House of Representatives

Tax Laws Amendment (2012 Measures No. 6) Bill 2012

Explanatory Memorandum

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

Chapter 3 - Extending deductibility of exploration expenditure to geothermal energy explorers

Outline of chapter

3.1 The provisions in Schedule 3 of the this Bill amends the Income Tax Assessment Act (ITAA 1997) to extend deductibility of exploration or prospecting expenditure to geothermal energy exploration or prospecting. Geothermal energy explorers will be able claim deductions in an equivalent manner to mining and petroleum explorers.

3.2 All references to legislative provisions in this chapter are to the ITAA 1997.

Context of amendments

3.3 Geothermal energy is heat energy contained or stored in rock, water or any other material occurring naturally within the Earth. It is an emerging clean and renewable energy source with the potential to be used for the generation of electrical power in a largely emissions-free manner. Prospective geothermal energy resources have been identified in every Australian State and the Northern Territory.

3.4 Currently the definition of 'exploration or prospecting' in the ITAA 1997 does not extend to geothermal energy exploration. For this reason, geothermal energy explorers are treated differently to their mining and petroleum exploration counterparts.

3.5 Consistent with the Government's policy objective of encouraging exploration or prospecting for geothermal energy resources, the legislation extends deductibility of exploration or prospecting expenditure to taxpayers exploring for geothermal energy resources on an equivalent basis to that currently enjoyed by taxpayers exploring for traditional energy resources obtainable by mining.

3.6 These amendments align deductions for geothermal energy exploration with the deductions available to mining and petroleum explorers.

3.7 The Policy Transition Group, established to consult on the detailed design of the Minerals Resource Rent Tax, recommended that that the income tax law should be amended to incorporate geothermal energy exploration into the wider definition of 'exploration or prospecting'. This recommendation is consistent with the Australian Government's policy objective of encouraging the development of geothermal energy production in Australia.

3.8 From 1 July 2012, geothermal energy explorers will be able to immediately deduct applicable exploration or prospecting expenditure incurred on or after that date on an equivalent basis to the deductions available to explorers for traditional resources obtainable by mining.

Summary of new law

3.9 The amendments extend deductions for expenditure incurred on geothermal energy exploration or prospecting on an equivalent basis to those provided for expenditure incurred on mining and petroleum exploration or prospecting. The amendments will allow taxpayers to immediately deduct their exploration or prospecting expenditure if they meet the applicable tests.

3.10 The amendments define 'geothermal exploration rights' and 'geothermal exploration information' as depreciating assets. Along with other depreciating assets first used for exploration or prospecting for geothermal energy resources (from which energy can be extracted by geothermal energy extraction), the cost of these assets can be deducted immediately in certain circumstances, rather than over the relevant asset's effective life.

3.11 The amendments also extend the definition of 'exploration or prospecting' to encompass activities associated with geothermal energy exploration or prospecting, allowing expenditure of this nature to be deducted immediately in certain circumstances.

3.12 These immediate deductions are available only if: the relevant depreciating asset is not first used for-or the relevant exploration or prospecting expenditure is not expenditure on-development drilling for geothermal energy resources or operations in the course of working a property containing geothermal energy resources. This limits the deductions to exploration or prospecting expenditures not related to development or extraction, as is the case with mining and petroleum exploration.

3.13 Other technical amendments are made to ensure:

·
that a balancing adjustment amount is not reduced to the extent that it is attributable to any non-taxable use of geothermal exploration information;
·
deductions can be attributed to particular periods;
·
deductions relevant to other types of activities (for such items as capital expenditure on landcare operations; connecting power to land or upgrading the connection; or the construction of capital works) are denied;
·
that no income tax liability arises where a geothermal energy explorer stops holding a geothermal exploration right because they acquire a geothermal energy extraction right relating to the same area (or an area that is not significantly different);
·
tax cost setting for exploration and prospecting assets, potentially applicable when an entity joins a consolidated group, is outlined; and
·
other relevant terms are defined.

Comparison of key features of new law and current law

New law Current law
Geothermal exploration rights and geothermal exploration information are included in the definition of 'depreciating assets'. The existing law does not treat geothermal exploration rights or geothermal exploration information as depreciating assets under Division 40 of the ITAA 1997 (Division 40). Geothermal exploration rights are capital gains tax (CGT) assets. Geothermal exploration information is not a CGT asset.
The definition of 'exploration or prospecting' is extended to include geothermal energy exploration activities.

As a consequence, definitions for 'geothermal energy resources' and 'geothermal energy extraction' have been included in the amendments.

