House of Representatives

Tax Laws Amendment (2011 Measures No. 8) Bill 2011

Pay As You Go Withholding Non-compliance Tax Bill 2011

Pay As You Go Withholding Non-compliance Tax Act 2012

Explanatory Memorandum

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

Chapter 2 - Petroleum Resource Rent Tax: clarifying the taxing point

Outline of chapter

2.1 Schedule 2 describes amendments to the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA 1987) to provide certainty about the location of the taxing point for the purposes of the Petroleum Resource Rent Tax (PRRT).

2.2 The amendments do this by clarifying what constitutes a 'marketable petroleum commodity' under the PRRTAA 1987. Where marketable petroleum commodities are produced, within a petroleum operation, is central to the determination of the taxing point.

2.3 These amendments confirm the long established application of the PRRTAA 1987 in relation to the taxing point. This application was recently affirmed by the Federal Court.

Context of amendments

The Petroleum Resource Rent Tax

2.4 The PRRT is a tax of 40 per cent of certain taxable profits derived from the extraction and processing of petroleum recovered in Commonwealth waters (but excluding the North West Shelf project area). The PRRT was imposed by the Petroleum Resource Rent Tax Act 1987 , and is assessed under the PRRTAA 1987.

2.5 The PRRT was extended to the Bass Strait project with effect from 1 July 1990.

The operation of the PRRT

2.6 The PRRT is assessed on a petroleum project basis, and is levied on the 'taxable profit' derived by a person in a financial year from a petroleum project. Taxable profit is calculated by deducting the person's eligible project expenses from their assessable receipts derived from the project.

2.7 Deductible expenditure broadly includes those expenditures, whether capital or revenue in nature, which are directly incurred in relation to the petroleum project.

2.8 Assessable receipts primarily comprise the consideration receivable from the sale of petroleum, or marketable petroleum commodities produced from the petroleum, recovered from a project, or their market value where they become 'excluded' other than by sale.

2.9 Where a taxpayer incurs deductible expenditure that exceeds their assessable receipts in a financial year, the excess is carried forward and uplifted to be deducted against assessable receipts derived by the person in future years.

What is a petroleum project?

2.10 Under the PRRTAA 1987, a 'petroleum project' is taken to exist when there is a production licence in force (see subsection 19(1) of the PRRTAA 1987).

2.11 A petroleum project incorporates the activities, facilities and other things related to the recovery of petroleum from the production licence area. A petroleum project also includes such treatment, transport and other facilities and operations integral to the production and initial on-site storage of the petroleum recovered and marketable petroleum commodities produced prior to them becoming 'excluded commodities' (see subsection 19(4) of the PRRTAA 1987).

2.12 The fact that what constitutes a 'petroleum project' is defined by reference to the activities associated with the recovery of petroleum and production of marketable petroleum commodities up to the point of their exclusion - rather than by prescribing particular processes for which relevant activities may be carried on - ensures that the PRRT can be applied in a practical manner to the various types of petroleum project operations that may arise.

What is a marketable petroleum commodity?

2.13 A marketable petroleum commodity is currently defined in section 2 of the PRRTAA 1987 to mean any of the following products produced from petroleum:

(a)
stabilised crude oil;
(b)
sales gas;
(c)
condensate;
(d)
liquefied petroleum gas;
(e)
ethane;
(f)
any other product declared by the regulations to be a marketable petroleum commodity;

not being a product produced from another product of a kind referred to in paragraphs (a) to (f).

2.14 Of these, 'sales gas', 'condensate' and 'liquefied petroleum gas' are further specified in section 2 of the PRRTAA 1987 by reference to their chemical composition. For instance, 'condensate' is specified as meaning a mixture that includes pentane and hexane where the pentane and hexane comprise more than 50 per cent by weight of the mixture. Similarly 'liquefied petroleum gas' means a mixture that includes propane and butane, where the propane and butane comprise more than 50 per cent by weight of the mixture.

The PRRT taxing point

2.15 The taxing point in relation to a particular petroleum project occurs where a 'marketable petroleum commodity' produced from project petroleum becomes an 'excluded commodity' (except in cases where petroleum is sold prior to a marketable petroleum commodity being produced). It is at this point that assessable receipts are brought to account, and up to which eligible project expenditures incurred are deducted to determine PRRT taxable profit.

2.16 In effect, the point at which a marketable petroleum commodity becomes an excluded commodity delineates the boundary between 'upstream' operations, which fall within the PRRT, and 'downstream' operations, which do not. Because it effectively defines the boundary of the PRRT project, the concept of the taxing point is fundamental to the operation of the PRRT.

