Focus: Taxing time for PRRT
18 April 2011
In brief: A recent Federal Court decision highlights the difficulties that can be encountered in trying to define the taxing point in a manner that is capable of applying to a wide variety of different projects. The case could also prove instructive for those drafting the Minerals Resource Rent Tax legislation. Partner Grant Cathro (view CV) reports.
- Taxing point
- Payments for variation of sales contract
- The take or pay payment
- The value of gas used to generate electricity
- Implications for the MRRT
How does it affect you?
- The Federal Court's decision in Esso Australia Resources Pty Ltd v The Commissioner of Taxation  FCA 360 contains a number of observations about the point at which resources are to be taxed and the basis upon which amounts are to be brought to account as revenue. These observations are relevant to other companies that are currently paying Petroleum Resource Rent Tax (PRRT) , or will be coming into the PRRT net when it is extended, effective 1 July 2012.
- The decision casts doubt on the point at which gas produced for liquefaction in an LNG plant is to be taxed for PRRT purposes.
- Although the Minerals Resource Rent Tax (MRRT) legislation will be drafted in different terms, the approach taken by the court to the issues in this case is instructive for those reviewing the MRRT legislation.
On 13 March 2011, the Federal Court handed down a decision in a dispute between the Bass Strait joint venturers (BHP Billiton and ExxonMobil) over the point at which profits were to be calculated for the purposes of the PRRT. The case highlights the importance of the definition of the 'Taxing Point' in both the PRRT and the proposed MRRT.
The case also considered the assessability of a range of other amounts. Those other amounts were:
- payments received for a variation in the contractual terms of a gas supply contract;
- payments received at the end of a gas supply contract under a so-called 'take or pay' provision; and
- the assessability of the value of gas used to generate electricity, part of which was sold into the Victorian electricity grid.
The key issue in the case related to the point at which the joint venture parties were required to bring to account revenue for the purposes of calculating the taxable profit arising from the Bass Strait project.
The Bass Strait joint venturers recover petroleum from a variety of platforms in Bass Strait and separate the petroleum into gaseous and liquid streams that are then transported to processing facilities at Longford, where they are processed into stabilised crude oil, natural gas and something the court referred to as 'raw' LPG. The stabilised crude oil and raw LPG are piped to facilities at Long Island Point on Western Port Bay, where the raw LPG is processed into three commercial products: ethane, commercial butane and commercial propane.
The key taxing point issue was whether the joint venturers were liable to tax on something which met the definition of a marketable petroleum commodity, 'sales gas', under section 24(c) of the Petroleum Resource Rent Tax Assessment Act 1987 (Cth) (the PRRTA Act), at some point before it was processed into a final product for sale at the exit of the Longford plant, or were, as asserted by the Commissioner, liable to tax on the sale proceeds of the processed gas after it exited the Longford plant. This issue arose both under the old definition of 'sales gas' which applied prior to 1 April 2002 and the new definition which was inserted from 1 April 2002 specifically to accommodate LNG projects.
While the court accepted that the joint venture partners had a mixture that met the pre-April 2002 definition of 'sales gas' in the PRRTA Act on a number of their offshore platforms, the court ultimately found that they were not assessable on the value of this mixture under s24(c), but instead were assessable on the value of the commercial products produced.
In reaching this conclusion, Justice Middleton was influenced by the object of the Bass Strait facilities which he saw as integrated in nature and designed to produce commercially saleable oil and gas products. He felt that the concept of a project to which the tax applied 'must envisage a scheme or plan carried out with a particular commercial purpose in mind. Relevantly, in these proceedings the joint venture'. In his view, 'one is entitled to look at the objective of the facilities themselves and their overall purpose or object to determine the exact nature and extent of a particular petroleum project' for the purposes of the PRRT.
His Honour stated:
[The] concept of products 'produced' from petroleum (referred to in s 24 and again in the definition of 'marketable petroleum commodity') along with the nature of a petroleum project, envisages the bringing into existence of something that is sold or will create value or command a price.
