes. Closing down expenditure (whether capital or revenue) represents the costs of closing down a petroleum project, including the costs of removing project facilities and of consequential environmental restoration. A project is closed down when the last related production licence, and the operations in relation to recovery under it, end. Closing down expenditure incurred as part of bringing the project to an end is a deductible expense in working out the PRRT liability of the petroleum project.

3.5 Infrastructure licences were introduced in March 2000 to allow the construction and operation of petroleum infrastructure facilities in Commonwealth (offshore) waters. Infrastructure licences allow the use of facilities for engaging in specified activities associated with the processing, storing, preparing for transport and remote control of recovery of petroleum. Facilities may go on being used for specified activities under an infrastructure licence after they are no longer used for the original petroleum project of which they were part. Facilities associated with a petroleum project under a production licence can be converted partly or completely into continuing operations under an infrastructure licence after the original petroleum project and its production licence ends, typically when the commercially recoverable petroleum reserves of the original petroleum project are exhausted. This allows the economic life of offshore petroleum project facilities to be extended as much as possible. It is not intended that an infrastructure licence be used for activities other than those specified in the Petroleum (Submerged Lands) Act 1967, or the Offshore Petroleum Act 2006, whichever is applicable.

3.6 Where the taxpayer with an interest in a petroleum project receives consideration for disposal of part or all of the project's facilities for use under an infrastructure licence, the arm's length value of this consideration should reflect both the value of future income from using the facilities under the infrastructure licence and the costs of closing down the facilities once they are no longer used under the infrastructure licence sometime in the future. In this circumstance, the current law ordinarily produces the correct result, as the consideration for disposing of project facilities is an assessable receipt included in working out the PRRT liability for the petroleum project (under paragraph 27(1)(a) of the PRRT Act).

3.7 Similarly, where the taxpayer with an interest in a petroleum project stops using all or part of the project's facilities for the project but continues to use them under an infrastructure licence, the arm's length value of the facilities should reflect both the value of future income from using the facilities under the infrastructure licence and the costs of closing down the facilities sometime in the future once they are no longer used under the infrastructure licence. Here too, the current law ordinarily produces the correct result, as the value of the project facilities when they stop being used in relation to the petroleum project is an assessable receipt included in working out the PRRT liability for the petroleum project (under paragraph 27(1)(b) of the PRRT Act). However, taxpayers are concerned that the value of the facilities might be held not to take account of such closing down costs, or might be held not to be capable of being made negative by expected costs exceeding expected returns.

3.8 Where the taxpayer owning the petroleum project pays consideration for disposal of the facilities for use under an infrastructure licence, this consideration is not taken into account in working out the PRRT liability of the petroleum project in which the facilities stop being used. This consideration should reflect both the value of future income from using the facilities sometime in the future under the infrastructure licence, and the costs of closing down the facilities once they are no longer used under the infrastructure licence. Giving this consideration relieves the taxpayer of closing down expenditure when the facilities are no longer used for the petroleum project, and makes the purchaser responsible for closing down the facilities once they are no longer used under the infrastructure licence. These closing down expenditures are currently not included in closing down expenditure for the particular petroleum project because they relate to closing down the activities under the infrastructure licence rather than under the production licence.

3.9 In these circumstances, part of the closing down expenditures would have been incurred anyway had the continued use of the facilities under the infrastructure licence never happened. However, these closing down expenditures are neither recognised when the petroleum project ends, nor when the ongoing use under the infrastructure licence ends, for PRRT purposes. The inability of PRRT taxpayers to take account of closing down costs in all circumstances when some or all of the project's facilities convert from a production licence to an infrastructure licence acts as an economic disincentive against continuing use of project facilities to maximise their economic life and to develop marginal petroleum resources located near existing facilities.

Summary of new law

3.10 This Bill ensures that, when a petroleum project ends but some or all of the project's facilities continue to be used for other specified purposes under an infrastructure licence, the present value of estimated closing down costs of the facilities under the infrastructure licence is taken into account in working out the PRRT liability of the petroleum project that has ended. This outcome is achieved both where the taxpayer still owns the project's former facilities used under an infrastructure licence, and where the taxpayer gives consideration to dispose of the project's former facilities for further use under an infrastructure licence. However, the mechanism to achieve this outcome is different depending on the circumstance.