The definition of 'exploration or prospecting' does not include geothermal energy exploration activities. The existing law defines 'exploration or prospecting' by reference to mining and petroleum exploration activities.
The cost of depreciating assets first used for exploration or prospecting for geothermal energy resources is immediately deductible if certain conditions are met, or may otherwise be deductible over the effective life of the depreciating asset if used for a taxable purpose. The existing law does not allow geothermal exploration rights and geothermal exploration information to be deducted under Division 40 of the ITAA 1997 as they are intangible assets which are not recognised as depreciating assets.

Geothermal exploration assets which are tangible depreciating assets may be depreciated over their effective lives, provided they are used for a taxable purpose.

Expenditure on 'exploration or prospecting' for geothermal energy resources from which energy can be extracted by geothermal energy extraction may be immediately deductible if certain criteria are met. The existing law does not allow for expenditure on exploration or prospecting for geothermal energy resources to be deducted under Division 40 of the ITAA 1997 as the definition of 'exploration or prospecting' does not include geothermal energy exploration activities.
Geothermal energy explorers who stop holding a geothermal exploration right that is made a depreciating asset by these amendments because they acquire a geothermal energy extraction right relating to the same area (or an area that is not significantly different) will not incur an immediate income tax liability as a result of this transaction. Geothermal energy explorers who stop holding a geothermal exploration right because they acquire a geothermal energy extraction right relating to the same area (or an area that is not significantly different) may obtain a capital gains tax roll-over to avoid incurring an income tax liability as a result of this transaction.

Detailed explanation of new law

Geothermal exploration rights are included as depreciating assets

3.14 Mining, quarrying or prospecting rights are included as depreciating assets under Division 40. The cost of depreciating assets first used for exploration or prospecting for minerals obtainable by mining operations is able to be deducted immediately if certain criteria are met.

3.15 To bring deductions for geothermal energy exploration expenditure in line with those available to mining and petroleum exploration or prospecting expenditure, the amendments include geothermal exploration rights in the list of intangible assets that are defined as depreciating assets. It is important to note that geothermal extraction and production rights (or other related rights) have not been included as depreciating assets, only geothermal exploration rights. [Schedule 3, item 5, paragraph 40-30(2)(ba)]

3.16 The definition of 'geothermal exploration right' is inserted in subsection 995-1(1) of the ITAA 1997. A geothermal exploration right means: (a) an authority, licence, permit or right under an Australian law to explore for geothermal energy resources; or (b) a lease of land that allows the lessee to explore for geothermal energy resources on the land; or (c) an interest in such an authority, licence, permit, right or lease [Schedule 3, item 33, subsection 995-1(1)] . Geothermal exploration rights are issued by State and Territory governments.

3.17 Geothermal energy resources and geothermal energy extraction are defined in subsection 995-1(1) by reference to subsections 40-730(7A) and (7B). Geothermal energy resources are matter occurring naturally within the Earth and containing energy as heat. Geothermal energy extraction means operations that are for the extraction of energy from geothermal energy resources and that are for the purpose of producing assessable income [Schedule 3, item 22, subsection 40-730(7A)and (7B)] . References to these definitions are also included in subsection 995-1(1). [Schedule 3, items 31 and 29, subsection 995-1(1)]

Geothermal exploration information is included as a depreciating asset

3.18 Mining, quarrying or prospecting information is included in the list of intangible assets that are included in the definition of 'depreciating asset' under the ITAA 1997. The cost of such a depreciating asset is able to be immediately deducted under Division 40 provided certain criteria are met.

3.19 To align deductions for geothermal energy exploration with deductions available for mining and petroleum exploration or prospecting, the amendments include geothermal exploration information in the list of intangible assets that are included as depreciating assets. This allows for an immediate deduction for the cost of geothermal exploration information by applying new subsection 40-80(1A) if the other conditions of that provision are satisfied. [Schedule 3, item 5, paragraph 40-30(2)(bb)]

3.20 'Geothermal exploration information' is defined in subsection 995-1(1) by reference to new subsection 40-730(9). Geothermal exploration information is geological, geophysical or technical information that: (a) relates to the presence, absence or extent of geothermal energy resources in an area; or (b) is likely to help in determining the presence, absence or extent of such resources in an area [Schedule 3, item 23, subsection 40-730(9)] . A reference to the definition of 'geothermal energy information' is also inserted into subsection 995-1(1). [Schedule 3, item 32, subsection 995-1(1)]

