House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 7 Starting base allowances

Outline of chapter

7.1 This chapter explains Part 3-5 (Divisions 80, 85 and 90) of the Minerals Resource Rent Tax Bill 2011 (MRRT Bill), which deals with starting base allowances. Starting base allowances reduce a mining project interest's Minerals Resource Rent Tax (MRRT) liability for an MRRT year.

7.2 All legislative references throughout this chapter are to the MRRT Bill unless otherwise indicated.

Summary of new law

7.3 Starting base allowances recognise investments in assets (starting base assets) relating to the upstream activities of a mining project interest that existed before the announcement of the resource tax reforms on 2 May 2010. They also recognise certain expenditure on such assets made by a miner between 2 May 2010 and 1 July 2012.

7.4 A mining project interest has a starting base allowance if it has profit remaining after using all other higher ranked allowances, and it has one or more starting base losses. Unlike other losses, starting base losses are never transferable to other mining project interests.

7.5 A starting base loss reflects the annual depreciation (decline in value) of the starting base assets. If there is insufficient profit to use a starting base loss, it is carried forward and uplifted.

7.6 A miner can choose to work out the starting base losses for its mining project interest based on either:

•

the market value of starting base assets (including rights to the resources) at 1 May 2010; or

•

the most recent accounting book value of starting base assets (not including rights to the resources) available at that time.

7.7 Under the market value approach, a starting base asset is depreciated over the shorter of: the asset's remaining effective life; the life of the mine; and the period until 30 June 2037. The undepreciated value of a starting base asset is not uplifted, though the real value of any unused losses is preserved by uplifting them by the consumer price index (CPI).

7.8 Under the book value approach, a starting base asset is depreciated over five years. The undepreciated value of a starting base asset is uplifted each year by the long term bond rate plus 7 per cent (LTBR + 7 per cent). Any unused losses are also uplifted by the LTBR + 7 per cent.

Detailed explanation of new law

A miner has an allowance when it can use a starting base loss

7.9 A mining project interest has a starting base allowance if it has sufficient profit to use some or all of its starting base losses, after using all other higher ranked allowances [sections 80-10 and 80-15] . Royalty, transferred royalty, pre-mining loss, and mining loss allowances are all higher ranked allowances [section 10-10] .

7.10 A mining project interest has a starting base loss for a year when the miner holds a starting base asset and there is a decline in value of that asset. The loss is reduced to the extent it is applied as a starting base allowance, and ceases to exist when it has been fully applied. [Section 80-20]

Starting base assets produce starting base losses

What is a starting base asset?

7.11 Starting base assets include most tangible and intangible assets that are relevant to the upstream operations of a mining project interest. [Section 80-25]

7.12 A starting base asset is one that is used, installed ready for use, or being constructed for use in carrying on the upstream mining operations in relation to a mining project interest at the 'start time' [subsections 80-25(1) and (2)] . The concept of 'upstream mining project operations' is explained in Chapter 5. The 'start time' is explained below.

7.13 The definition of a starting base asset is based on the income tax definition of a 'CGT asset' (see section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997)), which means any kind of property or a legal or equitable right.

7.14 The 'asset' concept is a broad one, encompassing all types of legal property and rights. Where a miner holds an interest in an asset, the interest in the underlying asset is itself capable of being a starting base asset. [Section 250-15]

7.15 Land that is used in upstream mining operations can be a starting base asset. Improvements to land or fixtures on land are treated as separate assets, not as part of the land, regardless of whether they can be removed from the land or are permanently attached. This ensures that a miner can hold these things as starting base assets, regardless of whether it holds the land on which the improvement or fixture exists. [Subsection 80-25(5)]

Some starting base assets are combined under the market value approach

7.16 Notwithstanding that improvements to land are treated as separate to the land, under the market value approach, any improvement to land (but not a fixture) in the project area of a mining project interest is taken to be part of the same starting base asset as the rights and interests constituting the mining project interest. This inclusion reflects the practical difficulty in ascribing a separate market value to improvements to land, which of their nature cannot be dealt with separately from the underlying mining rights. [Paragraph 80-30(1)(d)]

7.17 In further recognition of these valuation difficulties, under the market value approach, an improvement to land that existed on 1 May 2010 is recognised in the starting base even if it is consumed or destroyed before the start time [paragraph 80-25(4)(b)] . In contrast, other starting base assets must be used, installed ready for use, or being constructed for use in the upstream mining operations at the start time [subsection 80-25(1)] .

7.18 For an interest using the market value approach, mining information (as defined in subsection 40-730(8) of the ITAA 1997) is treated as an item of property or a legal or equitable right. This is necessary since information is not otherwise considered a legal asset as it is not capable of assignment (for example, see Hepples v FCT (1990) 90 ATC 4497 and Taxation Determination TD 2000/33). [Paragraph 80-25(4)(a) and section 300-1, definition of 'mining, quarrying and prospecting information']

7.19 Like improvements to land, any mining information relating to a mining project interest is taken to be part of the same starting base asset as the rights and interests that comprise the mining project interest. Again, this reflects the interdependent nature of these assets and the difficulties that would arise if they were to be valued separately. For the same reason, any goodwill that would otherwise be considered a separate starting base asset is instead taken to be part of this single starting base asset. [Subsection 80-30(1)]

7.20 This composite starting base asset is taken to be a depreciating asset (unless none of the constituent assets are depreciating assets), which has an effective life equal to the longest effective life of any of those rights and interests. As a consequence, it will be written off over the shorter of that life and the period until the end of 30 June 2037. [Subsections 90-15(1), (2) and (3)]

