House of Representatives

Tax Laws Amendment (2007 Measures No. 2) Bill 2007

Explanatory Memorandum

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

Chapter 1 - Effective life provisions

Outline of chapter

1.1 Schedule 1 to this Bill amends Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) to more closely align the decline in value deductions for mining, quarrying and prospecting rights (mining rights) with that for other depreciating assets.

Context of amendments

1.2 Division 40 of the ITAA 1997, provides for a uniform capital allowance system that establishes general rules that, among other things, allow deductions for the decline in value of depreciating assets based on their effective lives. The 'effective life' of a depreciating asset is generally the estimated period the asset can be used by any entity for a taxable purpose or for the purpose of producing exempt income or non-assessable non-exempt income. The uniform capital allowance system was enacted with effect from 1 July 2001.

1.3 Taxpayers, in calculating deductions for the decline in value of their depreciating assets, generally have the choice either to use the Commissioner of Taxation's (Commissioner) 'safe harbour' determinations, or they can self-assess the effective lives of their assets. If they self-assess, they must, if relevant for the asset, have regard to the wear and tear reasonably expected from their circumstances of use and assume the asset will be maintained in reasonably good order and condition.

1.4 The Commissioner publishes determinations of effective life for numerous depreciating assets used in a wide range of industries. The Commissioner has an on-going review which continually updates the 'safe harbour' effective lives determinations.

1.5 If a Commissioner's determination is not in force for a particular asset, taxpayers generally must self-assess the effective life of that asset.

1.6 Once they have worked out their asset's effective life, taxpayers can generally work out their decline in value deductions using either the prime cost method or diminishing value method.

1.7 The Commissioner's determination is based on the asset being new when it starts being used. A taxpayer purchasing a second-hand asset for use for a taxable purpose (eg, item of machinery), will generally have the choice either to still use the relevant 'safe harbour' effective life determined by the Commissioner (notwithstanding that it is based on the asset being new) or self-assess the asset's effective life by estimating the period the second-hand asset can be used by any entity for the relevant purposes set out in paragraph 1.2.

1.8 Certain intangible depreciating assets listed in the table in subsection 40-95(7) do not use those general rules. The uniform capital allowance system prescribes statutory effective lives for these intangible assets and stipulates (in subsection 40-70(2)) that the diminishing value method cannot apply to most of them. Therefore, the prime cost method must be used to calculate their decline in value.

1.9 Although mining rights were included in the table in subsection 40-95(7), the diminishing value method can still be applied to them, because subsection 40-70(2) does not include mining rights as one of those intangible assets where the diminishing value method cannot apply. Mining rights were included in the table in items 11 to 13 in subsection 40-95(7) by the Tax Laws Amendment Act (No. 4) 2003 . Those items expressly linked the effective life of the mining right to the life of the relevant 'mines', that is, existing or proposed mine or mines, petroleum field or quarry or quarries.

1.10 Unfortunately, including mining rights with other intangible assets in the table in subsection 40-95(7) resulted in mining rights being treated differently from both other depreciating assets out of the table and from other intangible assets in the table. This was not the intended outcome of the Tax Laws Amendment Act (No. 4) 2003 .

Summary of new law

1.11 These amendments will remove mining rights from the table in subsection 40-95(7). Instead, the effective life of mining rights will be worked out under the new subsections 40-95(10) and (11) under broadly the same rules in the current law. A new rule will be introduced to clarify how to work out the life of a mine.

Comparison of key features of new law and current law

New law Current law
Mining rights will be removed from the table in subsection 40-95(7) and the effective life of mining rights will be worked out under new subsections 40-95(10) and (11).
A new rule will clarify how to work out the life of a mine.
Specific rules apply to mining rights including expressly linking the effective life of a mining right to the life of the existing or proposed mine or mines to which the right relates.
These rules are covered in items 11 to 13 in the table in subsection 40-95(7).

Detailed explanation of new law

1.12 Mining rights will be removed from the table in subsection 40-95(7). [Schedule 1, item 1, items 11 to 13 in the table in subsection 40 - 95(7)]

1.13 There was a possible interpretation that including mining rights in this table led, in cases where taxpayers chose the diminishing value method of working out the decline in value of their mining right, to the effective life of a mining right being based on the whole rather than remaining life of the existing or proposed mine or mines to which the right relates. In addition, there was an interpretation that holders of mining rights were required to assess the life of the right annually. These interpretations led to outcomes that were inconsistent with that for other depreciating assets under the uniform capital allowance system for which the diminishing value method of working out the decline in value is being used.