Geothermal exploration information is held by an entity

3.21 In order to deduct an amount for the decline in value of a depreciating asset, you must first 'hold' the depreciating asset. The table in section 40-40 is used to work out the holder of a depreciating asset. If an entity holds geothermal exploration information that is relevant to geothermal energy extraction they carry on, or propose to carry on, or a business that includes exploration or prospecting for geothermal energy resources which they carry on, then the holder of the information is the entity. The entity holds the information even if the information is generally available because the information is still of special value to the entity. [Schedule 3, item 6, section 40-40, table item 9A]

The cost of a depreciating asset first used in geothermal energy exploration may be immediately deductible

3.22 Subsection 40-80(1) applies to depreciating assets first used for exploration or prospecting for minerals or quarry materials obtainable by mining operations. It provides that in certain circumstances an asset's decline in value is the asset's cost with the consequence that an immediate deduction of the asset's cost may be available. A depreciating asset starts to decline in value when it is first used or installed ready for use for any purpose by the taxpayer (section 40-60). Therefore, no deduction is available until the asset is actually used or installed ready for use.

3.23 Section 40-80 is amended to extend the immediate deductibility for the cost of a depreciating asset to geothermal energy explorers. Subject to a number of conditions, the decline in value of a depreciating asset a taxpayer holds is the asset's cost if the taxpayer first uses the asset for exploration or prospecting for 'geothermal energy resources' from which geothermal energy can be extracted by 'geothermal energy extraction'. 'Geothermal energy resources' and 'geothermal energy extraction' are defined terms and are explained at paragraph 3.16. [Schedule 3, item 7, paragraph 40-80(1A)(a)]

3.24 In the context of Division 40, the use of an intangible depreciating asset requires consideration of the nature of the asset. For example, a geothermal exploration right permits a holder to explore for geothermal energy resources in a particular area. Therefore, the taxpayer will use the right for the purposes of Division 40 if they use it to explore for geothermal energy resources.

3.25 The first use of a geothermal exploration right for exploration or prospecting may include the conduct of something that has been described as a 'proof-of-concept' demonstration. Such a demonstration is said to involve the drilling of an initial well of sufficient depth to reach the pre-determined necessary temperature and to tap a pre-existing underground heat reservoir, from which the heat might be able to be brought to the surface for exploitation. Fracturing of the rock may need to be undertaken to allow fluid injection and passage and to create a fluid reservoir and underground heat exchange. A second well may then need to be drilled to intersect the reservoir, away from the first hole, and testing undertaken to provide information to determine if the heat can be brought to the surface economically.

3.26 An immediate deduction is not available if, when the asset is first used, it is used for development drilling for geothermal energy resources or for operations in the course of working a property containing geothermal energy resources. This is to ensure that the immediate deduction is available for the cost of depreciating assets first used for exploration or prospecting only, and not used for development or extraction of a geothermal energy resource. [Schedule 3, item 7, paragraph 40-80(1A)(b)]

3.27 Examples of a disqualifying use under paragraph 40-80(1A)(b) are as follows:

·
preparing a site for geothermal energy extraction;
·
providing water, light and power for use on the site for future geothermal energy extraction;
·
determining the size and location of development wells and any other infrastructure;
·
any activity conducted in preparation for the drilling of development wells after exploitation of the geothermal energy resource has been proven to be technically feasible and economically viable; and
·
the construction of any infrastructure related to or to be used in the geothermal energy extraction.

3.28 In order to be entitled to the immediate deduction of a depreciating asset's cost, at that asset's start time the entity must be involved to some extent in geothermal energy extraction. That is, the entity either carries on geothermal energy extraction; or it would be reasonable to conclude that they proposed to carry on geothermal energy extraction; or the entity carries on a business of, or a business that included, exploration or prospecting for geothermal energy resources from which energy can be extracted by geothermal energy extraction, and expenditure on the asset was necessarily incurred in carrying on that business. The entity may satisfy more than one of these criteria. [Schedule 3, item 7, paragraph40-80(1A)(c)]