Comparison of key features of new law and current law

New law Current law
Where ownership of the facilities used under the production and infrastructure licences is maintained, or where the taxpayer with an interest in the petroleum project gives consideration for disposal of the facilities for use under an infrastructure licence, the present value of estimated closing down costs of the facilities under the infrastructure licence is taken into account in working out the PRRT liability of the petroleum project that has ended. Where ownership of the facilities used under the production and infrastructure licences is maintained, or where the taxpayer with an interest in the petroleum project gives consideration for disposal of the facilities to be used under an infrastructure licence, closing down costs associated with the facilities under the infrastructure licence are not always taken into account in working out the PRRT liability of the petroleum project that has ended. This is because there are no closing down expenditures when the facilities stop being used for the petroleum project and actual closing down expenditures occur when the facilities stop being used under the infrastructure licence.

Detailed explanation of new law

Background

3.11 For PRRT purposes, closing down costs of a petroleum project will ordinarily be incurred no later than when the project ends. At this point, all the project's facilities become redundant to the project and are closed down. They may be partially or completely removed, made safe or reclaimed, and the environment may be partially or completely restored. The costs of doing this are closing down expenditure for PRRT purposes.

3.12 The amendments take into account the circumstance where a project facility ceases to be used in relation to a petroleum project, but continues to be used in whole or in part for other purposes under an infrastructure licence. At present, the value of such a project facility the taxpayer keeps is an assessable property receipt of the project under paragraph 27(1)(b) of the PRRT Act. This value may not necessarily take future closing down expenditure into account. If the future closing down expenditure exceeds the value of the facility, the excess is not deductible expenditure for PRRT purposes in relation to the petroleum project that is closed down. If the taxpayer disposes of such a project facility, any consideration the taxpayer receives is an assessable property receipt of the project under paragraph 27(1)(a) of the PRRT Act. This assessable receipt should take account, implicitly, of future closing down expenditure. However, if the taxpayer must pay more on that account than any consideration received for the disposal, then the excess is not deductible expenditure of the taxpayer in relation to the project for PRRT purposes.

Key terms

3.13 'Future closing down expenditure' may arise if a petroleum project ends and some or all of the project's facilities continue to be used under an infrastructure licence, so long as the taxpayer would have incurred closing down expenditure on those facilities but for that continued use [Schedule 3, item 5, subsection 2C(1)] . An 'infrastructure licence' is an infrastructure licence under Part III of the Petroleum (Submerged Lands) Act 1967 or section 6 of the Offshore Petroleum Act 2006, whichever is applicable. An infrastructure licence is required for the use, other than under a production licence, of any of a range of offshore facilities [Schedule 3, items 2 and 3, section 2] . The particular facility which continues to be used under an infrastructure licence is 'licensed property' [Schedule 3, item 4, section 2, and item 5, paragraph 2C(1)(b)] .

3.14 The future closing down expenditure is based on the 'future closing down costs'. These costs are the payments (both revenue and capital) the taxpayer would expect any person responsible for closing down the particular facility covered by the infrastructure licence to be liable to make in carrying on operations to close it down. This includes any consequential environmental restoration costs. However, it excludes any costs relating to alterations or additions to the particular facility to be made after the petroleum project ends. The future closing down costs are discounted at the 'long-term bond rate' (defined under the PRRT Act) for the year in which the petroleum project ends, plus 2 percentage points, compounded for the number of whole years after the petroleum project ends and over which the particular facility is expected to be used as the infrastructure licence allows. This discounted amount is the future closing down expenditure. [Schedule 3, item 5, subsections 2C(2) to (4)]

Receipts and expenditures when the taxpayer keeps the project facility after the petroleum project ends

3.15 One scenario is where the taxpayer has an interest in the production licence, and has an interest in the infrastructure licence under which at least part of the petroleum project continues to be used. Under this scenario, the taxpayer has an assessable property receipt under paragraph 27(1)(b) of the PRRT Act of the value of a project facility which the taxpayer keeps after it stops being used for a petroleum project, perhaps because the project ends or perhaps earlier. Any future closing down expenditure must now be taken into account in working out this assessable property receipt [Schedule 3, item 6, subsection 27(3)] . This treatment removes any economic impediment to the ongoing use of the facility for other purposes in this circumstance.