1.14 Under these changes, the treatment of mining rights will be more closely aligned with that for other depreciating assets. This means that a taxpayer acquiring their mining right from a prior holder will be able to estimate the remaining period until the end of the life of the existing or proposed mine or mines to which the right relates irrespective of whether the taxpayer chooses the prime cost or the diminishing value method of working out the decline in value of their mining right. As well, there will be no requirement for a taxpayer to undertake a yearly or periodic assessment of the effective life of their mining right.

1.15 Mining rights are to be excluded from the general rules that apply to self-assessing the effective life of a depreciating asset in section 40-105 because the effective life of a mining right relates to the estimated period until the end of the life of another asset - a mine. The capital costs of developing a mine are typically deductible over time. If the capital costs do not create depreciating assets in their own right, then special provisions apply to this expenditure in Subdivision 40-I. Further, the general rules in section 40-105 require the taxpayer to estimate the period the depreciating asset can be used by any entity for various purposes including 'a taxable purpose'. This term is defined in subsection 40-25(7) to not only include 'the purpose of producing assessable income' (which would be the dominant purpose during the life of the mine), but also 'the purpose of exploration or prospecting', 'the purpose of mining site rehabilitation' and 'environmental protection activities'. However for mining rights the effective life relates to a shorter period, the period until the end of the life of the mine. [Schedule 1, item 4, subsection 40 - 105(4)]

How the effective life of a mining right will be worked out

1.16 Taxpayers work out the effective life of their mining right themselves by estimating the period until the end of the life of the mine or proposed mine to which the right relates or, if there is more than one such mine, the life of the mine that has the longest estimated life, that is, the period until the end of the life of the only remaining mine. A proposed mine for the purposes of subsection 40-95(10) is where preparatory work to the actual extraction of the reserves has started at the site. It is a mine which may not be constructed at the time of acquisition of the mining right but for which a decision has been made by the acquiring company that the mine will be constructed. This would be expected to be evidenced by the approval of the proposed capital expenditure required to construct the mine infrastructure by the acquiring company's board of directors. Likewise, when a mine is already under construction at the time of the acquisition of the mining right this would also represent a proposed mine for the purposes of subsection 40-95(10). A similar process applies if the right relates to mining operations to obtain quarry materials. There a taxpayer estimates the period until the end of the life of the quarry or proposed quarry to which the right relates or, if there is more than one quarry, the life of the quarry that has the longest estimated life, that is, the period until the end of the life of the only remaining quarry. However, if the mining right relates to mining operations to obtain petroleum, the effective life of that right is worked out by estimating the period until the end of the life of the petroleum field or proposed petroleum field. [Schedule 1, item 3, subsection 40 - 95(10)]

1.17 The period in subsection 40-95(10) will be worked out from the start time of the mining right. [Schedule 1, item 3, paragraph 40 - 95(11)(a)]

1.18 For the purposes of working out the period in subsection 40-95(10), the period until the end of the life of an existing or proposed mine will be worked out as the period over which the reserves are expected to be extracted from the mine. This period is worked out by determining the amount of the reserves, reasonably estimated by a competent person using an appropriately accepted industry practice, divided by the expected extraction rate from the mine. Current examples of such accepted industry practices are:

·
the Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves (referred to as the JORC Code). This is a code for mineral reporting prepared by the Joint Ore Reserves Committee of the Australasian Institute of Mining and Metallurgy, the Australian Institute of Geoscientists and the Minerals Council of Australia; and
·
the Guidelines for the Evaluation of Petroleum Reserves and Resources - ( A Supplement to the SPE/WPC / Petroleum Reserves Definitions and the SPE/WPC/AAPG Petroleum Resources Definitions ) published by the Society of Petroleum Engineers (SPE). The abbreviations used in the title above stand for the World Petroleum Council (WPC) and the American Association of Petroleum Geologists (AAPG).

[Schedule 1, item 3, paragraph 40 - 95(11)(b)]

1.19 As pointed out in paragraph 1.14, once the life of the mine has been estimated, there will be no requirement in the new law for a yearly or periodic re-estimation of the period until the end of the life of the mine and similarly, no requirement for a yearly or periodic re-estimation of the effective life of the mining right. However, as noted in paragraphs 1.22 to 1.26, there is the ability for the taxpayer to choose to reassess the effective life of the mining right, should they so decide.