Example 3.13 : Immediately deducting the cost of a depreciating asset - tangible capital assets Greensteam Pty Ltd is a geothermal energy exploration company searching for geothermal energy resources within geothermal exploration rights it holds in the Great Sandy Desert. Greensteam carries on a business that includes exploration or prospecting for geothermal energy resources from which energy can be extracted by geothermal energy extraction.Greensteam estimates that it will need to drill over 500 exploration wells as part of its exploration program. Rather than lease drilling machinery to conduct the exploration work, Greensteam determines that it would be cheaper to purchase its own drill rig.Greensteam purchases a drill rig on 15 May 2013 for $500,000 and uses it to explore for geothermal energy resources. The first exploratory drill hole undertaken as part of Greensteam's exploration program is drilled in search of hot underground water. The drilling of this first hole constitutes a use of the drill rig for exploration or prospecting for geothermal energy resources.At that time Greensteam does not know that the required conditions will be found in the drill hole and so it does not use the drill rig for development drilling for geothermal energy resources or for operations in the course of working a property containing a geothermal energy resource.Greensteam is able to immediately deduct the cost of the drill rig under subsection 40-25(1) by applying subsection 40-80(1A).

Example 3.2: Exploration expenditure which is not immediately deductible CityLights Energy Co, having conducted exploration activities on its four geothermal exploration rights (tenements) which indicated geothermal energy resources that are technically feasible to extract, has also undertaken economic viability studies and determined that, coupled with the technical feasibility findings, geothermal energy extraction was economically feasible on all tenements and that an extraction plant should be established.However, CityLights Energy Co, having insufficient funding to develop the resources on all four tenements, disposed of their least attractive tenement to Steamy Turbine Co for $2 million.Steamy Turbine Co, concurrently with the decision to purchase the tenement, makes the decision to extract and develop the geothermal energy resource based on the findings of CityLights Energy Co's studies. The company applies to the relevant state government authority for the grant of a geothermal extraction right with the expectation that it will be approved within six months.In the meantime, Steamy Turbine Co continues to use the geothermal exploration right it purchased from CityLights Energy Co by drilling further holes to determine where the best energy flows are located and where their extraction and power plant should be built.The cost of Steamy Turbine Co's geothermal exploration right is not immediately deductible under subsection 40-80(1A). The purpose of the first additional hole drilled was to determine how to extract the geothermal energy resource and therefore the right was first used for operations in the course of working a property containing geothermal energy resources. Instead, Steamy Turbine Co will claim a decline in value deduction over the effective life of the geothermal exploration right under subsection 40-25(1) of Division 40.

Deduction for expenditure on exploration or prospecting for geothermal energy resources

3.29 Expenditure on exploration or prospecting that is not expenditure which forms part of the cost of a depreciating asset may qualify for an immediate deduction under subsection 40-730(1). Subsection 40-730(1) provides an immediate deduction for expenditure incurred on exploration or prospecting for minerals, petroleum or quarry materials which are obtainable by mining operations. Expenditure is only deductible if the taxpayer satisfies certain conditions. This deduction is extended to exploration or prospecting for geothermal energy resources. A new sub-heading is inserted to separate paragraphs relating to exploration and prospecting for minerals and exploration and prospecting for geothermal energy resources. [Schedule 3, item 15, above subsection 40-730(1)]

3.30 The legislation amends section 40-730 to allow an immediate deduction for expenditure incurred on exploration or prospecting for 'geothermal energy resources' that is not the cost of a depreciating asset. [Schedule 3, item 16, subsection 40-730(2A)]

3.31 In order to be entitled to a deduction under subsection 40-730(2A) a number of conditions must be satisfied.

3.32 The first condition is that expenditure must be incurred on exploration or prospecting for 'geothermal energy resources' from which energy can be extracted by 'geothermal energy extraction'. [Schedule 3, item 16, subsection 40-730(2A)]

3.33 To ensure that deductions cannot be made twice, expenditure that is included in the cost of a depreciating asset, for example, expenditure incurred on the asset's engineering design, is excluded from deductibility under new subsection 40-730(2A). Deductions for such expenditure included in the cost of assets are available under the general provision of Subdivision 40-B. [Schedule 3, item 17, subsection 40-730(3)]

3.34 Above subsection 40-730(4) a new heading 'Definitions' is inserted to indicate that the remaining subsections of the section refer to definitions. [Schedule 3, item 18, above subsection 40-730(4)]

3.35 The definition of 'exploration or prospecting' has been amended to include 'geothermal energy resources' in paragraph 40-730(4)(b). ('Geothermal energy resources' is a defined term and is explained at paragraph 3.16.)The amendment has been made in this way because the nature of exploration or prospecting activities for geothermal energy resources is more similar to exploration or prospecting activities associated with petroleum mining than with exploration or prospecting activities associated with mining in general or quarrying. The amendment allows for exploration expenditure incurred on geological, geophysical and geochemical surveys, exploration drilling and appraisal drilling for 'geothermal energy resources' (which is not the cost of a depreciating asset), to be immediately deductible. [Schedule 3, item 19, paragraph 40-730(4)(b)]