Some starting base assets are excluded under the book value approach

7.21 For a mining project interest using the book value approach, the rights and interests that make up the mining project interest itself are not included in the definition of a starting base asset. This reflects the policy to exclude the value of the taxable resources if a miner chooses the book value approach. For the same reason, the value of mining information is also excluded. It is unlikely that goodwill would be an asset that can be meaningfully identified in relation to the upstream operations of a mining project interest (as goodwill is normally associated with a business enterprise as a whole). However, to the extent that it would otherwise be considered a starting base asset, goodwill is also excluded under the book value approach. [Paragraph 80-25(3)(a)]

Mine development expenditure as a starting base asset

7.22 Some expenditure that is incurred between 2 May 2010 and 1 July 2012 is included in the starting base even though it does not relate to another starting base asset. This expenditure, called mine development expenditure, is itself taken to be a starting base asset. It is expenditure incurred in carrying on upstream mining operations that relates to developing a mine. It includes the costs of removing overburden, excavating a pit and sinking a mineshaft, which are generally treated as a revenue expense and so would not otherwise be included in the starting base. Mine development expenditure is discussed further under 'interim expenditure' below. [Section 80-35]

There are no starting base assets unless a starting base return is lodged

7.23 An asset is not considered to be a starting base asset where a miner fails to make a valid choice about whether to use the market value or the book value approach or fails to lodge a starting base return. The starting base choice is described below and the starting base return is discussed in Chapter 18. [Paragraph 80-25(3)(b)]

Assets used, installed ready for use, or being constructed for use

7.24 The concept of an asset being 'used, or installed ready for use' also appears in the depreciation provisions of the income tax law (see section 40-60 of the ITAA 1997).

7.25 The word 'used' takes its ordinary meaning, which in any particular case will depend on the context in which the word is employed and the purpose for which the asset is held ( Newcastle City Council v Royal Newcastle Hospital (1956) 96 CLR 493).

7.26 The degree of physical or active use that is required to constitute 'use' will depend to a certain extent on the nature of the asset and the purpose for which it is held. For a tangible depreciating asset, physical or active employment of the asset would generally be expected in order for an asset to be considered to be being 'used'. For an intangible asset, employment of the asset may not be physical and the asset may be considered to be being 'used' in the context of passive use. However, use would generally be expected to involve an exploitation of the inherent character of the asset.

7.27 The phrase 'installed ready for use' is defined in subsection 995-1(1) of the ITAA 1997 and requires not only that the asset be installed ready for use but also that it be 'held in reserve'. In that context, a thing is 'held in reserve' if it is held for future use in an existing operation and the concept of holding in reserve is not 'so wide as to embrace income producing operations which may be undertaken at some future time' ( Case X46 90 ATC 378 (at 381)). [Section 300-1, definition of 'installed ready for use']

7.28 In the context of the MRRT starting base, the phrase 'being constructed for use' is intended to cover assets that are in the process of being created by the miner for later use in the upstream operations of the mining project interest. A similar concept exists in section 41-25 of the ITAA 1997 in respect of the investment allowance, and there is case law on the former investment allowance provisions which provides guidance on the concept. See, for example, FC of T v. Tully Co-operative Sugar Milling Association Limited 83 ATC 4495; Monier Colourtile Pty Ltd v. FCT (1984) 84 ATC 4846, and Utah Development Co. v. FCT (1983) 83 ATC 4545.

Start time for starting base assets

7.29 A starting base asset is one that is used, installed ready for use, or being constructed for use in carrying on the upstream mining operations in relation to the mining project interest at the later of:

•

1 July 2012; and

•

the time production (other than incidental production) commences for the mining project interest.

[Subsection 80-25(2)]

7.30 This time is referred to as the 'start time' of the starting base asset. It defines the time from which the asset's decline in value is worked out to produce starting base losses. Before this time, the assets will not be recognised as starting base assets and so will not be capable of producing starting base allowances. In this way, the start time defines the way in which recognition of the starting base is deferred until there is production of taxable resources from a mining project interest.

7.31 Many mining project interests that exist on 1 July 2012 will already be producing taxable resources and so, for them, the start time will be that date.

Production other than incidental production

7.32 However, some mining project interests will be in a development phase on 1 July 2012 and will not be producing until a later time. For these interests, the start time is deferred until that production gets underway.

7.33 The start time does not occur when there has merely been incidental production of taxable resources from the project area of a mining project interest. That is, it is not sufficient that a mining revenue event has occurred in relation to a taxable resource extracted from a project area.

7.34 Whether the extraction of taxable resources amounts to 'production' or merely 'incidental production' is a question of fact that should be determined having regard to the purpose for which, and the manner and volume in which, those resources are being extracted. For instance, the extraction of taxable resources that occurs before the development of a mine may constitute 'incidental production'. However, 'production' is not intended to be necessarily limited to the way in which, and the extent to which, taxable resources are planned to be extracted when the mine is fully developed and operational.

Example 7.78 : Not incidental production

Blue Tongue Co. has a mining project interest, which relates to an underground coal mine it is developing on land covered by its production right.

On 1 July 2012, Blue Tongue Co. is extracting coal as part of its work to build the shaft and underground development workings of the mine. It is able to sell these resources for $50 million. It is liable to pay MRRT in relation to the sale of these resources.

The amount of coal being extracted, and the value at which it is sold is significant enough to represent non-incidental production, notwithstanding that part of the purpose for which the coal is extracted is to further develop the mine.

