House of Representatives

Taxation Laws Amendment Bill (No. 5) 1992

Taxation Laws Amendment Act (No. 5) 1992

Income Tax (Dividends and Interest Withholding Tax) Bill 1992

Income Tax (Dividends and Interest Withholding Tax) Amendment Act 1992

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Petroleum Resource Rent Tax Technical Amendments

Summary of proposed amendments

A. Transfer of expenditure from a lapsed project or exploration right

Purpose of amendment: To enable a person to transfer expenditure incurred on a petroleum project or exploration right to another petroleum project, where the person holds an interest in both entities but the project licence or exploration right on which the expenditure was incurred has ceased to be in force.

Date of Effect: 1 July 1991

B. Transfer of expenditure associated with transfer of entire interest in a petroleum project

Purpose of amendment: To ensure that when a person (the vendor) transfers his or her entire entitlement to assessable receipts from a petroleum project to another person (the purchaser), all exploration expenditure of the vendor on or after 1 July 1990 is taken to be incurred by the purchaser.

Date of Effect: 1 July 1991

A. Transfer of expenditure from a lapsed project or exploration right

Background to the legislation

Under the Petroleum Resource Rent Tax Assessment Act 1987 (the PRRT Act), taxpayers who have an interest in a petroleum project carry forward their expenditure on that project, with augmentation, until their receipts have absorbed the expenditure. Taxpayers who have an interest in more than one petroleum project must transfer unused exploration expenditure incurred on or after 1 July 1990 between projects, if possible. They then pay PRRT on their net receipts.

The transfer must be in accordance with general transfer rules in the Schedule to the PRRT Act. Part 5 of the Schedule deals with project interests of a single taxpayer and Part 6 with project interests of group companies.

The person must transfer unused expenditure incurred on a petroleum project (that is, associated with a production licence) or on an exploration right. Exploration right is defined in Clause 1 of the Schedule to include a retention lease or exploration permit. Transfers can only be made to a project with a notional taxable profit (calculated under the Schedule), that is, to projects which would have a taxable profit if expenditure were not transferred to them. Transfers are made preferentially to the most recent production licence.

The common interest rule requires that the taxpayer has an interest in:

·
the project or exploration right on which the expenditure was incurred (the transferring entity); and
·
the project to which it is transferred (the receiving entity) from the beginning of the financial year in which the expenditure was incurred to the end of the financial year in which it is transferred (the transfer year).

The common interest rule is contained in clause 22 of the Schedule in relation to a single with interests in more than one petroleum project and in clause 31 in relation to a group of companies. For group companies, it requires one group company to have held the interest in the transferring entity, another to have held an interest in the receiving entity, and both to have been group companies for the relevant period. The rule ensures that during the transfer year, a person cannot buy up a PRRT-liable project to receive expenditure from a failed exploration project, or buy up a failed project in order to transfer expenditure to a PRRT-liable project.

Explanation of proposed amendments

Where the production licence or exploration right associated with the transferring entity lapses before the end of the transfer year, the taxpayer is unable to transfer expenditure associated with the lapsed licence or right because the common interest rule is not satisfied. In effect, the transferring entity has ceased to exist before the expenditure could be transferred; so the taxpayer's interest has also ceased to exist.

This Bill amends the Schedule to enable transfer of expenditure where the licence or exploration right associated with the transferring entity has ceased to be in force.

The day the licence or exploration right associated with the transferring entity has ceased to be in force will be the finishing day in relation to the transferring entity [Clause 1 of the Schedule to the Act; Clause 110].

Where the transferring entity is a petroleum project, the finishing day is the first day on which there is no longer in force a production licence in relation to the project. This is because there may be more than one licence associated with the project. Where the transferring entity is an exploration right, the finishing day is the day on which the retention lease or exploration permit ceases to be in force [Clause 1 of the Schedule to the Act; Clause 110].

The common interest rule in clause 22 will be amended so that a person transferring expenditure is not required to have held an interest in the transferring entity after the finishing day in relation to that entity [New subclause 22(2A) of the Schedule to the Act; Clause 114].