3.36 The definition of 'exploration or prospecting' is also amended by paragraph 40-730(4)(c) to include feasibility studies to evaluate the economic feasibility of extracting energy from geothermal energy resources, once they have been discovered. [Schedule 3, item 20, paragraph 40-730(4)(c)]

3.37 Finally, the definition of 'exploration or prospecting' is also amended to include obtaining 'geothermal exploration information' associated with the search for and evaluation of areas containing 'geothermal energy resources'. ('Geothermal exploration information' is a defined term and is explained in paragraph 3.20.) [Schedule 3, item 21, paragraph 40-730(4)(e)]

3.38 The second condition is that the entity must have carried on 'geothermal energy extraction'; or it would be reasonable to conclude that they proposed to carry on 'geothermal energy extraction'; or that the entity carried on a business of, or a business that included, exploration or prospecting for 'geothermal energy resources' from which energy can be extracted by 'geothermal energy extraction', and the expenditure on the asset was necessarily incurred in carrying on that business. [Schedule 3, item 16, subsection 40-730(2A)]

3.39 An entity is not entitled to an immediate deduction under subsection 40-730(2A) if the expenditure in question was on development drilling for 'geothermal energy resources' or on operations in the course of working a property containing geothermal energy resources. This is to ensure that the immediate deduction is available for expenditure incurred on exploration or prospecting only, and not expenditure on developmental work or extraction of a 'geothermal energy resource'. [Schedule 3, item 16, subsection 40-730(2B)]

Example 3.3: Immediately deducting expenditure incurred on a feasibility study BubblyWater Pty Ltd carries on geothermal energy extraction. Following extensive drilling of exploration wells on one of its exploration tenements, BubblyWater is confident that they have discovered a geothermal energy resource from which geothermal energy extraction is technically feasible and thus may occur in the future.BubblyWater engages a contractor, Ecofease, to undertake a feasibility study to evaluate the economic viability of extracting energy from the geothermal energy resource. The feasibility study will allow BubblyWater to determine whether, coupled with the technical feasibility findings, the geothermal energy resource is economically feasible for future development. The feasibility study costs BubblyWater $450,000.The expenditure incurred by BubblyWater on the feasibility study is not incurred on development drilling for geothermal energy resources or on operations in the course of working a property containing geothermal energy resources.The cost of the feasibility study is immediately deductible to BubblyWater under subsection 40-730(2A).

3.40 Examples of expenditure that are disqualified from deduction by subsection 40-730(2B) are similar to those that disqualify expenditure found in paragraph 3.27.

Example 3.4: Exploration expenditure which is not immediately deductible Percolating Power Co holds a geothermal exploration right and conducts exploration activities on the tenement, the results of which indicate a geothermal energy resource that is technically feasible to extract. The company undertakes further work to determine if development of the resource is economically feasible. Based on the these findings, the company determines that geothermal energy extraction is economically feasible and that a power plant should be established to utilise the geothermal energy extracted to produce electricity to be fed into the transmission lines of the local grid.The company applies to the relevant State government authority for the grant of a geothermal energy extraction right with the expectation that it will be approved within six months.In the meantime, Percolating Power Co continues to use its exploration right to drill further holes to determine where the best energy flows are located and where the power plant should be built. It spends $1 million on this additional work.The expenditure incurred on the additional drilling is not incurred on exploration or prospecting for geothermal energy resources from which energy can be extracted by geothermal energy extraction. Rather, the character of the expenditure is such that the expenditure is directed towards operations in the course of working a property containing geothermal energy resources under subsection 40-730(2B). As a result, the cost of the additional drilling work is not immediately deductible under subsection 40-730(2A).

Example 3.5: No deductions for non-geothermal businesses Energy For The Future Co currently carries on a business generating solar energy. It is considering expanding its business by exploring for geothermal energy resources in Queensland. Before it applies for geothermal exploration rights, it purchases a series of maps providing geothermal exploration information from the Queensland Geological Survey Service for $30,000.Energy For The Future Co is not entitled to an immediate deduction under subsection 40-730(2A) for the expenditure incurred on the geothermal exploration information contained in the maps. This is because they do not carry on geothermal energy extraction, nor do they carry on a business of, or a business that included, exploration or prospecting for geothermal energy resources from which energy can be extracted by geothermal energy extraction. Due to the preliminary nature of Energy For The Future Co's activities regarding a possible geothermal energy venture, it would not be reasonable to conclude that it proposed to carry on geothermal energy extraction.