Blue Tongue Co. will be able to recognise and write off its starting base assets from 1 July 2012 even though it has not yet started to produce taxable resources in the volumes it intends when the mine is fully operational.

Example 7.79 : Incidental production

Tiger Co. holds a production right on which it is considering developing an open cut mine. In assessing the viability of that potential development, Tiger Co. decides to mine enough coal to make a trial shipment to a potential customer in Japan, to test the quality of the coal in a Japanese blast furnace. Tiger Co. mines 20,000 tonnes of coal from the mine and sells it as one cargo for $4 million. It is liable to pay MRRT in relation to the sale of these resources.

This production is considered to be incidental production, as it was a single cargo, prior to a commitment to build the coal mine on the area covered by the production right. While it was able to sell these taxable resources, Tiger Co. is not producing resources in sufficient quantities to meet regular orders from customers. As this extraction is merely incidental to a wider purpose of testing the feasibility of a mine it is not production that meets the test for determining the start time of starting base assets.

Start time of a combined mining project interest under the market value approach

7.35 In some cases, a miner can choose to combine mining project interests that are integrated in their downstream mining operations. This is discussed in detail in Chapter 9. The interests that are combined are referred to as 'constituent interests'. Under the market value approach, the start time of an asset that is, or includes, one of these constituent interests is deferred until the time that production commences in relation to that constituent interest. [Paragraph 80-25(2)(b) and subsection 80-30(2)]

7.36 In other words, for a single starting base asset that relates to a constituent interest that, apart from a downstream integration choice, would be a separate mining project interest, the start time is the time production (other than incidental production) commences in the project area of the constituent interest.

7.37 However, where a miner has a mining project interest that includes constituent interests that are combined because they are upstream integrated, and the market value approach is chosen, the start time for the asset that is, or includes, one of these constituent interests is when production commences from any of those constituent interests. So, if a mine covers multiple production rights that meet the upstream integration test, the start time for the single starting base asset comprising those rights is when the production occurs from any of those rights. [Paragraph 80-25(2)(b)]

Example 7.80 : Downstream integration of constituent interests that include upstream integrated interests

Nelson Minerals Co. has two separate iron ore mines, Grimley and Stolarek. Grimley mine is made up of two production rights. The production rights making up Grimley mine satisfy the upstream integration test. The two mines are also sufficiently integrated to meet the downstream integration test. Nelson Minerals Co. has chosen to combine the mines into a single mining project interest.

At 1 July 2012, Grimley mine is producing taxable resources from an area covered by one of its production rights, but not the other. The start time for the starting base asset that includes the two production rights that relate to Grimley mine is 1 July 2012.

At that time, no taxable resources are extracted from the area covered by the production right that relates to Stolarek mine. The start time for the starting base asset that includes that production right occurs when taxable resources start to be produced from that production right.

When does a miner hold a starting base asset?

7.38 The MRRT meaning of 'hold' broadly adopts the income tax definition for depreciation purposes (see section 40-40 of the ITAA 1997), which generally refers to the economic owner of the asset. However, in order to ensure that the entity that will bear an MRRT liability also has the benefit of a starting base, the entity that has a mining project interest is taken to hold the starting base asset that is the rights and interests constituting the mining project interest. [Sections 250-5 and 250-10]

Amount of a starting base loss

7.39 The starting base loss is based on a portion of the value (the decline in value) of the starting base assets. The principles and mechanisms used in the depreciation provisions of the income tax law (Division 40 of the ITAA 1997) have, to the extent possible, been adopted to work out the decline in value of a starting base asset.

Amount of a starting base loss in the year in which it arises

7.40 For the year in which the starting base loss arises, it is worked out as follows:

•

Step 1: Work out the decline in value of each starting base asset the miner held in the year.

•

Step 2: Reduce that result to the extent that the asset is used, installed ready for use, or being constructed for use, for a purpose other than upstream mining operations of the mining project interest.

•

Step 3: Reduce the result further to the extent the asset relates to a use that would not be deductible under the MRRT.

•

Step 4: Add up the resulting amounts for each of the starting base assets.

Step 1 - Decline in value of each starting base asset

7.41 The starting base loss includes an amount equal to the 'decline in value' for a year of a starting base asset that a miner held for any time during the year. This is explained further below. [Subsection 80-40(1)]

Step 2 - Ignore the decline in value to the extent it does not relate to upstream mining operations

7.42 The starting base loss does not include any part of the asset's decline in value that is attributable to the miner using the asset, having it installed ready for use, or constructing it for use, for a purpose other than upstream mining operations in relation to the mining project interest. [Subsections 80-40(2) and (3)]

7.43 Any decline in value that is not attributable to upstream mining operations will not contribute to a loss. However, this does not affect the decline in value itself, which will continue irrespective of the use of the asset. This means that any decline that is attributable to a period when the asset was not used for upstream mining operations is not available to form part of a starting base loss in a later year.

Example 7.81 : Ignore decline in value for downstream use

Fran Co. has one starting base asset with a base value for the MRRT year of $10 million. The decline in value of the asset for the year is $1 million.

Fran Co. uses the asset 20 per cent in the upstream mining operations of its mining project interest. Therefore, the starting base loss is $200,000 (which is the full decline, reduced by $800,000 to reflect the use of the asset other than in upstream mining operations).

Fran Co. has chosen the market value approach for the mining project interest, so the base value of the asset for the next MRRT year is $9 million.