Under Part 6 of the Schedule, a group company which has unused exploration expenditure incurred after 1 July 1990 on a project (a "loss" company) must transfer as much as possible of that expenditure to other companies in the group with projects that have taxable profits (a "profit" company). The common interest rule in clause 31 requires that the "loss" company must hold an interest in the transferring entity and the "profit" company hold an interest in the receiving project from the beginning of the financial year in which the unused expenditure was incurred to the end of the transfer year.

Clause 31 will be amended so that the "loss" company will not be required to hold an interest in the transferring entity at a time after the finishing day in relation to that entity [New subclause 31(2A) of the Schedule to the Act; Clause 115].

Example

In July 1990, a person has interests in two petroleum projects and incurs expenditure on both of them. The person does not pursue one project as it is not economically viable. That production licence is allowed to lapse at the end of the 1991 income year. The person does proceed with the other project, and in the 1993 income year this project has become profitable and is PRRT-liable. Under the existing law, the person cannot transfer expenditure from the lapsed project to the profitable project.

The amendment will enable the person to transfer this expenditure. The finishing day in relation to the transferring project may be earlier than the transfer year. In this example, the finishing day was the last day of the 1991 income year, two years before the transfer of expenditure.

The same applies to group companies. Suppose a group of companies initiates a number of exploration ventures in an area after 1 July 1990. Subsidiary A incurs expenditure on an exploration permit but finds insufficient petroleum to proceed and does not renew the permit when it expires on 1 January 1993. However, Subsidiary B finds petroleum in its exploration permit area and takes out a production licence. In the 1995 income year, it has net taxable profits.

Under the existing law, the unused transferable exploration expenditure of Subsidiary A cannot be transferred to Subsidiary B. The amendment will enable this expenditure to be transferred although the transfer occurs after the finishing day (1 January 1993) in relation to Subsidiary A's project.

Consequential amendments

Parts 2, 3 and 4 of the Schedule to the Act deal with the calculation of class 2 ABR exploration expenditure, class 2 GDP factor expenditure and all amounts of transferable expenditure in relation to a project, a person and a financial year. The matters dealt with in each of these parts are outlined in clause 6 (Part 2), clause 10 (Part 3) and clause 13 (Part 4). In each of these parts, the financial year is called the assessable year .

The amendments will make it clear that the assessable year may be a financial year which starts after the finishing day in relation to a petroleum project or exploration right. That is, transferable expenditure may be calculated and transferred in a financial year after any project licence, exploration lease or retention permit associated with the transferring entity has ceased to be in force [Clauses 6, 10, and 13 of the Schedule to the Act; Clauses 111, 112 and 113].

B. Transfer of expenditure associated with the transfer of an entire entitlement to derive receipts from a petroleum project.

Background to the Legislation

A taxpayer (the vendor) can transfer their entire entitlement to derive receipts from a petroleum project to another person (the purchaser) under section 48 of the PRRT Act.

Under paragraph 48(a), at the time of transfer of the entire entitlement, the purchaser of the entitlement is taken to have derived any assessable receipts and to have incurred any deductible expenditure in relation to the project, which were actually derived or incurred by the vendor in the financial year up to the transfer time.

Under the existing law, not all exploration expenditure incurred on or after 1 July 1990 is able to be transferred to the purchaser under section 48. Calculation of deductible expenditure of the vendor in relation to a project must be done in accordance with the Schedule to the PRRT Act. As a result of this calculation, some exploration expenditure incurred on or after 1 July 1990 may be transferable to another project held by the vendor. Therefore it will not be deductible for the project on which it was incurred.

In particular, class 2 augmented bond rate (ABR) exploration expenditure and class 2 GDP factor expenditure, calculated under Parts 2 and 3 of the Schedule, are transferable to other projects of the vendor. The calculation of these expenditures of the vendor may have the result that some amounts of expenditure in relation to a project are taken not to have been incurred by the vendor.

For example, take the calculation of class 2 ABR exploration expenditure. If it is found that the vendor has no notional taxable profit , as defined in clause 5 of the Schedule, in relation to the project and the financial year, then under clause 7 any class 2 ABR exploration expenditure in relation to the project is taken not to have been incurred by the vendor. Instead, this amount is transferable to any other project held by the vendor.

Where an amount of expenditure is taken not to have been incurred by the vendor in this way, it cannot be "deductible expenditure" of the vendor under Section 48. In effect, it is rendered "invisible" to section 48. Therefore it cannot be transferred to the purchaser.

