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Ruling

Subject: Deductions for depreciation of exploration tenements.

Question 1

Is the allocable cost amount (ACA) allocated to the exploration tenements in which A Co has an interest, immediately deductible under subsection 40-80(1) of the Income Tax Assessment Act 1997 to B Co when B Co forms a tax consolidated group with A Co?

Answer

Yes

This ruling applies for the following periods:

1 June 2010 to 30 July 2011

The scheme commences on:

Scheme has not yet commenced

Relevant facts and circumstances

The principle activity of A Co is mineral exploration.

In 20XX, A Co acquired 100% ownership of the shares in B Co.

The principal activity of B Co was mineral exploration.

A Co will elect to form a tax consolidated group, with B Co as a subsidiary member of that group, in 20XX.

B Co has interests in a number of exploration tenements.

At the time A Co carried on a business of exploration, and has continued to do so since then.

The tax costs of the exploration tenements in which B Co has interests will be reset upon formation of the consolidated group.

The interests in the exploration tenements do not constitute trading stock of A Co nor of B Co at any time.

A Co has undertaken exploration on the tenements since it acquired B Co.

No applications have been lodged for mine development licenses or mining leases in relation to any of the exploration tenements in which B Co holds an interest.

No development proposals currently exist in relation to any of the exploration tenements in which B Co holds an interest.

No development budgets have been prepared in relation to the exploration tenements in which B Co has an interest.

B Co acquired its interests in the exploration tenements after 1 July 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 40-25(1)

Income Tax Assessment Act 1997 section 40-30

Income Tax Assessment Act 1997 subsection 40-30(2)

Income Tax Assessment Act 1997 subsection 40-80(1)

Income Tax Assessment Act 1997 section 40-80

Income Tax Assessment Act 1997 Section 40-730.

Income Tax Assessment Act 1997 Subsection 40-730(4)

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 section 701-5

Income Tax Assessment Act 1997 Subsection 701-10(4)

Income Tax Assessment Act 1997 Section 701-55

Income Tax Assessment Act 1997 subsection 701-55(2)

Income Tax Assessment Act 1997 Paragraph 701-55(2)(a)

Income Tax Assessment Act 1997 Division 705

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Subsection 40-25(1) of the ITAA 1997 provides that you can deduct an amount equal to the decline in value for an income year of a depreciating asset that you held at any time during the year.

A depreciating asset, as defined in section 40-30 of the ITAA 1997, includes intangible assets which are (provided they are not trading stock):

· mining, quarrying or prospecting rights, or

· mining, quarrying or prospecting information (subsection 40-30(2) of the ITAA 1997).

A mining, quarrying or prospecting right is defined in section 995-1 of the ITAA 1997 as:

(a) an authority, licence, permit or right under an ^*Australian law to mine, quarry or prospect for minerals, ^*petroleum or quarry materials; or

(b) a lease of land that allows the lessee to mine, quarry or prospect for minerals, petroleum or quarry materials on the land; or

(c) an interest in such an authority, licence, permit, right or lease; or

(d) any rights that:

(i) are in respect of buildings or other improvements (including anything covered by the definition of housing and welfare) that are on the land concerned or are used in connection with operations on it; and

(ii) are acquired with such an authority, licence, permit, right, lease or interest.

However, a right in respect of anything covered by the definition of housing and welfare in relation to a quarrying site is not a mining, quarrying or prospecting right.

Mining, quarrying or prospecting information is defined in section 40-730(8) of the ITAA 1997 as:

Mining, quarrying or prospecting information is geological, geophysical or technical information that:

(a) relates to the presence, absence or extent of deposits of ^*minerals or quarry materials in an area; or

(b) is likely to help in determining the presence, absence or extent of such deposits in an area.

The exploration tenements in which B Co has interests are depreciating assets under paragraph 40-30(2) of the ITAA 1997.

Subsection 40-80(1) of the ITAA 1997 provides you can deduct an asset's cost if the asset is first used for exploration and prospecting for minerals obtainable by mining operations and when first used it is not used for operations in the course of working a mining property.

For purposes of the deduction in terms of subsection 40-80(1) of the ITAA 1997, it is also necessary that when the interests in the exploration tenements are first used you can satisfy one or more of the following:

(i) you carried on mining operations

(ii) it would be reasonable to conclude you proposed to carry on such operations

(iii) you carried on a business of, or a business that included exploration or prospecting for natural resources obtainable by such operations and expenditure on the asset was necessarily incurred in carrying on that business.