7.44 The narrow base of the MRRT means there is a need to apportion the decline in value. This will be relevant when starting base assets are partly used to mine taxable resources and partly used to mine non-taxable resources, or even when assets used solely to mine taxable resources are partly used for downstream mining operations (that is, activities after the valuation point). As under the general mining expenditure provision (discussed in Chapter 5), this apportionment should be made on a fair and reasonable basis.

Step 3 - Ignore the decline in value to the extent it relates to amounts that would be explicitly not deductible

7.45 The starting base loss does not include any part of the asset's decline in value that would be excluded expenditure if it were an amount that was incurred on or after 1 July 2012 [subsections 80-40(2) and (4)] . So, to the extent that the circumstances which lead to an amount being specifically non-deductible apply in relation to a starting base asset in a year, the decline in value of that asset is so reduced. For an explanation of 'excluded expenditure', see Chapter 5.

Example 7.82 : Ignoring the decline that relates to excluded expenditure

Cham Co. has a starting base asset which is a building located away from the project area. In the 2013-14 year, the building is used partly for accounting activities. If Cham Co. had incurred a capital amount during the year in relation to the building it would be excluded expenditure to that extent. As a consequence, to that extent the decline in value of the starting base asset (the building) for the year is not taken into account in working out the starting base loss.

7.46 Expenditure incurred to acquire an interest in a production right is one type of excluded expenditure [section 35-35] . However, if the market value approach is chosen, the decline in value of a starting base asset that is a production right (or an interest in a production right) is not reduced simply because it relates to the production right [subsection 80-40(5)] .

Example 7.83 : Decline that relates to a starting base asset that is a production right

Fox Co. chooses to use the market value approach. It has a starting base asset which is an interest in a production right. If Fox Co. incurred an amount during the year to acquire this interest, it would be excluded expenditure. However, the decline in value for the year for the starting base asset (the interest) is not affected in these circumstances.

Step 4 - Add up the remaining amounts for each starting base asset

7.47 The starting base loss is the total of the amounts worked out under steps 1 to 3 for each starting base asset [subsections 80-40(1) and (2)] . In other words, a miner adds together the decline in value of each of the starting base assets of a particular mining project interest to work out the interest's starting base loss for the year (less any reductions under steps 2 and 3). As explained above, this starting base loss produces an allowance to the extent that the interest has sufficient mining profits to offset these losses.

Amount of a starting base loss after the year in which it arises

7.48 In a later year, the starting base loss includes any unused starting base loss for the mining project interest for the previous year, increased by an uplift factor. [Section 80-45]

7.49 An unused starting base loss is any part of a starting base loss that did not become a starting base allowance in the previous year. In other words, it is the amount (if any) by which the starting base loss for the previous year exceeded the mining profit for the previous year, after all higher ranked allowances had been applied.

7.50 the extent that a starting base loss is not used in a year, it is uplifted and carried forward to the next year. The uplift factor that applies is:

•

under the book value option - LTBR + 7 per cent [paragraph (a) of the definition of 'uplift factor' in subsection 80-45(1)] ; and

•

under the market value option - the CPI for the previous year ending 31 March. The CPI is expressed in the same way as in subsection 960-275(1) of the ITAA 1997 [paragraph (b) of the definition of 'uplift factor' in subsection 80-45(1)] .

Example 7.84: Starting base loss for a year after the loss arose

Link Co. has a starting base loss of $1 million for the 2015-16 MRRT year. It has no mining profits remaining after it applies its higher ranked allowances, so it carries forward the entire loss to the next year.

Link Co. has chosen the book value approach for the mining project interest, so it uplifts the loss by the LTBR + 7 per cent. Assume the long term bond rate (LTBR) for the 2015-16 MRRT year is 6 per cent.

Therefore, in the 2016-17 MRRT year, the amount of the 2015-16 starting base loss is $1.13 million ($1m x (0.06 + 1.07)).

Starting base losses of a mining project interest originating from pre-mining project interests with different valuation approaches

7.51 A starting base loss can arise in relation to a pre-mining project interest from which a mining project interest originates. Also, a mining project interest can originate from two or more pre-mining project interests. Where this occurs and a miner has chosen to use the book value approach in relation to one or more of the pre-mining interests and the market value approach in relation to one or more of the other pre-mining interests, then there are two starting base losses that arise in an MRRT year for the mining project interest. One is a starting base loss in relation to any pre-mining interest that uses the book value approach, and the other is a starting base loss in relation to any pre-mining interest that uses the market value approach. Of the two starting base losses that arise in the same year, the starting base losses that relate to book value approach will be applied first, then the starting base losses that relate to market value approach. This is also what happens when two mining project interests that use different valuation methods combine, which is discussed in more detail in Chapter 9. [Section 80-50]

Choosing between the market value and book value approaches

7.52 A miner can choose to value and write off all the starting base assets in relation to a mining project interest using either the market value or the book value approach. [Paragraph 85-5(1)(a), subsection 85-5(2) and section 85-15]

7.53 The choice can also be made in relation to a pre-mining project interest. Although a starting base will not apply in relation to a pre-mining interest, the choice can be exercised in relation to that interest so that a mining project interest originating from the pre-mining project interest can apply that choice. [Paragraph 85-5(1)(b)]

Choice applies to all assets used in a project

7.54 The choice as to which approach to adopt needs to be made by a miner in relation to all the starting base assets in a particular mining project interest. As the choice may need to be made before the start time, it applies to those assets that are not yet, but may become, starting base assets of the mining project interest or of a mining project interest that will originate from the pre-mining project interest. [Subsection 85-5(1)]

7.55 Where a miner has more than one mining project interest, it can adopt different approaches in relation to the different interests. As starting base losses are not transferable between different mining project interests, there is no requirement that the different mining projects of a miner (or a closely associated miner) have adopted the same approach.