1.20 The following examples help to illustrate how this measure will work.

Example 1.1 Black Stump Pty Ltd acquired the Lockyer Coal mine from one of its competitors on 1 July 2007. The mine is operated on a single mining right, issued by Queensland. Immediately following the acquisition Black Stump determines that the mine has ore reserves, calculated using the JORC Code, of 100 million tonnes. The use of the JORC Code to calculate ore reserves is the accepted practice in the Australian mining industry, and represents the 'reserves', for the purposes of paragraph 40-95(11)(b). Black Stump Pty Ltd has also determined that the average extraction rate of the ore reserves is expected to be 5 million tonnes per annum. Based on these estimates the life of the mine is calculated to be 20 years. This will be the effective life of the mining right for the purposes of subsection 40-95(10).

Example 1.2 Mine Co. Pty Ltd acquired the Frontier copper deposits (F47 and F52) from one of its competitors on 1 December 2006. The deposits are located within the boundaries of a single mining right issued by New South Wales. Each of the deposits is currently extracted via separate open cut mines each with their own operational infrastructure. Immediately following the acquisition, Mine Co. Pty Ltd determined that the F47 deposit has ore reserves of 25 million tonnes and the F52 deposit has ore reserves of 50 million tonnes. The determination of these ore reserves was made using the JORC Code. Mine Co. Pty Ltd has also determined that the average extraction rate of the F47 ore reserves is expected to be 3 million tonnes per annum and the average extraction rate of the F52 ore reserves is expected to be 5 million tonnes per annum. Based on these estimates the life of the F47 mine is 8.3 years and the life of the F52 mine is 10 years. The mine with the longest estimated life is therefore F52 which has a mine life of 10 years. This will be the effective life of the mining right for the purposes of subsection 40-95(10).

Example 1.3 Barrel Oil Pty Ltd acquired a production licence from one of its competitors on 1 July 2007. It is Barrel Oil Pty Ltd's intention to continue extracting oil from the one existing oil field within that production licence. Immediately following the acquisition of the production licence, Barrel Oil Pty Ltd determines that the field has proved and probable developed and undeveloped oil reserves of 200 million barrels. The oil reserves have been calculated using accepted industry practices (eg, those recommended by the Society of Petroleum Engineers), through reference to available seismic well and reservoir information, production and pressure trends and data from other producing reservoirs in the immediate area. The proved and probable developed and undeveloped oil reserves represent the 'reserves', for the purposes of paragraph 40-95(11)(b). Barrel Oil Pty Ltd has also determined from the development plan that it had prepared at the time that it acquired the production licence, that it expected it would take 12 years to extract and process the recoverable reserves. The effective life of the mining right relating to mining operations to obtain petroleum is 12 years for the purposes of subsection 40-95(10).

Example 1.4 Bauxite Co. Pty Ltd acquires the Big W mine on 1 July 2005, which is contained on a single permit together with a proposed mine which has just commenced construction (the Big X mine). The Big W mine has JORC Code reserves at 30 million tonnes which are being mined at 10 million tonnes per annum. Based on these calculations the life of the Big W mine is three years, and will close in 2008. The construction of the Big X mine is expected to be completed in 2008, when the Big W mine closes, and has JORC Code reserves of 200 million tonnes which will also be mined at 10 million tonnes per annum. Based on these calculations the life of the proposed mine is 20 years, and will close in 2028. As the Big X mine will close later than the Big W mine, the effective life of the permit will be 23 years (1 July 2005 until 1 July 2028).

How mining right decline in value deductions will be calculated

1.21 As with other assets, taxpayers will generally have the choice of using either the prime cost or diminishing value methods in calculating the decline in value of their mining right. Should the mining right be transferred, the new acquirer of that right will generally be allowed to work out the decline in value of their acquired right by estimating the remaining period until the end of the life of the mine or proposed mine to which the right relates (or, if there is more than one such mine, the life of the mine that has the longest estimated life), as illustrated in Example 1.4. Following this, taxpayers will choose either the prime cost method or diminishing value method to work out the right's decline in value. As with other depreciating assets, the transfer of the right will generally be considered to be a balancing adjustment event.