An amount received for the provision of geothermal exploration information is assessable income

3.41 Under section 15-40 an amount received for providing mining, quarrying or prospecting information to another entity is assessable income if the entity continues to hold the information and the amount received is not assessable as ordinary income under section 6-5.

3.42 Consideration received for dealing with or disclosing such information will be ordinary income assessable under section 6-5 where:

·
the information is disclosed for the purpose of profit-making, or
·
the information is dealt with or disclosed under an agreement for the provision of a service that involves sharing the information with another person and has no adverse effect on the profit-yielding structure of the business.

3.43 However, where the consideration received for dealing with or disclosing such information does not give rise to ordinary income, the amount is not assessable under section 6-5. The amount is statutory income and is included in assessable under section 15-40.

3.44 To ensure that geothermal exploration information is treated in the same manner as mining, quarrying or prospecting information, section 15-40 is amended to ensure that an amount received by an entity for providing geothermal exploration information to another entity is assessable income, providing they continue to hold that information and the information is not assessable as ordinary income. [Schedule 3, item 4, section 15-40]

3.45 'Geothermal energy' and a reference to providing geothermal exploration information are added to the list of provisions about assessable income. [Schedule 3, item 1, section 10-5]

3.46 The heading for section 15-40 has been substituted with the new heading 'Providing mining, quarrying or prospecting information or geothermal exploration information'. [Schedule 3, item 3, section 15-40]

Geothermal energy information and balancing adjustments

Balancing adjustments

3.47 Where a balancing adjustment event occurs for a depreciating asset and the termination value differs from the adjustable value of the asset, the difference between those two amounts (the balancing adjustment amount) is either assessable (if the termination value exceeds adjustable value) or deductible (if the adjustable value exceeds termination value) (section 40-285).

3.48 Section 40-290 provides for the balancing adjustment amount to be reduced if the taxpayer's deductions for the depreciating asset (or deductions of specified earlier holders of the asset) were reduced under section 40-25.

3.49 If a balancing adjustment event occurs in relation to a depreciating asset which is 'mining, quarrying or prospecting information' (as defined in subsection 40-730(8)), there can be no reduction to the balancing adjustment amount under subsection 40-290(5). This is intended to reflect the exclusion of such information from any residual capital gains consideration; as such information is not a CGT asset.

3.50 Like mining information, geothermal exploration information is not a CGT asset and so it is appropriate that there also be no reduction to any balancing adjustment amount concerning it under section 40-290. [Schedule 3, item 8, subsection 40-290(5)]

Attributing deduction to periods

3.51 Section 165-55 sets out the rules for attributing deductions to particular periods. This is one of the steps involved in determining the notional loss or notional taxable income for the period under section 165-50.

3.52 Under subsection 165-55(2), certain deductions are attributable to periods in proportion to the length of the period. The deductions include deductions for depreciating assets; deductions for exploration and prospecting or mining capital expenditure in connection with mining or quarrying; any other deductions for expenditure which are spread over two or more years, and deductions for capital expenditure in connection with Australian films.

3.53 The legislation amends subsection 165-55(2) by the inclusion of a paragraph (ba) which creates a new category of deductions that are attributed to each period in proportion to the length of the period. The new subparagraph includes deductions for exploration and prospecting for geothermal energy resources. This amendment ensures consistent treatment between the attribution of mining exploration or prospecting expenditure and geothermal energy exploration or prospecting expenditure. [Schedule 3, item 26, paragraph165-55(2)(ba)]

Denying deductions for landcare

3.54 Section 40-630 provides an immediate deduction for capital expenditure incurred by a taxpayer on a landcare operation. 'Landcare operation' is defined in section 40-635.

3.55 The deduction is available if the taxpayer incurs the capital expenditure at a particular time in an income year on a landcare operation for land in Australia, and at that time the land is used by the taxpayer for carrying on a 'primary production business' (as defined in subsection 995-1(1)). Alternatively, the operation has to be on rural land in Australia used by the taxpayer at the time for carrying on a business for a taxable purpose from the use of that land.

3.56 No deduction is available if the land is used for carrying on a business of 'mining operations' (defined in subsection 40-730(7)).