Making the choice

7.56 The starting base choice is made by lodging a starting base return in the approved form that specifies the choice to use the market value or book value approach and provides information about the base value of starting base assets. The starting base return is discussed in greater detail in Chapter 18. [Section 85-5 and Schedule 1 to the Minerals Resource Rent Tax (Consequential Amendments and Transitional Provisions) Bill 2011 (MRRT (CA & TP) Bill), item 8, section 117-20 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953)]

7.57 Generally, an entity is able to make its starting base choice and lodge its starting base return up to the earlier of the day its MRRT return for the first MRRT year is due (or would have been due if it was required to lodge a return for that year), or within a further time allowed by the Commissioner of Taxation (Commissioner). However, where the project interest is transferred after 1 July 2012 and before a choice is made, the transferee must make the choice and lodge the starting base return by the same time the transferor would have been required to if it had continued to have the interest.

7.58 The choice is irrevocable [Schedule 1 to the MRRT (CA & TP) Bill, item 8, section 119-10 of Schedule 1 to the TAA 1953] . It applies to the starting base assets of the mining project interest for the first MRRT year and all later years [subsections 85-5(1) and (5)] .

7.59 However, the irrevocable choice could be problematic if there is uncertainty as to what constitutes a mining project interest at the time the choice needs to be made. In these circumstances, there would be compliance and administrative difficulties if an entity was required to specify the particular mining project interests to which a choice applies. For example, at that time there may be doubt as to whether mining project interests were integrated and so able to combine (see Chapter 9 for an explanation of integration and combination). In order to ameliorate these potential difficulties, an entity can choose to use a valuation approach in relation to the mining project interest(s) or pre-mining project interests that relate to a particular area, rather than nominating the project interests directly. [Subsection 85-5(4)]

Example 7.85 : Choice covering an area

Bay Co. has two mining operations, Alpha and Beta, which it initially considers to be two mining project interests. The start time for each is 1 July 2012.

Bay Co. elects to use the book value approach in relation to any mining project interest(s) it has at 1 July 2012 that relate to the area covered by Alpha.

Bay Co. elects to use the market value approach in relation to any mining project interest(s) it has at 1 July 2012 that relate to the area covered by Beta.

After making the choice, Bay Co. identifies that it actually held three mining project interests on 1 July 2012, as it had been mistaken about the ability to combine two mining project interests (Gamma and Delta) into the one mining project interest Beta.

Bay Co.'s choice to use the market value approach validly applies to Gamma and Delta as these mining project interests relate to an area covered by the choice, notwithstanding the irrevocable nature of the choice which it originally thought applied to Beta.

Example 7.86 : Choice covering more than one mining project interest

Port Co. has two mining operations, Epsilon and Zeta, which it initially considers to be separate mining project interests. The start time for each is 1 July 2012.

Port Co. elects to use the book value approach in relation to Epsilon, and to use the market value approach in relation to the other mining project interests it has at 1 July 2012. At a later time, Port Co. identifies that it actually held one mining project interest on 1 July 2012, as it had been mistaken about the ability to separately identify Epsilon and Zeta, which should have been identified as a single mining project interest, Omega.

Port Co.'s choice to use the market value approach in relation to the other mining project interests it has at 1 July 2012 validly applies to Omega, notwithstanding the irrevocable nature of the choices which it originally thought applied to Omega.

Restrictions on when a miner can choose the book value approach

7.60 Any miner can choose the market value approach to work out the value of its starting base assets. However, a miner can only choose the book value approach if an audited financial report was prepared in relation to the mining project interest during the 18 months before 2 May 2010. [Paragraph 85-10(1)(a)]

7.61 This financial report must also relate to a financial period that ended in the 18 months prior to 2 May 2010. This precludes the use of a financial report that relates to a financial period that ended before that time, even if the report was prepared in the 18 months prior to 2 May 2010. [Paragraph 85-10(1)(b)]

7.62 The miner (or the consolidated entity of which it is a part) must have prepared the financial report in accordance with the accounting standards. The financial report must also have been audited in accordance with the auditing standards. [Paragraphs 85-10(1)(a) and (c) and subsection 85-10(2)]

7.63 A 'financial report' means an annual financial report or a half-year financial report prepared under Chapter 2M of the Corporations Act 2001 . Either of these is acceptable, though the initial book value would be the value of the asset recorded in the most recent audited financial report available before 2 May 2010. [Paragraph 90-25(3)(a)]

7.64 'Accounting standard' and 'auditing standard' are both defined as having the same meaning as in the Corporations Act 2001 [section 300-1, definitions of 'accounting standard' and 'auditing standard'] . 'Consolidated entity' is also defined in the Corporations Act 2001 to mean a 'company, registered managed investment scheme or disclosing entity together with all the entities it is required by the accounting standards to include in consolidated financial statements'.

What happens if a miner does not make a valid choice?

7.65 As mentioned above, if an entity fails to make a valid choice about whether to use the market value or the book value approach and lodge a starting base return, it will not have any starting base assets [paragraph 80-25(3)(b)] . However, the Commissioner may allow further time for an entity to do this [Schedule 1 to the MRRT (CA & TP) Bill, item 8, subsection 117-20(3) of Schedule 1 to the TAA 1953] .