2.17 Under the PRRTAA 1987, a marketable petroleum commodity becomes an excluded commodity when:

·
it has been sold;
·
after being produced, it has been further processed or treated;
·
it has been moved away from the place of its production other than to a storage site adjacent to that place; or
·
it has been moved away from a storage site adjacent to the place of its production.

2.18 Where the taxing point occurs was recently considered by the Federal Court in Esso Australia Resources Pty Ltd v The Commissioner for Taxation [ 2011 ] FCA 360 in relation to the Bass Strait project.

2.19 In that case, it was suggested that what constitutes a marketable petroleum commodity could be ascertained solely through reference to the relevant chemical compositions of particular marketable petroleum commodities specified in section 2 of the PRRTAA 1987, without having regard to the rest of the Act. Specifically, it was argued that a marketable petroleum commodity should be taken to be produced at the point in the production process where a substance first meets the specified composition component of the marketable petroleum commodity definition (for example, sales gas or liquefied petroleum gas), rather than the point at which processing is complete and the product is in its intended final form (whether for sale, use as feedstock for a downstream process, or for use as energy), consistent with how the PRRT has applied since commencement.

2.20 Under the narrow interpretation suggested in that case, a marketable petroleum commodity would become an excluded commodity following either movement away from the point at which it met the particular specification, or further modification of its composition. Similarly PRRT taxable profit would be determined at that point rather than the point at which the marketable petroleum commodity is in its final form, even though much of the operations to treat, transport, produce and initially store the marketable petroleum commodity in its final form may occur only after the point at which the marketable petroleum commodity arguably first meets the particular specification.

2.21 The Federal Court rejected this narrow interpretation, instead affirming the long established application of the PRRT in relation to the taxing point consistent with the policy intent.

2.22 Notably, the narrow interpretation would, in most cases, have significantly restricted the scope of what constitutes a petroleum project under the PRRT. In addition to being inconsistent with the intention of the PRRT being a tax on profit, the practical implications of such an interpretation include that:

·
the taxing point would, in many cases, occur at a point earlier than that at which a marketable petroleum commodity is sold, distributed offsite, or ready for processing into another commercial product, requiring a derived market value to be used to determine assessable receipts rather than the actual consideration received, significantly increasing uncertainty and complexity for taxpayers; and
·
the scope of activities related to a petroleum project would be artificially limited, reducing the expenditure which is deductible for PRRT purposes and excluding expenditure on the actual operations to treat, transport, produce and initially store the marketable petroleum commodity the taxpayer actually sells.

2.23 When the Bass Strait project transitioned to the PRRT on 1 July 1990, expenditures incurred prior to that date were made non-deductible on the basis that the project's establishment expenditures had been long recovered prior to the transition. Consequently, having the taxing point occur earlier in the production process, as argued, would have reduced the PRRT payable on the Bass Strait project due to the reduction in assessable receipts far outweighing any reduction in deductible expenditure.

2.24 However, the impact on other PRRT taxpayers would have been less certain, and potentially increased their tax liability. This is because having an earlier taxing point could well reduce the assessable receipts from a project by less than the reduction in deductible expenditure, compared to the intended taxing point.

2.25 The amendments in this Schedule put this matter beyond doubt, by clarifying that a marketable petroleum commodity is only produced when it is in its final form for its intended purpose (within the context of a particular project), and not at some earlier point part-way through the production process.

2.26 This Schedule also puts beyond doubt that the PRRT applies to, inter alia , profits relating to the production of marketable petroleum commodities from petroleum.

2.27 These amendments clarify the tax treatment of those projects currently subject to PRRT, consistent with its application since the PRRT commenced and which was affirmed by the Federal Court. This measure was first announced as part of the 2011-12 Budget.

Summary of new law

2.28 This Schedule amends the PRRTAA 1987 to address any remaining uncertainty regarding the location of the taxing point in relation to a petroleum project. It does this by explicitly inserting within the definition of what constitutes a 'marketable petroleum commodity' the requirement that, to be a marketable petroleum commodity, a product produced from petroleum must be in its final form for:

·
sale (if it is to be sold);
·
use as a feedstock for conversion to another product (if it is to be so used); or
·
direct consumption as energy (if it is to be so consumed).

2.29 Consistent with the existing law, a product cannot be a marketable petroleum commodity if it has been produced wholly or partly from something that was itself a marketable petroleum commodity.

Comparison of key features of new law and current law

New law Current law
Clarifies that a marketable petroleum commodity must also be in its final form for sale, use as a feedstock for conversion to another product, or direct consumption as energy.

