Australia: Understanding the terms “exploration,” “use” and “first use” regarding asset depreciation
Court decision provides taxpayer-favourable interpretations of the terms “exploration” and “use”
Court decision provides taxpayer-favourable interpretations of “exploration” and “use”
The Full Federal Court held in favour of the taxpayer in an important decision concerning the meaning of the terms “exploration” and “first use” in the context of depreciating assets under Division 40 of the Income Tax Assessment Act 1997 (Cth) (ITAA 97).
The Full Federal Court considered and determined the following issues:
- The meaning of the expression “for exploration” and specifically whether certain activities conducted by the taxpayer pursuant to state and Commonwealth licences involved “exploration”
- The meaning of the expression “first use” and “use” in section 40-80 ITAA 97
- Whether provisions of the relevant transitional legislation operated to deny the deduction
The case is: Commissioner of Taxation v. Shell Energy Holdings Australia Ltd.,  FCAFC 2 (25 January 2022). Read the decision
Full Federal Court’s decision
- The depreciating asset related to statutory titles that authorized the taxpayer and another joint venture partner to “explore for petroleum.”
- In 2012, the taxpayer purchased its joint venture partner’s interest in the petroleum project and sought to claim a deduction for the cost of acquiring this interest.
- Although the parties did not dispute that the additional proportional interests in the statutory titles were depreciating assets, the first issue in dispute was whether such an asset could be said to have been used by the taxpayer “for exploration.”
- The Commissioner contended that activities directed towards the recovery of petroleum on an appraisal basis did not constitute “exploration,” arguing that that phrase does not encompass activities directed to investigating the commercial recoverability of petroleum that has been discovered.
- The taxpayer countered that the ordinary meaning of the word “exploration,” the relevant legislative text, and the context of the provision in the larger body of statutes relevant to the exploration of petroleum, meant that its activities directed towards the commercial recoverability of petroleum fell within that phrase’s meaning.
The Full Federal Court held that:
“…there is nothing in the statutory history or in the enactment in the Commonwealth to suggest that Parliament intended that ‘exploration for petroleum’ should be limited to the discovery of petroleum and not include activities directed to investigating the commercial recoverability of petroleum.”
It is possible that the Full Federal Court’s finding may have broader implications on the interpretation of identical terms adopted in the Petroleum Resource Rent Tax (PRRT) and may be inconsistent with the holding of the Administrative Appeals Tribunal (AAT) in ZZGN v. Commissioner of Taxation  AATA 351 (ZZGN) and the Commissioner’s ruling in TR 2014/9.
Section 37 of the PRRT defines “exploration expenditure” as payments to the extent they are made in carrying on or providing operations and facilities involved or in connection with exploration for petroleum. In both the ZZGN case and TR 2014/9, it was accepted that the term “exploration” needed to be construed according to its ordinary meaning—and that ordinary meaning was held to “not extend to include feasibility studies of the field for future development and production.”
The AAT’s approach in ZZGN and Commissioner’s in TR 2014/9 had the effect of narrowing the meaning of “exploration” to:
“…the discovery and identification of the existence, extent and nature of petroleum and not activities associated with evaluating, appraising and scrutinising a potential project after a discovery has been made to ascertain whether production might be economically or commercially viable…”
This position taken by the Commissioner in TR 2014/9 and the AAT in ZZGN appears to now be at odds with the Full Federal Court’s recent decision. This is particularly so when the Full Court held that activities directed to investigating the commercial recoverability of petroleum do fall within the ordinary meaning of the word “exploration.”
The Full Court’s decision on the same concept raises questions as to whether that phrase is to be understood now to include activities associated with “evaluating, appraising and scrutinising a potential project after a discovery has been made to ascertain whether production might be economically or commercially viable” (which have traditionally been excluded by the Commissioner relying on ZZGN and TR 2014/9).
It is also interesting to contrast the Full Federal Court’s decision with the Commissioner’s approach in TD 2019/1 to determining what constitutes “use” of a mining, quarrying or prospecting right that is a depreciating asset for the purposes of section 40-80 ITAA. In TD 2019/1, the Commissioner submitted that merely holding, or meeting the conditions or requirements to hold, or retain a mining quarrying or prospecting right (MQPR) does not constitute a “use” of it for the purposes of section 40-80. The Commissioner suggested that activities that are purely incidental, accidental or irrelevant to the activities permitted by the MQPR will ordinarily be de minimis or trivial and thus not a use of the MQPR for the purposes of section 40-80.
In the lower court’s decision, it was held that the “mere holding” of an MQPR does not amount to “use” even when the asset is installed ready for use. On appeal to the Full Federal Court, the taxpayer argued that there was “first use” of its asset when it held that asset ready for use and that the “first use” of an intangible asset corresponds with the asset’s “start time.” The Commissioner countered that the concepts of “start time” and “first use” are not necessarily coincident and that the notion that a depreciating asset may be “first used” without anything being done was not consisted with the statutory language of 40-80.
Ultimately, the Full Federal Court accepted the taxpayer’s position, and held that “use” in the context of section 40-80 is capable of being passive and that such intangible MQPR assets can be concluded to have been first used once held for use (the start time).
Again, the Full Federal Court’s holding brings into question the correctness of the Commissioner’s determination in TD 2019/1 and supports a view that a broader class of MQPR assets are eligible for depreciation deductions under section 40-80 than have been recognized by the Commissioner in recent years.
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