How to work out the decline in value of starting base assets

7.66 As discussed above, the starting base loss will be based on the decline in value of the starting base assets. The decline in value of a starting base asset is worked out using the following formula: [Section 90-5]

7.67 The 'base value' of an asset represents the value of the asset that can be further declined. It is a year-start amount on which the decline in value for the year can be worked out. The base value of a starting base asset will depend on whether the miner has elected to use the book value approach or the market value approach. This is explained further below.

7.68 'Starting base days' are the days in the year (other than those that occur before the start time or after a starting base adjustment event) in which the miner held the starting base asset and either used it, had it installed ready for use, or was constructing it, for any purpose [subsection 80-40(6)] . This part of the formula apportions the decline in value where an asset is held for less than the full MRRT year (such as where it is disposed of during the year). Consistent with other parts of the tax law, this apportionment is done over 365 days, regardless of whether the year is a leap year. As explained above, where a miner uses its starting base asset for purposes other than upstream mining operations, this will not affect the decline in value but it will affect the amount of the starting base loss.

7.69 The 'write off rate' of a starting base asset will depend on whether the miner has elected to use the book value approach or the market value approach.

Write off rate under the book value approach

7.70 The following table lists the annual write off rates under the book value approach. [Section 90-10]

Table 7.1 : Annual write off rates under the book value approach

7.71 These rates are based on those announced on 2 May 2010. However, the rates have been adjusted to reflect the declining balance approach used in the formula above.

7.72 The 2 May 2010 announcement stated that depreciation was to occur over five years with the following profile: 36 per cent; 24 per cent; 15 per cent; 15 per cent; and 10 per cent. However, this profile assumed a fixed balance being depreciated in each year. Under the declining balance approach, the equivalent write off rates are: 36 per cent; 37.5 per cent; 37.5 per cent; 60 per cent; and 100 per cent.

7.73 The results under each approach are identical. However, the declining balance approach has been chosen as a more efficient legislative expression, given the need to make adjustments to increase the base value of an asset for any interim expenditure and the LTBR + 7 per cent uplift.

Write off rate under the market value approach

7.74 Under the market value approach, the write off rate of a starting base asset for an MRRT year is worked out by reference to its remaining effective life, according to the following equation:

100% / Remaining effective life of the asset

[Subsection 90-15(1)]

7.75 The 'remaining effective life' of an asset that is a depreciating asset (under Division 40 of the ITAA 1997) is any period of its effective life that is yet to elapse as at the start of the MRRT year. [Subparagraph (a)(i) of the definition of 'remaining effective life' in subsection 90-15(1)]

7.76 For this purpose, the effective life of a starting base asset is the period worked out under Division 40, as at the asset's start time. This may require a miner to reassess the effective life of its assets at the start time, rather than relying on its original estimates for income tax purposes. This may be significant when the original estimates have not taken into account changes in the way the assets are used.

7.77 The term 'effective life' describes the length of time over which any entity could reasonably expect to use the particular asset. The estimated effective life of an asset is expressed in years. Part years are expressed as a fraction, and are not rounded to the nearest whole year (see sections 40-100 and 40-105 of the ITAA 1997).

7.78 Under Division 40 of the ITAA 1997, a taxpayer usually has the option to use an effective life determined by the Commissioner or to work out the effective life of the asset itself according to how long the asset can be used to produce income (see section 40-95 of that Act). An exception is the effective life of a mining, quarrying or prospecting right, which is the period over which the taxpayer reasonably expects the reserves can be extracted from the mine.

7.79 The remaining effective life of the combined starting base asset (explained above) is taken to be the longest remaining effective life of any of the constituent assets are that are depreciating assets. If none of the constituent assets are depreciating assets, then the combined asset will not be taken to be a depreciating asset. [Subsection 90-15(3)]

Example 7.87 : Effective life of the starting base asset that includes the mining project interest and mining information

Tool Co. has a single starting base asset that consists of its interest in production right Kappa, and another interest in production right Sigma. The remaining effective life of the single starting base asset is worked out according to the longest effective life of these rights, as worked out under Division 40 of the ITAA 1997 at the start time.

On 1 July 2012 (the start time), Tool Co. works out the effective life of Kappa to be 15 years, and Sigma to be 10 years (according to Tool's estimates on 1 July 2012 about the reserves of the different mines to which each right relates).

The remaining effective life of the starting base asset is based on the period of the effective life of Kappa that is yet to elapse. Therefore, at the end of 30 June 2013, the remaining effective life of the starting base asset is 14 years.

7.80 The remaining effective life of a starting base asset may be capped to the shorter of the following:

•

the longest remaining effective life of any right or interest that makes up the mining project interest; and

•

the period until 1 July 2037 (which is 25 years after the MRRT commences).

[Subsection 90-15(2) and subparagraphs (a)(ii) and (iii) of the definition of 'remaining effective life' in subsection 90-15(1)]

7.81 In other words, an asset with a remaining effective life that exceeds any of these caps is taken to have a remaining effective life equal to the shorter of the caps.

7.82 Starting base assets that are not depreciating assets (and so do not have an effective life for income tax purposes, such as land and many intangibles) will also be taken to have a remaining effective life equal to the shortest of those caps. [Subsection 90-15(2) and paragraph (b) of the definition of 'remaining effective life' in subsection 90-15(1)]

Base value under the book value approach

Base value for the year in which the start time occurs

7.83 Under the book value approach, for the MRRT year in which the start time occurs, the base value of a starting base asset that was held in relation to the mining project interest (or the pre-mining project interest from which the mining project interest originates) at all times in the interim period is:

•

the initial book value of the asset [subparagraph 90-25(1)(a)(i)] ; plus

•

any valuation amounts (uplifted interim expenditure) [subparagraph 90-25(1)(a)(ii)] .