When the effective life of a mining right may be changed

1.22 The existing section 40-110 permits taxpayers to choose to recalculate the effective life of a depreciating asset in certain circumstances (subsection 40-110(1)), and mandates it in other circumstances (subsections 40-110(2) and (3)). Subsection 40-110(1) currently permits (but does not mandate) a taxpayer to recalculate the effective life of a depreciating asset if it is no longer accurate, because of changed circumstances relating to the nature of the use of the asset. This subsection will not be applicable for mining rights but it is to be supplemented by the addition of a subsection 40-110(3B), to permit the recalculation of the effective life of a mining right if it is no longer accurate because of changed circumstances relating to an existing or proposed mine. This recalculation is done using subsections 40-95(10) and (11), which means a re-estimation of the period from the mining right's start time until the end of the life of the mine. Circumstances that may cause a taxpayer to choose to make a re-estimation of the effective life of a mining right are discussed further in paragraph 1.25. [Schedule 1, item 5, subsection 40 - 110(3B)]

1.23 The existing section 40-110 requires the recalculation to be undertaken using the principles in section 40-105 (about self-assessing effective lives). However, as noted in paragraph 1.15, mining rights are to be excluded from the general rules that apply to self-assessing the effective life of a depreciating asset in section 40-105. Accordingly any recalculation of the effective life of a mining right pursuant to section 40-110 must be undertaken using the principles set out in subsections 40-95(10) and (11) as described in paragraph 1.21. [Schedule 1, item 6, subsection 40 - 110(4)]

1.24 By stating that the effective life of a mining right relates to the estimated period until the end of the life of the mine, this measure leaves it open for taxpayers to choose to re-estimate that period, if the original estimate is no longer accurate. Accordingly if a taxpayer chooses to undertake a re-estimation of the life of the mine this re-estimation will change the effective life of the mining right.

1.25 The actual period until the end of the life of the mine would, in most cases, be constantly changing. Despite this, there is no requirement in this measure for a regular or periodic re-estimation of the effective life of the mining right to be undertaken. Circumstances that may cause the taxpayer to choose to make a re-estimation of the effective life of a mining right would be varied, but could include:

·
a considerable structural price change for the mineral being extracted which leads to the mine's premature permanent closure;
·
previously uneconomically mineable geologies becoming economically mineable;
·
a noticeable improvement in extraction methods or transport arrangements from the mine which leads to faster extraction of the mineral and a consequential shortening of the remaining life of the mine;
·
new information becoming available as a result of further exploration or prospecting on the mining tenement as to the presence of minerals likely to be recoverable which leads to an increase in the remaining life of the mine; or
·
a change to the accepted industry practice that affects the estimation of the life of the mine.

1.26 Subsections 40-110(2) and (3) will also not apply to mining rights. Although capital expenditure is being incurred at the mine in the normal course of the extraction process, this expenditure has rarely any relation to the cost of the mining right itself. From an economic point of view, and all other economic factors being equal, the taxpayer will try to extract the reserves as quickly as possible. Therefore capital expenditure incurred other than in the course of the extraction process is, generally, directed at facilitating or improving the efficiency of the extraction process; this in turn reduces the life of the mine. [Schedule 1, item 5, subsection 40 - 110(3A)]

Application and transitional provisions

1.27 The amendments made by Schedule 1 to this Bill apply to assessments for the income year in which 1 July 2001 occurred, and later income years. [Schedule 1, item 7]

1.28 This retrospectivity is required because the 2003 amendments, which specifically listed mining rights in the table in subsection 40-95(7), were also retrospective to 1 July 2001. This will ensure that the policy intent - to more closely align the treatment of mining rights to that for other depreciating assets, is reflected in the law since the introduction of Division 40. This does not disadvantage taxpayers as the intent of the law has always been followed and this measure clarifies the law.

Consequential amendments

1.29 Subsection 40-95(8) establishes an upper limit on the effective life of an intangible depreciating asset. Intangible depreciating assets mentioned in the table in subsection 40-95(7) (which statutorily provides an effective life for certain intangible assets) and an indefeasible right to use a telecommunication cable system are excluded from subsection 40-95(8) as they are included in the table in subsection 40-95(7). As the new law will remove mining rights from this table, a specific reference to mining rights being excluded from subsection 40-95(8) will be inserted in that subsection in order to preserve their exclusion from that subsection. [Schedule 1, item 2, subsection 40 - 95(8)]


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