Edited version of private ruling

Authorisation Number: 1011678206008

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Ruling

Subject: Are exploration wells depreciating assets?

Question 1

Is an exploration well a depreciating asset, other than an intangible asset, for the purposes of paragraph 41-10(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ended 31 December 2009

Relevant facts and circumstances

The taxpayer, is a mining company with mining exploration and production operations within Australia and overseas.

The taxpayer lodged a private ruling application for the consideration of whether a number of mining exploration wells would each be classified as a depreciating asset, other than an intangible asset, for the purposes of paragraph 41-10(1)(a) of the ITAA 1997.

The taxpayer holds exploration permits.

Each exploration permit was subject to a minimum work requirement, which usually included a requirement for exploration wells.

The taxpayer advised that:

§ the cost of each well exceeded the *new investment threshold of $10,000 [applicable to paragraph 41-35(b)];

§ each exploration well was spudded;

§ each well was formed by drilling a well bore to an identified reservoir;

§ each well was used to gather data from reservoir formations to verify the presence or absence of hydrocarbons in the reservoirs and, where applicable, quantify hydrocarbon reserves;

§ each well shaft is cased with steel pipe to provide structural support to maintain the integrity of the well and isolate underground formations;

§ on completion of the exploration activities for each well, the well head assemblies were dismantled, the casing strings cut to below ground level and the wells were plugged with cement and abandoned;

§ the drilling rig was released from each well;

§ over time the steel casing used in the exploration wells will deteriorate due to corrosion and seabed pressure and the wells will collapse upon itself; and

§ as a result, the wells cannot be economically maintained in reasonably good order for an indefinite time.

Detailed reasoning

All legislative references are to the ITAA 1997.

Paragraph 41-10(1)(a) provides that you can deduct an amount in relation to an asset if it is a depreciating asset other than an intangible asset. Division 41 relies on the meaning of 'depreciating asset' given by section 40-30.

The taxpayer has described the process of creating the well including its casement with a steel tube. The resulting artefact is tangible and self-evidently a fixture on land.

At common law, fixtures on land become part of the land. Land is specifically excluded in paragraph 40-30(1)(a) from being a depreciating asset, even if, in certain circumstances, it may satisfy the other requirements of the definition of a depreciating asset. However, paragraph 1.16 of the Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 indicates fixtures on land may still qualify as depreciating assets. To this end, subsection 40-30(3) states that fixtures on land (among other things) are treated as assets separate from the land for the purposes of Division 40.

Given the mechanism allowing fixtures on land to be treated as separate to the land for the purposes of Division 40, the exception of land from being a depreciating asset is limited to land within the ordinary meaning of that word, rather than in its legal meaning as mentioned above. A fixture on land is inherently separately distinguishable from the land, in its ordinary meaning, to which it is attached.

Note 1 to subsection 40-30(3) makes it clear that, even though a fixture on land is treated as separate from the land, whether a fixture is a depreciating asset depends on whether it falls within the definition of depreciating asset in subsection 40-30(1). Therefore, it is necessary to determine if the well in this case is a depreciating asset under subsection 40-30(1).

A depreciating asset is broadly defined in subsection 40-30(1) as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

The term 'effective life' is defined by reference to the method of its calculation. Section 40-105 provides that you work out the effective life of an asset by estimating the period, in years, it can be used for a taxable purpose or for the purpose of producing exempt or non-assessable non-exempt income and, if relevant, having regard to the wear and tear you reasonably expect from the expected circumstances of your use, and assuming that it will be maintained in reasonably good order and condition.

The taxpayer has described how the well and its steel casing will deteriorate under the conditions of pressure. Therefore, it is clear that the well cannot be economically maintained in reasonably good order and condition for an indefinite period.

The well in this case has a limited effective life and will decline in value over the time it is used. Therefore, it is considered that the well is a depreciating asset for the purposes of subsection 40-30(1) and a tangible depreciating asset for the purposes of paragraph 41-10(1)(a).

This ruling does not attempt to rule on the most suitable provision for a taxpayer to claim a deduction, nor on the quantum of any potential deduction, for these assets.