7.84 If the starting base asset was not held at all times in the interim period (because it was acquired during that period), then its initial base value is simply the sum of the valuation amounts (uplifted interim expenditure) [paragraph 90-25(1)(b)] . 'Interim period' is explained below.

Initial book value

7.85 The initial book value of a starting base asset is:

•

the amount recorded in the accounts that produced the most recent audited financial report available before 2 May 2010, uplifted from the date of that report until the end of the year in which the start time occurs; or

•

if the auditor's report recorded another value in relation to the asset - that value, uplifted from the date of the auditor's report until the end of the year in which the start time occurs.

The uplift factor is the LTBR + 7 per cent. [Subsections 90-25(3) and (5)]

Valuation amounts for interim expenditure

7.86 Valuation amounts for interim expenditure include the interim expenditure (explained below) in relation to starting base assets, uplifted by the LTBR + 7 per cent for the period between when the amount is incurred and the end of the year in which the start time for the asset occurs. [Subsections 90-25(6) and (7)]

Base value for later years

7.87 For every later MRRT year, the base value of the asset is reduced by the decline in value, and the result is then uplifted by the LTBR for the previous year + 7 per cent. [Section 90-30]

Base value under the market value approach

7.88 Under the market value approach, the base value of a starting base asset reflects its market value as at 1 May 2010, plus any interim expenditure in relation to the asset. [Subsection 90-40(1) and section 90-35]

Base value for the year in which the start time occurs

7.89 For the MRRT year in which the start time occurs, the base value of a starting base asset that was held in relation to the mining project interest (or the pre-mining project interest from which the mining project interest originates) at all times from 2 May 2010 to 30 June 2012 is:

•

the market value of the asset on 1 May 2010 [subparagraph 90-40(1)(a)(i)] ; plus

•

any interim expenditure [subparagraph 90-40(1)(a)(ii)] .

7.90 If the starting base asset was not held at all times in the interim period (because it was acquired during that period), then its initial base value is simply the sum of the interim expenditure. [Paragraph 90-40(1)(b)]

Market value of the asset

7.91 'Market value' is not defined in the legislation, though its ordinary meaning is modified for the effect of GST and the costs of converting non-cash benefits. [Section 300-1, definition of 'market value']

7.92 The common law definition of market value (discussed in Spencer v Commonwealth of Australia (1907) 5 CLR 418) is based on the principles of:

•

a willing but not anxious vendor and purchaser;

•

a hypothetical market;

•

the parties being fully informed of the advantages and disadvantages associated with the asset being valued; and

•

both parties being aware of current market conditions.

7.93 The market value of a starting base asset will be the amount worked out using these principles. In addition, the general MRRT valuation principles discussed in Chapter 14 are particularly relevant to the determination of the market value of a starting base asset.

7.94 Where a mining project interest originates from a pre-mining project interest that existed on 1 May 2010, the market value of the mining project interest is taken to be the market value of that pre-mining project interest as at 1 May 2010. [Section 90-45]

7.95 The market value of a starting base asset that is (or includes) a mining project interest should be worked out ignoring any liability to pay a private mining royalty [subsection 90-40(3)] . This ensures that these liabilities, which would be excluded expenditure, do not reduce the value of the starting base. However, this does not include private mining royalties paid on or after 1 July 2012 under a pre 2-May 2010 arrangement, as these are not excluded expenditure (explained in Chapter 5).

Market value of starting base assets that relate to a pre-mining project interest that existed on 2 May 2010

7.96 In some circumstances, an entity that has chosen to write off its starting base assets using the market value approach will not be required to actually market value those assets.

7.97 Where the market value approach is chosen for a pre-mining project interest that existed on 2 May 2010, an entity can make a further choice to work out the base value of its starting base assets using a 'look back' approach. The look-back approach is intended to ease compliance costs for entities that would otherwise find it difficult or costly to undertake a proper market valuation of assets. [Subsection 180-5(1)]

7.98 This choice (like the choice to use the market value approach) is irrevocable and needs be made as part of the starting base return (discussed above and in Chapter 18). [Section 180-5 and Schedule 1 to the MRRT (CA & TP) Bill, item 8, sections 117-20 and 119-10 of Schedule 1 to the TAA 1953]

7.99 The look-back choice can only be made in relation to a pre-mining project interest that existed on 2 May 2010. However, the choice itself will be made soon after the end of the first MRRT year. By this time, a mining project interest may have originated from the pre-mining project interest. In this case, the choice applies to the starting base assets that relate to that mining project interest. [Subsection 180-5(1)]

7.100 The effects of the choice to use the look-back approach are that:

•

all the starting base assets are treated as a single asset; and

•

the initial base value of that single starting base asset is taken to be the sum of pre-mining expenditure incurred in the 10 years before 2 May 2010. Chapter 6 explains the types of expenses that are included in pre-mining expenditure.

