In brief 2 min read
As part of the Federal Government's 2023-24 Budget (Budget), it was announced that legislation would be enacted to apply a narrow meaning of 'exploration' for petroleum resource rent tax (PRRT) purposes. In September 2022, we declared that the decision in FCT v Shell Energy Holdings Australia Limited  FCAFC 2 marked the end of the long journey to determine the meaning of 'exploration' for tax purposes as highlighted in this Insight. To our surprise, the journey continues, as it was announced in the Budget that a narrow meaning of exploration for PRRT purposes will be retrospectively applied with effect from 21 August 2013.
- PRRT taxpayers will need to consider the treatment of both 'exploration' expenditure and transfers of exploration expenditure since 2013, as a narrow meaning will now apply from 21 August 2013.
- Legislative amendments will ensure that mining, quarrying and prospective rights (MQPRs) cannot be depreciated for income tax purposes until they are used (not merely held), with effect from 9 May 2023.
- Legislative amendments will limit the tax adjustments relating to MQPRs where new rights relate to areas covered by pre-existing rights, with effect from 9 May 2023.
Prior to the Shell Energy case, the debate between taxpayers and the ATO was whether the meaning of 'exploration' for tax purposes was confined to activities directed at identifying the existence of a resource (a narrow meaning), or extended to the activities that commercial enterprises will undertake to evaluate whether a discovered resource is recoverable on a commercial basis (a broad meaning).
The Shell Energy case settled the debate in a petroleum context when the Federal Court found that 'exploration' should be given a broad meaning. According to Chief Justice Allsop in FCT v Shell Energy:
'The notion that the words "explore" and "exploration" should be limited to finding the existence of some petroleum; and that any steps thereafter to find or discover its extent, worth or commercial feasibility for exploitation are not exploration or exploratory cannot be accepted and must be rejected.'
Exploration activities are given special treatment for the purposes of both income tax law and PRRT. The effect of the decision in Shell Energy was that the broad meaning of 'exploration' would apply in relevant circumstances for both income tax and PRRT. At least, that was the case before Budget night, 9 May 2023.
In the 2023 Federal Budget, the Government announced that legislation would be enacted to apply the narrow meaning of 'exploration' for PRRT purposes. This will be retrospective legislation as it will apply the narrow meaning of exploration for PRRT purposes with effect from 21 August 2013.
Specifically, with effect from 21 August 2013, for PRRT purposes ‘exploration for petroleum’ will be limited to the ‘discovery and identification of the existence, extent and nature of the petroleum resource’ and will not extend to ‘activities and feasibility studies directed at evaluating whether the resource is commercially recoverable’. The Government states that this will achieve alignment with public ruling TR 2014/9 (which applied from 21 August 2013).
For PRRT purposes, the meaning of 'exploration' will be reset to a narrow meaning with effect from 21 August 2013. PRRT taxpayers will need to consider how this may affect the way they have treated 'exploration' expenditure since 2013, and transfers of exploration expenditure since 2013. The PRRT Act provides that a taxpayer must transfer as much of the transferable exploration expenditure as can be transferred, and failure to do so is an offence of strict liability unless the taxpayer can prove there is a reasonable excuse for not doing so.
For income tax purposes, the meaning of 'exploration' and the guidance from the Shell Energy case will be unaffected by the retrospective law change. As such, where it is necessary to consider the ordinary meaning of 'exploration' in Division 40 of the Income Tax Act, the guidance from the Shell Energy case on the ordinary meaning will continue to apply. This is separate and distinct from existing subsection 40-730(4)(c), which specifies that 'exploration' includes feasibility studies directed at evaluating the economic feasibility of exploiting the relevant resource.
Beware the risk of law change
The Government's announcement serves as a reminder of the risk of law change where a court decision might not align with the Government's policy objective. It shows us that taxpayers need to keep one eye on the Government's desired policy outcome, for if the law is determined to be otherwise, parliament can intervene and legislate for the desired outcome, and can do so with retrospective effect.
In addition to the announcement of the retrospective law change discussed above, the 2023 Federal Budget also contained two related measures that will apply prospectively, from 9 May 2023.
The first is that legislative amendments will be introduced to ensure that MQPRs cannot be depreciated for income tax purposes until they are used (not merely held). This measure is expected to reverse the effect of the finding in Shell Energy that MQPRs can be used in the relevant sense when held ready for use. Taxpayers will need to watch this development carefully, as the term 'use' is applied extensively in Division 40 and elsewhere in the Income Tax Act.
The second will be to limit the circumstances in which the issue of new rights relating to MQPRs can be taken into account where the new rights relate to areas covered by pre-existing rights. This measure is also expected to reverse a finding of the Federal Court in Shell Energy. In Shell Energy, in the context of the transitional provisions it was held that the word 'same' meant 'identical' and, as such, a right covering area A does not cover the 'same' area as area B where area A is a subset of area B.