However, a product cannot be a marketable petroleum commodity if it has been produced from something that was itself a marketable petroleum commodity.

A marketable petroleum commodity means any of the following products produced from petroleum:

(a)
stabilised crude oil;
(b)
sales gas;
(c)
condensate;
(d)
liquefied petroleum gas;
(e)
ethane;
(f)
any other product declared by the regulations to be a marketable petroleum commodity;

not being a product produced from another product of a kind referred to in paragraphs (a) to (f).

Detailed explanation of new law

Definition of a 'marketable petroleum commodity'

2.30 These amendments address any remaining uncertainty regarding where the PRRT taxing point occurs in relation to a petroleum project following the Federal Court's decision in Esso Australia Resources Pty Ltd v The Commissioner for Taxation [ 2011 ] FCA 360 . It does this by repealing the current definition of 'marketable petroleum commodity' and inserting a new definition. [ Schedule 2, items 1 and 2, section 2, definition of ' marketable petroleum commodity' ]

2.31 The basis for the PRRTAA 1987 defining marketable petroleum commodities on a specific product basis (stabilised crude oil, sales gas, condensate etc.) was to demarcate between upstream and downstream operations, reflecting the fundamental principle that the PRRT is a resource tax and does not extend to downstream activities such as refining and transportation of marketable commodities.

2.32 The current definition of a 'marketable petroleum commodity' requires that it be a 'product produced from petroleum'. In ordinary parlance, a product is the end-result of an activity or process, and production is not complete until the process has been completed and the product is in its final form.

2.33 Implicit in this, was the intention that a substance is not a marketable petroleum commodity until it is in its intended final form, notwithstanding the fact that the substance may have attained a specified composition part-way through a process. This intention is clearly reflected in the explanatory memorandum to the Petroleum Resource Rent Tax Assessment Bill 1987, which states:


'The boundaries of a petroleum project will not extend beyond the first point at which a marketable petroleum commodity is initially stored after production. That is, the project boundaries will not extend to "downstream activities" such as refineries and facilities for the transport of marketable products from that storage.'

'In the event that a marketable petroleum commodity is not sold at the point at or immediately after the point of initial on-site storage (e.g. where stabilised crude oil is refined by the producer), the market value at that point (or such other value as is fair and reasonable) will be treated as an assessable receipt of the project.'

2.34 To put this matter beyond doubt, these amendments make these elements of the definition of a marketable petroleum commodity explicit. Under the new law, for a product to be a marketable petroleum commodity it must, in addition to being one of the products listed in paragraphs (a) to (f) of that definition, be in its final form for:

(a)
sale, if it is to be sold;
(b)
use as a feedstock for conversion to another product, if it is to be so used; or
(c)
direct consumption as energy, if it is to be so consumed.

[ Schedule 2, items 1 and 2, section 2, definition of ' marketable petroleum commodity' ]

2.35 A product produced from petroleum is in its final form when it has been fully processed for its intended use (whether it be for sale, feedstock or otherwise used). The intended final form of the relevant product is a question of fact, and will be informed by the nature and commercial purpose of the activities comprising the particular petroleum operation in question.

2.36 In this context, 'conversion' is not intended to be limited to the case where a product is to be converted into a new product via chemical reaction. It also encompasses the case, for example, where the intention is to convert a product (such as sales gas), into another product with different physical properties (such as liquefied natural gas (LNG)).

2.37 However, 'conversion' is not intended to be so broad as to capture changes in the conditions in which the same product is kept.

Example 2.4 : A marketable petroleum commodity is a product produced from petroleum which is in its final form Ocean Oil Co operates, and has a 100 per cent interest in, a petroleum project off the coast of South Australia. The project is subject to the PRRT.Ocean Oil's operation is integrated and continuous, involving the following steps:

·
the use of wells on an offshore platform to recover liquid and gaseous raw petroleum from the production licence area;
·
initial separation of the recovered petroleum on the platform into substantially liquid and substantially gaseous streams, which are then separately piped to shore; and
·
further separation and filtering of the substantially gaseous stream in Ocean Oil's onshore processing plant to produce the commercial product 'sales gas' as well as other products (which are not considered further here).