[Section 180-10]

Interim expenditure

7.101 The initial base value of a starting base asset will also include any interim expenditure incurred in relation to it. In contrast to the book value approach, interim expenditure under the market value approach is not uplifted for the period between when it is incurred and the end of the year in which the start time for the asset occurs. [Section 90-40]

Base value for later years

7.102 For every later MRRT year, the base value of a starting base asset is its base value for the previous year less the decline in value for the previous year. In contrast to the book value approach, this amount is not uplifted for the year under the market value approach. [Section 90-50]

Interim expenditure

7.103 Under either the book value approach or the market value approach, the base value of a starting base asset can include 'interim expenditure'. Interim expenditures are certain amounts incurred on starting base assets in the interim period - being the period ending on 30 June 2012 and starting on:

•

under the book value approach - the date of the accounts that are reflected in the audited financial report; and

•

under the market value approach - 2 May 2010.

[Subsections 90-55(1), (4) and (5)]

7.104 Interim expenditure includes amounts incurred on assets held throughout this period, as well as expenditure on assets that start to be held in this period. [Subsection 90-55(1)]

7.105 Interim expenditure includes the following kinds of amounts incurred in this period in relation to a starting base asset:

•

if the starting base asset is a 'depreciating asset' for income tax purposes - amounts included in the 'cost' of that asset for income tax purposes [subparagraph 90-55(1)(a)(i)] ; and

•

if the starting base asset is a 'CGT asset' (but not a depreciating asset) for income tax purposes - amounts included in the 'cost base' of that asset for income tax purposes, except for 'third element' costs (which are the costs of owning the asset, such as interest costs - see subsection 110-25(4) of the ITAA 1997) [subparagraph 90-55(1)(a)(ii) and subsection 90-55(2)] .

7.106 Interim expenditure also includes mine development expenditure that relates to the mining project interest. [Subsection 90-55(6)]

Mine development expenditure

7.107 Mine development expenditures are the amounts a miner incurs between 2 May 2010 and 1 July 2012 in developing the project area of its mining project interest as part of carrying on its upstream operations. In particular, it includes expenditure incurred in:

•

removing overburden from the project area;

•

excavating a pit in the area; and

•

sinking a mineshaft in the area.

[Section 80-35]

7.108 To the extent it is not interim expenditure on another starting base asset, mine development expenditure itself is taken to be a starting base asset [paragraph 80-35(1)(c)] . The deemed asset is taken to be held for as long as the miner has the mining project interest, and is taken to be used in the upstream mining operations [subsections 80-35(2) and 250-10(2)] . The deemed asset is not a depreciating asset and so, if the market value approach is chosen, will be written off accordingly [paragraph (b) of the definition of 'remaining effective life' in subsection 90-15(1) and subsection 90-15(2)] .

7.109 Mine development expenditure cannot itself be interim expenditure relating to another amount of mine development expenditure [subsection 90-55(7)] . That is, any amount of mine development expenditure that does not relate to another starting base asset (other than one deemed to be an asset because it was another amount of mine development expenditure) is taken to be a separate starting base asset.

Example 7.88 : Mine development expenditure is taken to be a starting base asset

Mystic Mining Co. incurs mine development expenditure on 1 June 2011. The expenditure does not relate to any of its other starting base assets for the mining project interest. Therefore, the expenditure is taken to be a new starting base asset that Mystic Mining Co. holds and uses in the upstream mining operations of the mining project interest.

Mystic Mining Co. incurs another amount of mine development expenditure on 1 July 2011. The expenditure does not relate to any of its other starting base assets for the mining project interest. The expenditure cannot be considered interim expenditure relating to the new starting base asset (that is, the earlier mine development expenditure). Instead, the expenditure is taken to be another starting base asset that Mystic Mining Co. holds and uses in the upstream mining operations of the mining project interest.

Other reductions to base value

Recoupment of base value

7.110 In most cases where a miner receives an amount for a starting base asset a starting base adjustment will apply (see Chapter 13). However, if a miner receives an amount for a starting base asset that is not part of a starting base adjustment event, then the base value of the asset is reduced to the extent there is an economic recoupment of the asset's base value [section 90-65] . This is equivalent to the recoupment of mining expenditure (which is explained in Chapter 4).

Example 7.89 : Recoupment of the base value of a starting base asset

Continuing the previous example, on 30 June 2011 Mystic Mining Co. receives a government grant that subsidises the activities on which Mystic Mining Co. had incurred the mine development expenditure to the extent of 50 per cent. The base values of the starting base assets that were taken to have arisen when the expenditure was incurred are reduced by half of the subsidy (which is the proportion of the grant that has the effect of offsetting the base value for each asset).

Partial disposals of starting base assets

7.111 The base value of a starting base asset is also reduced to the extent that the miner disposes of any interest in the asset before its start time. This ensures that the impaired value of an asset is reflected in a lower base value for the asset. [Section 90-60]

7.112 Where a miner stops holding a part of a starting base asset after the start time, there is a starting base adjustment, which is discussed in Chapter 13.

Starting base and schemes to avoid MRRT

7.113 The general anti-avoidance rule (discussed in Chapter 17) applies to schemes that increase the base value of a starting base asset. This means that the increase in the base value of a starting base asset will be treated as an 'MRRT benefit' for the purposes of applying the general anti-avoidance rule. [Schedule 4 to the MRRT (CA & TP) Bill, item 12]

7.114 The fact that the starting base is recognised over a number of MRRT years (whereas capital expenditure is otherwise recognised immediately under the MRRT) and that starting base losses are not transferable (whereas mining losses are transferable to close associates) means that there will be an incentive for entities to access the value in the starting base more quickly than intended by transferring starting base assets between mining project interests. Such arrangements are also subject to the general anti-avoidance rule, which is discussed in Chapter 17.