As the Bass Strait project produced a product for sale (namely natural gas) which was sales gas as defined and therefore a marketable petroleum commodity, it was only at that point that a product was produced from petroleum recovered within the terms of s24(c) of the legislation.
Post-1 April 2002
The court went on to consider whether the change in the 'sales gas' definition effective from 1 April 2002 altered its conclusion.
His Honour found that even though a mixture existed within the Longford plant which was in a gaseous state when at a temperature of 150C and a pressure of 1 atmosphere, that the change to the definition of 'sales gas' made in 2002 was not intended to change the outcome for the Bass Strait project. Consequentially, he did not go on to consider whether or not the mixture which existed within the Longford plant met the other requirements embodied in the 'sales gas' definition.
His Honour reached the conclusion that the gas produced was not to be taxed within the Longford plant for the same reasons that applied in the period prior to 1 April 2002.
Ramifications for LNG projects
The approach which has been adopted by the court in relation to the period after 1 April 2002 appears to introduce a number of requirements which are not found in the definition of 'sales gas' itself, but which need to be satisfied before an amount is to be included in assessable petroleum receipts. It seems that not only must there be something which meets the various requirements embodied in the definition of 'sales gas', but that substance must be something that is 'sold, creates value or commands a price', in a sense which the gas within the Longford plant did not.
The court's approach to the scope of a project in the context of an integrated operation calls into question whether these requirements will be met before the end of an integrated LNG project. Of course where gas is sold by an upstream joint venture to a downstream joint venture before it is liquefied, the taxing point would be the point of first sale.
This aspect of the case concerned the liability of payments received by each of the joint venture participants in return for agreeing to a variation in the terms of a contract for the sale of gas. These contractual variations were intended to enable the buyer to access a higher maximum daily quantity of gas under the sales contract at particular times, if the buyer found that necessary.
Ultimately, the court held that the payments received for this variation were not assessable. Following the reasoning of the court in the earlier Woodside decision, Justice Middleton indicated that:
The PRRT is relevantly imposed on the sale of gas. The focus is upon that sale and the consideration for the sale. ...[T]he question is to determine, within that context, what the consideration was for the sale of the gas.
In his view:
[T]he...payments did not have the relevant and direct nexus with the sales of gas originally agreed in ... the Sales Agreement.
The principles applied by the court to the take or pay payment were similar to those applied to the payment for the variation of contract. Ultimately, the question in the case came down to one of analysis of the nature of the rights under the particular contract in question and the characterisation of the payment made.
The court held that the take or pay payment was assessable, as it had a relevant relationship with the gas delivered in the year of payment.
The analysis on this point turns very much upon the terms of the particular contract in question and it should not be assumed that all take or pay payments will necessarily be assessable when received, particularly when the payment is received in return for an option to take delivery of gas in future years.
Esso had included in its assessable receipts, for each of the years in dispute, an amount representing the market value of gas used by it to generate electricity at Longford, in circumstances where surplus electricity was sold into the Victorian electricity grid. Esso then objected to the inclusion of these amounts.
The court ultimately held that the market value of this gas was not assessable.
It will clearly be necessary for the legislation imposing the MRRT to identify the point at which the value of iron ore and coal is to be brought to account.
The Federal Government has accepted the recommendations made by the Policy Transition Group (the PTG) in its December 2010 report. Those recommendations include recommendations about the location of the taxing point.
Generally, the taxing point will be at the point that the iron ore or coal leaves the point at which it has been stockpiled after being extracted (the run of mine stockpile).
The terms of the MRRT legislation will obviously differ significantly from the PRRT legislation. This case, however, is instructive for those drafting the legislation. The case highlights the difficulties which can be encountered in trying to define the taxing point in a manner which is capable of applying to a wide variety of different projects.
The PTG has recommended that take or pay payments received should be assessable for MRRT purposes. Given this recommendation, it seems likely that the MRRT legislation will have specific provisions in it dealing with take or pay payments, which are not found in the PRRT legislation.
- Grant CathroPartner,
Ph: +61 3 9613 8644
- Katrina ParkynPartner,
Ph: +61 7 3334 3323
- Tony KuhnPartner,
Ph: +61 3 9613 8940