Ocean Oil sells its 'sales gas' product, which it markets as OneGas, as it exits the onshore processing plant.

petroleum production process

By the time the substantially gaseous stream leaves the offshore platform via pipeline, it has a composition which meets that specified for sales gas. However, being only part-way through Ocean Oil's production process it cannot be said that the gas is a product produced from petroleum that is in its final form. The new law makes clear that, to be a marketable petroleum commodity, a product must be in its final form for sale, if it is to be sold, which is clearly Ocean Oil's purpose.The sales gas is not a marketable petroleum commodity at that point notwithstanding that it might be in its final form for use as feedstock for conversion to another product, or for direct consumption as energy. The purpose of Ocean Oil's operations is to produce sales gas for commercial sale. The production process, involving a series of operations to produce the intended final sales gas product is not complete.The sales gas which is ultimately sold as OneGas is not in the final form in which it is to be sold, and hence a marketable petroleum commodity, until it has undergone the separation and filtration processes within the onshore processing plant where the production process is concluded and the final sales gas product for sale is produced.The marketable petroleum commodity, OneGas, is sold at the onshore processing plant gate, and becomes an excluded commodity at that time. Consequently, the consideration receivable from sales are assessable petroleum receipts derived by Ocean Oil in relation to the project; with eligible expenditures being incurred up to the point the OneGas is sold and so being deductible.

Example 2.5 : A marketable petroleum commodity is a product produced from petroleum which is in its final form Rico Oil Co produces crude oil from an offshore project in which it holds a 100 per cent interest. The crude oil is sufficiently stable for safe storage and transport immediately following extraction at the well-head, due to it having a very low gas to oil ratio. Rico Oil transports the crude oil via pipeline from its platform to an onshore processing plant where unwanted substances, primarily water, are removed. The crude oil is then stored at an adjacent tank farm prior to being sold to nearby refineries.While the crude oil recovered is in a 'stable' form at the well-head, the object of Rico Oil's operation is to produce marketable stabilised crude oil for sale, and so the crude oil is not a marketable petroleum commodity (stabilised crude oil) at the well-head for PRRT purposes as it is not yet in its final form. The crude oil becomes a marketable petroleum commodity upon the completion of the processing required to remove impurities and producing the stabilised crude oil product Rico Oil sells.The stabilised crude oil marketable petroleum commodity does not become an excluded commodity when it is moved to the tank farm for storage, as the tank farm is located adjacent to where the marketable petroleum commodity is produced. Rather, the stabilised crude oil will become an excluded commodity when it is sold (if at the tank farm), or when it is moved away from adjacent storage.In this case, Rico Oil sells the stabilised crude oil at the tank farm and consequently, its assessable receipts will be the receipts received from the sale of the stabilised crude oil (less any expenses of sale). Eligible expenditure incurred in relation to activities occurring up to and including the storage on the tank farm will be deductible for PRRT purposes.

2.38 Whether a particular product produced from petroleum is a marketable petroleum commodity or not at a given place and time cannot be determined solely by reference to its chemical and physical properties. The point at which the taxing point occurs must also have regard to the specific operations, characteristics and purpose of the project from which the product is produced.

2.39 An implication of this is the potential that a product produced from petroleum may be a marketable petroleum commodity in one particular PRRT project, while another identical substance in a different PRRT project is not yet a marketable petroleum commodity because of further things that are to happen in the course of that project before the product is in its final form - whether for sale, downstream processing or treatment into some other commercial product, or for distribution for sale or processing or treatment into some other product. This is consistent with the design of the PRRT as a project-based rent tax.

2.40 Similarly, a marketable petroleum commodity may be produced from petroleum at different points within the same project where it has multiple purposes. For instance, a project may produce sales gas partly for sale to the domestic market, and partly for use as feedstock for conversion to LNG. Where the point at which final form of these products differs (due to them having different processing requirements), the point at which they become a marketable petroleum commodity will also differ.

Example 2.6 : Different projects may have different taxing points Ocean Oil operates, and has a 100 per cent interest in, a PRRT project off the coast of the Northern Territory. The configuration of this project up to (and including) the onshore processing plant is identical to the one described in Example 2.1.However, the sales gas that Ocean Oil sells to its Northern Territory customers is of a higher specification than the OneGas product it sells in South Australia. In order to meet these specifications, the gas stream is passed through a secondary onshore plant where further separation and filtration occurs. Ocean Oil sells this gas product, which it markets as SuperGas, as it leaves the second onshore plant.

taxing points

Applying the same reasoning as in Example 2.1 to this project configuration, the taxing point is when the SuperGas is sold upon leaving the second processing plant. The product is produced to its final form following the secondary processing. It becomes an excluded commodity at the point of sale.The taxing point for this project differs from that of the South Australian project in Example 2.1, reflecting the differences between the projects. It would be incorrect to suggest that because the gas stream leaving the initial onshore processing plant would be a marketable petroleum commodity in another petroleum project, then it is a marketable petroleum commodity at that point in relation to this project. The Northern Territory project involves an additional processing step, which does not result in the production of a new product, but rather results in the production of SuperGas, which is the marketable petroleum commodity sales gas in its final form for sale in relation to the Northern Territory project.