3.57 To ensure consistency between the treatment of mining operations and geothermal energy extraction, the legislation extends the denial of landcare deductions to geothermal energy extraction. [Schedule 3, items 10 to 12, paragraph 40-630(1)(b), note in subsection 40-630(1)and paragraphs 40-630(1A)(b, 1B)(b) and (3)(b)]

Example 3.6: Deduction for expenditure on landcare operation not available ExplosiveGeo is a geothermal energy company extracting geothermal energy from a tenement where they hold a geothermal energy extraction licence in South Australia. ExplosiveGeo incurs expenditure installing a drainage control system to assist with water run-off in the production area.ExplosiveGeo is not entitled to an immediate deduction for the expenditure incurred on installing the drainage system as it is carrying on a business of geothermal energy extraction and the drainage system is not a 'landcare operation' under section 40-630. However, ExplosiveGeo may be entitled to a decline in value deduction for the cost of the drainage system under subsection 40-25(1).

Denying deductions for electricity and phone lines

3.58 Section 40-650 deals with the amounts that cannot be deducted under Subdivision 40-G which relates to capital deductions for primary producers. The section limits the deductions available for the cost of connecting electricity and telephone lines under section 40-645.

3.59 The effect of subsection 40-650(3) is to deny a deduction for capital expenditure incurred in providing water, light or power for use on, access to or communication with, the site of mining operations or geothermal energy extraction. Similarly a deduction is denied for contributions to the cost of providing water, light or power for mining operations or that extraction.

3.60 The excluded expenditure would generally qualify for a deduction as 'mining capital expenditure' (paragraph 40-860(1)(d)) over the life of the project under section 40-830.

3.61 To ensure consistency between the treatment of mining operations and geothermal energy extraction, the legislation extends the denial of these deductions to geothermal energy extraction. [Schedule 3, items 13 and 14, paragraphs 40-650(3)(a) and (3)(b)]

Example 3.7: Denying deductions for expenditure on electricity and phone lines Brokenshire Resources carries on geothermal energy extraction activities on Shaun's Camel Farm in outback Queensland. Brokenshire Resources has promised its contracted scientist, Birgit, air-conditioning to allow her to work in the extreme heat.In lieu of paying Shaun for access to his farm and for the use of his workers quarters for Birgit, Brokenshire Resources uses its technicians to install power and air-conditioning into Shaun's employee housing.The cost of installing power by Brokenshire Resources cannot be deducted under the electricity and telephone line provisions of sections 40-645 and 40-650.

Deductions for construction expenditure

3.62 Capital works that are currently written off under other specific provisions such as those associated with exploration and prospecting are specifically excluded from Subdivision 43-B.

3.63 Subdivision 43-B explains the meaning of construction expenditure. Subsection 43-70(1) defines 'construction expenditure' as capital expenditure incurred in respect of the construction of capital works (section 43-20). However, subsection 43-70(1) is limited by subsection 43-70(2) which lists exclusions from the definition of 'construction expenditure'.

3.64 Subparagraph 43-70(2)(fa)(iv) precludes consideration under Division 43 in respect of expenditure that is the cost of a depreciating asset that the taxpayer can deduct applying subsection 40-80(1), that is, the cost of depreciating assets first used for exploration or prospecting of minerals or quarrying materials.

3.65 The legislation extends this preclusion of consideration under Division 43 to expenditure incurred on depreciating assets that the taxpayer can deduct by applying the subsection 40-80(1A) which deals with depreciating assets first used in exploration and prospecting for geothermal energy resources. [Schedule 3, item 24, subparagraph 43-70(2)(fa)(iv)]

Example 3.8: Denying deductions for construction expenditure MeziMoo Corporation is a geothermal energy explorer that constructs temporary housing on one of its exploration tenements to house its team of geologists who are conducting exploration drilling.The expenditure on the temporary housing forms the cost of a depreciating asset that is first used for exploration or prospecting for geothermal energy resources from which geothermal energy can be extracted by geothermal energy extraction. As an immediate deduction is available under subsection 40-80(1A), consideration of the expenditure under Division 43 is precluded by subparagraph 43-70(2)(fa)(iv).

Preserving relief from income tax liability for geothermal energy explorers

3.66 As these amendments provide that geothermal exploration rights are depreciating assets, if a geothermal energy explorer stops holding a geothermal exploration right relating to an area because they acquire a geothermal energy extraction right relating to the same area or an area that is not significantly different, a balancing adjustment event will happen. This may result in an amount being either assessable (if the termination value exceeds the asset's adjustable value) or deductible (if the asset's adjustable value exceeds its termination value).