Explanation of proposed amendments

Section 48 will be amended to enable all expenditure incurred or taken to be incurred by the vendor of an entire interest in a project to be transferred to the purchaser of the entire interest.

This is done in two stages in the amendments. First, class 2 ABR expenditure and class 2 GDP factor expenditure will be separated out from other deductible expenditure. All other kinds of deductible expenditure will continue to be dealt with in the same way as they are at present. That is, the following categories of expenditure will be augmented up to the transfer time in the hands of the vendor, and the augmented amounts transferred to the purchaser:

·
class 1 ABR general expenditure;
·
class 1 ABR exploration expenditure;
·
class 1 GDP factor expenditure;
·
class 2 ABR general expenditure.

None of these amounts are able to be transferred to other projects of the vendor. The problem of calculation under the Schedule therefore does not arise [Subparagraph 48(1)(a)(i)], Clause 109].

The purchaser will then be taken to have incurred, in addition to the above amounts, any expenditure which would have been included in the incurred exploration expenditure amount in relation to the vendor and the project, as if the financial year in which the transfer of the interest occurs had ended immediately before the transfer time [New subparagraph 48(1)(a)(ia)].

Transfer of incurred exploration expenditure amount

The incurred exploration expenditure amount in relation to the vendor is defined in clause 1 of the Schedule. It includes:

·
the amounts of exploration expenditure actually incurred by the person in the financial year in relation to the project; and
·
any expenditure which was transferred previously to the vendor under section 48.

In effect, this includes all expenditure which was actually incurred and has neither been absorbed against receipts from the project nor transferred to be absorbed against receipts from another project.

The definition operates in the same way for a single project and a combined project in which the person has an interest. For a combined project, the definition also includes actual exploration expenditure and section 48 expenditure of the person incurred before the combination certificate came into force.

The purchaser will be taken to have incurred all exploration expenditure actually incurred by the vendor plus all previous section 48 expenditure of the vendor. These amounts, which make up the incurred exploration expenditure amount , form the basis for the calculation of class 2 ABR exploration expenditure and class 2 GDP factor expenditure of the vendor under the Schedule. In contrast to other deductible expenditure transferred under section 48, these amounts are not augmented [Note to new subparagraph 48(1)(a)(ia)].

Under the amendment, the vendor of an entire interest under section 48 bypasses entirely the calculation of class 2 ABR exploration expenditure, class 2 GDP factor expenditure and transferable expenditure associated with the project which is the subject of the section 48 transaction [New subparagraph 48(1)(a)(ia)].

Because the incurred exploration expenditure amount has not been compounded up to the transfer time, the purchaser will be treated as if they had incurred the expenditure at the time when it was actually incurred, or taken to be incurred, by the vendor. The purchaser will be placed in the shoes of the vendor. The expenditure is compounded in the purchaser's hands as from the date on which it was actually incurred (or taken to be incurred) by the vendor. Under the Schedule, compounding is calculated to the extent that expenditure is to be absorbed in a particular year [New subsection 48(2)].

Previous section 48 expenditure of the vendor

Included in the incurred exploration expenditure amount as defined in clause 1 of the Schedule is any amount of exploration expenditure that a person is taken by section 48 to have incurred in a financial year in relation to the project.

Under the amendments, expenditure which the vendor was taken to have incurred under a previous section 48 transfer of the entire entitlement to receipts of the project will be transferred to the purchaser without being compounded. So the expenditure will be compounded in the purchaser's hands as from the date when it was taken to be incurred by the vendor. Under the Schedule, compounding is calculated to the extent the expenditure is to be absorbed in a particular year [New subparagraph 48(1)(a)(ia)].

That part of the definition of incurred exploration expenditure amount (for both single and combined projects) which deals with previous section 48 expenditure will be amended to refer specifically to expenditure that the person is taken by new subparagraph 48(1)(a)(ia) to have incurred, in relation to the financial year in relation to the project. This will ensure that expenditure transferred under section 48 will be transferred uncompounded under any successive section 48 transaction [Clause 1 of the Schedule to the Act; definition (a)(ii) and (b)(ii)].