PRRT only taxes the resource once

2.41 A product cannot be a marketable petroleum commodity if it has been produced, wholly or partly, from a product that was itself a marketable petroleum commodity. This prevents a PRRT liability from arising more than once in relation to the same amount of petroleum. [ Schedule 2, item 2, section 2, definition of ' marketable petroleum commodity' ]

PRRT does not apply to downstream activities

2.42 The new definition of 'marketable petroleum commodity' does not disturb the existing demarcation in the PRRTAA 1987 between upstream production processes which are taken into account under the PRRT and downstream activities, such as refining and distribution, which are not.

2.43 For example, in an integrated gas-to-liquid project the sales gas product is a marketable petroleum commodity and becomes an excluded commodity prior to entering the downstream processing stage, which liquefies the gas for subsequent transport.

Example 2.7 : The taxing point of an integrated gas to liquids project Coolit Co operates, and has a 100 percent interest in, a West Australian natural gas project. The project supplies gas solely as a feedstock for an integrated LNG plant (also owned by Coolit Co).

taxing point of an integrated gas to liquids

The project natural gas is processed via an onshore processing plant to remove contaminants including water, carbon dioxide and hydrogen sulphide, and to remove heavier hydrocarbons prior to liquefaction.The purpose of the process is to produce sales gas that is suitable for use as feedstock for conversion into the product LNG in the plant operated by Coolit. While the gas meets the specified chemical composition of sales gas part-way through processing, it is not a marketable petroleum commodity at that time. This is because it is not a product produced from petroleum in its final form until the processing involved in preparing it for its intended purpose within the context of the operation is complete.Notably the sales gas produced by Coolit is not intended to be subject to sale following its production, but is instead to be subject to further processes to convert it to an LNG product. Under the existing (and the new) PRRT law, a marketable petroleum commodity will also become an excluded commodity where it is further processed or treated, or is otherwise moved away from its place of production (other than to adjacent storage) or is moved away from that adjacent storage.The point at which sales gas is moved away from the processing part of the plant to, or further processed in, the LNG liquefaction part of the plant to produce LNG is the point at which the sales gas becomes an excluded commodity (that is, the taxing point), and is the point at which assessable petroleum receipts related to the sales gas produced are brought to account, and up to which eligible expenditures are able to be deducted.As the sales gas becomes an excluded commodity other than by sale, the assessable petroleum receipts will be worked out in accordance with the PRRT regulations (see paragraph 24(1)(e) of the PRRTAA 1987).The point at which the 'sales gas' marketable petroleum commodity is produced is the point at which the product both satisfies the definition of 'sales gas' and is in its final form for its intended purpose. In the context of an integrated LNG plant, that purpose is feedstock for conversion, via further processing, to another product - that being LNG, which is not a marketable petroleum commodity but which is produced from sales gas.This recognises there is a qualitative difference between recovery and early-stage processing activities (which are subject to the PRRT), and downstream activities, such as refining, distribution, and, in this case, LNG liquefaction. These downstream activities are not subject to the PRRT, which is designed as a rent tax on the petroleum resource (and marketable products produced from it), and is not intended to extend indefinitely so as to capture subsequent value-adding activities.It is worth briefly examining what the outcome would be if Coolit did not operate nor have an interest in the LNG plant, which was instead owned and operated by another party, who purchased Coolit's sales gas for use as feedstock.In that case, the outcome would be no different to that described in Example 2.1. The gas product becomes a marketable petroleum commodity once processing is complete (that is, at the exit of the processing plant), and becomes an excluded commodity at the point of sale. The PRRT is unconcerned with the use to which the unrelated purchaser puts this product, whether it is for converting into LNG or otherwise.

Application and transitional provisions

2.44 The amended definition of 'marketable petroleum commodity' applies from 1 July 1990. [ Schedule 2, item 3 ]

2.45 The amendments apply retrospectively to remove any uncertainty regarding the long-established operation of the PRRT. This is particularly important in light of the extension of the PRRT to all Australian oil and gas projects, including onshore projects, from 1 July 2012.

2.46 The amendments do not impose any new tax burden, as they merely clarify and confirm the current application of the PRRT, consistent with the policy intent.


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