3.67 These amendments set the termination value of the exploration right to zero, ensuring there is no immediate tax liability when the geothermal energy explorer stops holding a geothermal exploration right and acquires a geothermal energy extraction right. This modification only applies where the area that the geothermal energy extraction right relates to is the same as, or not significantly different from, the area to which the geothermal exploration right related. [Schedule 3, item 9, at the end of the table in subsection 40-300(2)]

3.68 As the geothermal energy extraction right that is acquired is not a depreciating asset, the right is subject to taxation under the CGT provisions. Because of the amendment to termination value for Division 40 purposes described in paragraph 3.66, permitting the ordinary cost base rules in Division 110 to apply would result in an inappropriate outcome.

3.69 These amendments accordingly provide that the first element of the cost base (and reduced cost base) of the geothermal extraction right be set to nil where the area the extraction right relates to is the same as, or not significantly different from, the area to which the geothermal exploration right related. [Schedule 3, item 25, section 112-38]

3.70 To facilitate the operation of the modification, the term 'geothermal energy extraction right' is defined in subsection 995-1(1). A geothermal energy extraction right is an authority, licence, permit or right under an Australian law to carry on geothermal energy extraction; or a lease of land that allows the lessee to carry on geothermal energy extraction on the land, or an interest in such an authority, licence, permit, right or lease. [Schedule 3, item 30, subsection 995-1(1)]

Tax cost setting for exploration and prospecting

3.71 Under subsection 40-80(1), the decline in value of a depreciating asset that is first used for exploration or prospecting is taken to be the cost of the asset so long as the taxpayer has met the conditions ascribed in subsection 40-80(1). Generally, this will mean that an immediate deduction is available for the cost of the asset in that year under subsection 40-25(1). Where subsection 40-80(1) applies, the taxpayer does not have to make a choice to use either the diminishing value method (section 40-70) or the prime cost method (section 40-75) to calculate the decline in value of the asset.

3.72 However, section 716-300 ensures that where an entity joins a consolidated group and the entity had previously deducted the cost of a depreciating asset first used for exploration or prospecting applying subsection 40-80(1), the asset's decline in value is deemed to have been calculated by the joining entity using the prime cost method. This affects the method and the effective life to be used by the head company of the consolidated group in working out the decline in value of the asset.

3.73 If the joining entity deducted an amount for the decline in value of a depreciating asset other than by applying subsection 40-80(1) (for example the decline in value of a depreciating asset other than one first used for exploration or prospecting was calculated on the basis of its effective life under section 40-70 or section 40-75), section 716-300 would not apply and whichever method was adopted by the joining entity would continue to apply to the head company under subsection 701-55(2).

3.74 The legislation extends section 716-300 treatment to depreciating assets first used for geothermal energy exploration or prospecting. That is, if a joining entity deducted an amount for the decline in value of a depreciating asset applying the new subsection 40-80(1A), the asset's decline in value is deemed to have been calculated using the prime cost method. This will affect the method and the effective life to be used by the head company of the consolidated group in working out the decline in value of the asset. [Schedule 3, items 27 and 28, paragraphs 716-300(1)(b) and (c) and note in subsection 716-300(1)]

List of Provisions about deductions

3.75 The legislation updates the list of provisions about deductions. Under the 'capital allowances' section of the table, references to exploration an prospecting are updated to includes references to section 40-80(1A) and 40-730. 'Geothermal exploration information' and 'geothermal exploration rights' are also added to their table with references to Subdivision 40-B. [Schedule 3, item 2, section 12-5, table item headed 'capital allowances']

Application

3.76 Broadly, the legislation is effective from 1 July 2012.

3.77 The legislation applies to amounts received on or after 1 July 2012 (for amendments to section 15-40), depreciating assets whose start time is on or after 1 July 2012 (for amendments to sections 40-30, 40-40, 40-80, 40-290 and 716-300), (depreciating assets that started to be held on or after 1 July 2012 for amendments to section 40-300), expenditure incurred on or after 1 July 2012 (for amendments to sections 40-630 and 40-650 and subsection 40-730(2A) and (2B)) and to geothermal energy extraction rights acquired on or after 1 July 2012 (for section 112-38). [Schedule 3, item 34, Application]

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Extending deductibility of exploration expenditure to geothermal energy explorers

3.78 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 .

Overview

3.79 The legislation extends the immediate deductibility of exploration expenditure provided to mining and petroleum explorers to geothermal energy explorers.

Human rights implications

3.80 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

3.81 This Schedule is compatible with human rights as it does not raise any human rights issues.

Assistant Treasurer, the Hon David Bradbury


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