Example 3.1 A production licence relating to Project A ceases to be in force on 1 August 2006, and some of the Project A's facilities continue to be used under an infrastructure licence with no change in ownership. In addition, the value of the facilities used under an infrastructure licence is $500 on the day the production licence ceases, and the present value of estimated future closing down costs of these facilities is $300. Assessable property receipts worked out under paragraph 27(1)(b) is $200 (ie, $500 less $300) due to the operation of subsection 27(3). In this case, because assessable property receipts include estimated future closing down costs, future closing down costs have already been taken into account in working out Project A's PRRT liability.

3.16 If the present value of future closing down expenditure exceeds what would otherwise be the assessable property receipt, then the assessable property receipt is taken to be zero [Schedule 3, item 6, subsection 27(4)] . However, where the value of the assessable property receipt when the facility stops being used for the petroleum project is less than the present value of future closing down costs, the excess is deductible for PRRT purposes as closing down expenditure [Schedule 3, item 8, subsection 39(3)] . This treatment removes any economic impediment to the ongoing use of the facility for other purposes in this circumstance.

Example 3.2 A production licence relating to Project A ceases to be in force on 1 August 2006, and some of the Project A's facilities continue to be used under an infrastructure licence with no change in ownership. In addition, value of the facilities used under an infrastructure licence is $500 on the day the production licence ceases, and the present value of estimated future closing down costs of these facilities is $800. Assessable property receipts worked out under paragraph 27(1)(b) is taken to be zero because of the operation of subsection 27(4) (ie, estimated future costing down costs are greater than assessable property receipts if future closing down costs were not taken into account). However, in this case, Project A can claim a deduction of $300 in working out its PRRT liability as closing down expenditure due to the operation of subsection 39(3).Expenditure when the taxpayer disposes of the project facility at the end of the petroleum project

3.17 The second scenario is where the taxpayer gives consideration to a new owner to take over some or all of the project's facilities subject to the infrastructure licence when the petroleum project ends. This means that the value of assessable property receipts placed on the facility subject to the infrastructure licence due to the operation of paragraph 27(1)(a) must be less than the present value of estimated future closing down costs. In this circumstance, to the extent that the consideration relates to the excess of the present value of estimated future closing down costs over the current value of the facility, it is included in closing down expenditure at the time the petroleum project ends (ie, the point the production licence ceases). Treating any such expenditure as closing down expenditure removes any economic impediment to the disposal of the facility in ways that allow it to be used for other purposes in this circumstance. [Schedule 3, item 8, subsection 39(2)]

Example 3.3 A production licence relating to Project A (which is owned by Company X) ceases to be in force on 1 August 2006, and some of the Project A's facilities are sold to Company Y where Company X pays Company Y $100 in an arm's length transaction to take ownership of these facilities which are now operated under an infrastructure licence. In addition, the value of the facilities apart from closing down costs is $70 and the present value of estimated future closing down costs is $170. In this case, Project A can claim a deduction of $100 in working out its PRRT liability as closing down expenditure due to the operation of subsection 39(2).

Future closing down expenditure not double counted

3.18 In the event a taxpayer has already taken into account future closing down expenditure for a project facility, any further actual closing down expenditure in relation to the same facility is reduced to this extent. Such actual closing down expenditure might otherwise include amounts for which future closing down expenditure had already been taken into account to reduce assessable property receipts, or to produce closing down expenditure. This could arise where a petroleum project ends (eg, due to low oil prices making the project unprofitable), some or all of the facilities associated with this project are used under an infrastructure licence, and the petroleum project recommences production sometime later under a new production licence (eg, due to a return of high oil prices making the project profitable). [Schedule 3, item 8, subsection 39(4)]

Application and transitional provisions

3.19 These amendments apply to assessments of PRRT for financial years beginning on or after 1 July 2006. [Schedule 3, item 9

REGULATION IMPACT STATEMENT

Policy objective

3.20 The policy objective of the infrastructure licence proposal is to remove a taxation impediment to ongoing use of petroleum project facilities for other purposes under an infrastructure licence.

Background

3.21 Infrastructure licences were introduced through an amendment to the Petroleum (Submerged Lands) Act 1967 in 2000. Infrastructure licences are granted to allow the use of petroleum infrastructure facilities in Commonwealth (offshore) waters for specified activities. A typical example is where the petroleum reserves for a project have been exhausted and rather than close down the project infrastructure related to this reserve, an infrastructure licence is granted to process petroleum piped in from an alternative source located nearby. The owners of the infrastructure would receive a fee for providing this service to a third party.