Where these conditions are satisfied, the operation of subsection 40-25(1) of the ITAA 1997 and subsection 40-80(1) of the ITAA 1997, will mean the cost of a depreciating asset first used in exploration and prospecting for natural resources obtainable by mining operations will be fully deductible.

Consolidation issue

It is necessary to consider the implications of the consolidation provisions and the single entity rule (refer Taxation Ruling TR 2004/11). Section 701-1 of the ITAA 1997 is a key provision of the consolidation regime. It is the means by which members of a consolidated group are treated as a single entity for income tax purposes (paragraph 3 of TR 2004/11).

The intended operation of the single entity rule is to apply the income tax laws to a consolidated group as if it were a single entity. The assets owned by a subsidiary member of the group are taken to be owned by the head company while the subsidiary remains a member of the consolidated group.

The principle underlying the single entity rule is to treat a consolidated group as a single entity with the head company being that entity for income tax purposes. To this end the single entity rule deems the subsidiary members of the consolidated group to be parts of the head company rather than separate entities (paragraph 7 of TR 2004/11).

A consequence flowing from the single entity rule is that while an entity is a subsidiary member of a consolidated group, actions and transactions of that member are treated as having been undertaken by the head company. In addition, the assets owned by subsidiary members of the group are taken to be owned by the head company (paragraph 8 of TR 2004/11).

In this regard, subsection 701-10(4) of the ITAA 1997 provides that an asset's "tax cost" is set at the time the entity becomes a subsidiary member of the group at the asset's tax cost setting amount. Paragraph 701-55(2)(a) of the ITAA 1997 confirms that at the time of consolidation an asset of a subsidiary is taken to have been acquired by the head company for a payment equal to its tax cost setting amount.

The tax cost setting amount is worked out in accordance with Division 705 of the ITAA 1997.

The Explanatory Memorandum to Taxation Laws Amendment (2004 Measures No.6) Bill 2004 states at paragraph 1.51:

When an entity joins a consolidated group, the cost setting rules apply such that the head company is taken to have purchased, at the joining time, all of the joining entity's depreciating assets for which the joining entity did (or could) deduct the decline in value under subsection 40-80(1) of the ITAA 1997.

While at paragraph 1.52:

Section 701-55 applies to set out for the head company a depreciating asset's tax cost, effective life and method for working out its decline in value. If the head company satisfies the criteria in subsection 40-80(1) for such an asset (e.g. the head company's first use of the asset after the joining time is for exploration or prospecting) it will be entitled to a deduction for a decline in value equal to the asset's tax cost.

Under the single entity rule the exploration tenements owned by B Co will be taken to be assets of A Co, and will be taken to be assets acquired by A Co for a payment equal to the tax cost setting amount worked out under the consolidation cost setting rules when B Co joins the consolidated group.

First use

Under paragraph 40-80(1)(a) of the ITAA 1997, you must first use the depreciating asset for exploration or prospecting for natural resources or quarry materials obtainable by mining operations. The 'first use' is by the current holder of the asset as the requirement is entity/taxpayer specific, not asset specific.

Generally the 'entry history rule' in section 701-5 of the ITAA 1997 prescribes that, for income tax purposes, everything that happened in relation to the entity before it became a subsidiary member is taken to have happened in relation to the head company. However, for depreciating assets, paragraph 701-55(2)(a) of the ITAA 1997 overrides the entry history rule in terms of acquisition date. Where Subdivision 40-B of the ITAA 1997 is to apply, it provides that the depreciating asset is taken to be acquired at the joining time for a payment equal to its tax cost setting amount. Applying this provision to B Co's exploration tenements, they would be deemed to be acquired by A Co at the joining time (when the consolidated group is formed), at the respective tax cost setting amounts allocated by A Co.

Further, as the deemed occurrences in section 701-55 of the ITAA 1997 override the entry history rule, the first use of those assets by B Co will be disregarded i.e. everything that happened in relation to B Co's assets before it became a subsidiary member of A Co's consolidated group will not be taken to have happened in relation to A Co.

Application of section 40-80 of the ITAA 1997

A Co has undertaken exploration of the tenements since a particular year, has not undertaken development activities on the tenements, and was an active exploration company. All of the conditions in section 40-80 of the ITAA 1997 are met. A Co will be taken to have acquired the exploration tenements on during 20XX (when the consolidated group forms). A Co is entitled to an immediate deduction for the decline in value of the tenements. The deduction will be the assets' costs, as determined under the consolidation cost setting rules.