Expenditure not transferable

The purchaser is not able to transfer expenditure which he or she is taken to have incurred under section 48 to another PRRT-liable project held by the purchaser. This is prevented by the common interest rule in clauses 22 and 31 of the Schedule. Expenditure related to the project in which the interest is transferred under section 48 can only be offset against receipts of that project.

Example V Co. holds the whole interest in a project and has no other project interests. In the 1992-93 financial year, V Co. decides to get out of the petroleum exploration business and transfers its entire interest in the project to P Co. with this intention. At the transfer time, V Co. had derived total assessable receipts from the project of $350 million. It had incurred total expenditure before 1 July 1990 of $400 million (as augmented), exploration expenditure of $50 million in the year ending 30 June 1991 and exploration expenditure of $20 million in the year ending 30 June 1992.Under section 48(1)(a)(i), P Co. is taken to have derived all assessable receipts which would have been receipts of V Co. had the financial year ended just before the transfer time. Therefore P Co. is taken to have derived $350m in assessable receipts on the project. By 48(1)(b), V Co. is taken not to have derived this amount.Under the existing law, the full deductible expenditure of V Co. must be established. This involves the calculation of any class 2 ABR exploration expenditure of V Co. (there is no GDP factor expenditure in this example), as well as its other deductible expenditure. Under the amendments, it is only necessary to determine deductible expenditure of V Co. other than class 2 ABR exploration expenditure for transfer under 48(1)(a)(i).Treatment of deductible expenditure other than class 2 ABR exploration expenditure will be the same under the amendments as under the existing law. Therefore P Co. is taken to have incurred $400m class 1 expenditure under section 48(1)(a)(i) [New subparagraph 48(1)(a)(i)]. By paragraph 48(1)(b), V Co. is taken not to have incurred this amount.

Treatment of 1991 and 1992 exploration expenditure under the existing law

Class 2 ABR exploration expenditure of V Co. is calculated under Part 2 of the Schedule as follows:

Assessable receipts = $350m
Deductible expenditure (other than class 2 expenditure) = $400m
Notional taxable profit under clause 5 = 350 - 400
= - $50m

There is no notional taxable profit. Therefore V Co. is taken by clause 7 not to have incurred any class 2 ABR exploration expenditure. This means that the $70m total exploration expenditure actually incurred by V Co. in the 1991 and 1992 financial years is not transferred to P Co. under section 48(a)(i).

Instead, that expenditure is deemed to be transferable to another project in V Co.'s hands. However, V Co. has no other projects eligible to receive this expenditure and has no intention of investing in further projects. Even if it had, it fails the common interest rule because it has sold its entitlement to receipts from the project. Therefore the expenditure cannot be used by either company.

Treatment of 1991 and 1992 exploration expenditure under the amendment

P Co. is taken to have incurred amounts that would have been included in the incurred exploration expenditure amount of V Co. for the financial year [New subparagraph 48(1)(a)(ia)].

This is not a combined project, so paragraph (a) of the definition of incurred exploration expenditure amount applies. In addition, there is no previous section 48 expenditure to be transferred because V Co. initiated the project and did not buy into it. Therefore the incurred exploration expenditure amount in this example is the amount of exploration expenditure actually incurred by V Co. in the financial year in relation to the project.

The exploration expenditure actually incurred under the definition is the exploration expenditure incurred by V Co. in 1991 and 1992. Therefore, P Co. is taken to have actually incurred $50m exploration expenditure in the 1991 financial year and $20m exploration expenditure in the 1992 financial year. These amounts are not augmented before the transfer [New subsection 48(2)].

Under the amendments, all expenditure associated with the project will be transferred to P Co. By paragraph 48(1)(b), V Co. is taken not to have incurred this expenditure. Therefore, V Co. has no longer any association with expenditures or receipts in relation to the project interest it has transferred to P Co.

Expenditure received by P Co. as a result of this section 48 transaction must be offset against receipts of the project on which it was incurred or was taken to be incurred. It will be compounded when it is offset, wholly or partly, in this way.

Clause 22 of the Schedule prevents the transfer to another project held by P Co. of expenditure related to a project entitlement which has been purchased under section 48. The purchaser (P Co.) must have held an interest with respect to the transferring entity (the project P Co. purchased from V Co.) at all times from the beginning of the financial year in which the expenditure was incurred to the end of the transfer year in order to transfer expenditure.


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