3.22 Under the PRRT Act, a tax credit is given for the costs involved in closing down a project. This includes costs such as removing offshore infrastructure (eg, a production platform) and any necessary environmental restoration.

3.23 The interaction of the PRRT Act with the infrastructure licence regime can result in the non-recognition of closing down expenditures for PRRT purposes. For example, in situations where a project facility stops being used for a petroleum project under a production licence and is granted an infrastructure licence to allow continuing use for another purpose, this project facility could remain in place for some time after the petroleum project subject to PRRT ends. As a result, the closing down costs in relation to assets covered by the infrastructure licence would not be incurred until the cessation of the infrastructure licence. Consequently, these costs would not be deductible for PRRT purposes in relation to the petroleum project that has ended. This is because the closing down costs would not be incurred in relation to closing down the petroleum project, but in relation to closing down the use of the assets under the infrastructure licence. This could provide an inducement not to allow non-project use of project facilities once they are no longer needed for a petroleum project, contrary to maximising use of facilities and minimising duplication.

Implementation options

3.24 These amendments amend the PRRT Act to take account of closing down costs to be incurred when a production facility continues to be used under an infrastructure licence, enabling the offset or deduction of such costs for PRRT purposes. There are no other options to implement this proposal.

Impact group identification

3.25 The group affected by these amendments are companies operating petroleum projects that cease to use facilities under a production licence, but continue to use these facilities under an infrastructure licence. An infrastructure licence allows the construction and operation of offshore facilities for purposes not covered by a production licence. The Department of Industry, Tourism and Resources advises that there are currently no known petroleum projects that would take advantage of these amendments in the short term. Over the medium term, it is possible that projects may choose to surrender an existing production licence but continue to operate an existing petroleum facility under an infrastructure licence for other purposes. At present, there is no information as to which projects are most likely to pursue this possibility. However, there could be several projects in the next few years approaching the stage where operators will need to decide whether to shut down the existing facilities completely, or seek an infrastructure licence to allow other continuing uses.

Assessment of costs and benefits

Business

3.26 These amendments benefit petroleum production companies by ensuring future closing down expenditure is taken into account in working out the PRRT liability of the petroleum project that is ending in the circumstance where some or all of the existing facilities relating to this project convert from a production licence to an infrastructure licence. This makes treatment of future closing down expenditure comparable to the treatment of actual closing down expenditure if the project facility concerned had not had any continuing use under an infrastructure licence when it stopped being used for the petroleum project. The removal of this taxation distortion will increase economic efficiency by enhancing the optimal development of petroleum resources. That is, the proposed change will enable existing infrastructure to continue to be used efficiently.

3.27 These amendments are expected to have no additional compliance implications for PRRT taxpayers. That is, under the current law PRRT taxpayers take account of closing down costs in determining their PRRT liability, and under the new law they also take account of closing down costs although in a different way if some or all of the petroleum project facilities are used under an infrastructure licence.

Administration

3.28 The Australian Taxation Office (ATO) is responsible for administering the PRRT. The ATO advise that the compliance and administrative impact of these amendments from a taxation perspective are negligible. Further, the Department of Industry, Tourism and Resources advise that the impact on their administration of the infrastructure regime is also negligible.

Revenue

3.29 The revenue impact is nil over the forward estimates period and beyond. This is because without this proposal, infrastructure would close down with its petroleum project and the actual closing down deductions would be claimed anyway. In the longer term, allowing the more efficient use of infrastructure should improve the profitability of petroleum production companies for consequent benefits for PRRT and company tax revenues.

Consultation

3.30 Consultation has been conducted with the Australian Petroleum Production and Exploration Association, and through them individual companies within the industry. They are supportive of amendments to ensure deductibility of expected closing down expenditures where a facility converts from a production licence to an infrastructure licence. In particular, no concerns were raised in relation to the draft legislation. They also support amendments to ensure deductibility of consideration given for the disposal of project property to the extent that this consideration is for expected closing down expenditures.

Conclusion and recommended option

3.31 These amendments are expected to enable existing infrastructure to be used more efficiently by removing a taxation distortion where the infrastructure is presently subject to the PRRT. It is expected to impose no additional compliance costs on PRRT taxpayers and no additional administrative costs on the ATO and the Department of Industry, Tourism and Resources.

3.32 The Treasury, the Department of Industry, Tourism and Resources and the ATO will monitor the administrative effect of these taxation amendments on an ongoing basis.


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