Capital v. Revenue expenditure re purchase of mining land

Is the taxpayer eligible to claim outright deductions pursuant to subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of land purchased to access existing ore bodies?

No. Land acquisition expenses are not deductible pursuant to subsection 51(1) ITAA 1936. Land acquisition expenses are allowable capital expenditure pursuant to Division 10 section 122A of the ITAA 1936.

The Commissioner is of the view that the expenditure incurred in acquiring the land was a once and for all payment for a substantial advantage of an enduring, ongoing or continuing nature, namely, the making of resources within the tenement area available for the commencement of extraction.

In the present case the purpose for the land acquisition expenditure was to obtain the key which unlocks the ability to mine, and buying that key, or having it cut, is capital not income.

In accordance with the comments made in the case, Federal Commissioner of Taxation v. Pine Creek Goldfields Ltd 42 ATR 758; (1999) 91 FCR 263; 99 ATC 4904 (the Pine Creek Case ) by Gyles J, capital outlay may be required more than once in the conduct of a business activity but that does not make the expenditure a revenue outgoing. The Commissioner is similarly of the view that the taxpayers frequency of the land purchases in the present case does not shift the categorisation of the expenditure from capital to revenue.

The Pine Creek Case includes a comment by Gyles J, in reference to Johns-Manville Canada Inc. v The Queen 85 DTC 5373 ( the Johns-Manville Case ), to the effect that even though the outlay was deductible in that case, the result had little relevance to the case before him. He also stated that he had difficulty with the judgement which was heavily influenced by the court's view that any factual ambiguity should be resolved in the taxpayers favour. The Commissioner is of the view that had the case been considered under Australian Law that the result would have been different and therefore any precedential benefit that could be obtained from the case would need to be discounted accordingly.

The expenses, which were previously capitalised for accounting purposes and amortised in accordance with Division 10 section 122A of the ITAA 1936 were now claimed as subsection 51(1) deductions for tax purposes.

As outlined in Taxation Ruling 95/36 (TR 95/36), which applies to taxpayers who carry on prescribed mining operations as defined in subsection 122(1) of Division 10 of Part III of the ITAA 1936, a general distinction must be drawn between capital expenditure incurred in the establishment or extension of a mine and revenue expenditure incurred in operating a mine for the purpose of working or extracting the ore-body.

The extractive process is limited to the removal of overburden necessary to expose the ore body to be mined including any overburden removal necessary to maintain a safe working slope for the open pit.

The expenses incurred in purchasing the land surrounding the mining operations were incurred in establishing, developing and extending the mine are to be viewed as capital in nature since they were incurred for the purpose of bringing a capital asset into existence or enhancing it. The expenditure was not incurred in the mining operations but in making the mining operations possible by removing a mining constraint.

The Commissioner is of the view that the expenditure incurred in acquiring the land was a once and for all payment for a substantial advantage of an enduring, ongoing or continuing nature, namely, the making of resources within the tenement area available for the commencement of extraction.

In the present case the purpose for the land acquisition expenditure was to obtain the key which unlocks the ability to mine, and buying that key, or having it cut, is capital not income.

Paragraph 64 of TR95/36 states:- 'The taxation treatment of various expenditures in relation to open pit mining was considered by the Supreme Court of Canada in Johns-Manville Canada Inc. v The Queen 85 DTC 5373. In this case the court decided that the on going costs of acquiring land surrounding an open pit mine to maintain a proper slope for economic and safety reasons were revenue expenses'.

The Johns-Manville Case was decided under Canadian law and the above reference was only an observation of the case and not an authority to be necessarily followed by the ATO.

Taxation Ruling TR 95/36 deals with the characterisation, for income tax purposes, of expenditure incurred in establishing and extending a mine. In particular it looks at the general distinction between capital expenditure incurred in the establishment or extension of a mine and revenue expenditure incurred in operating a mine. It further examines the capital/revenue distinction in regard to certain aspects of open pit mining and whether the characterisation of some expenditure which would be regarded as capital for an underground mine is revenue for an open pit mine.

Generally, expenditure incurred on the creation, making or extension of a mine is capital expenditure while expenditure incurred in the working or extraction of the ore body is a revenue expense. The context of paragraph 64 of TR 95/36, as revealed in the ensuing paragraphs of the Ruling, is that it is talking about haulage roads and not land acquisition costs.

As a general principle in the mining industry, the costs of acquiring land or mining or exploration rights are normally viewed as capital outlays made for the purpose of allowing rights of access to an area, to enable the conduct of exploration or prospecting or the extractive mining process to then be undertaken. Accordingly claims for deduction of this type of expenditure are not normally allowed under subsection 51(1) of the ITAA 1936.

The Pine Creek Case was about expenditure incurred by the taxpayer in diverting a public highway around the town of Pine Creek. The original highway ran through the taxpayer's mining tenement and restricted its ability to mine all of the known reserves in the pit on which it was currently mining and prevented it from opening up a new pit adjacent to the operating pit.

Hill J, in a single judgement, allowed the expenditure as a subsection 51(1) deduction on the basis that it was simply part of the trading operations of a mining business. Hill J referred to the principles espoused in the Johns-Manville Case but only cited two of them, No.1 and No.5 being the principles going to purpose and transitional benefit, as supporting his view that the expenditure was a subsection 51(1) deduction of the ITAA 1936.

On appeal the full Federal Court held (by majority) that the expenditure was capital and not deductible under subsection 51(1) of the ITAA 1936. However it did hold that the expenditure was deductible on an amortisation basis under the provisions of Division 10 of the ITAA 1936 even though the expenditure was not incurred on the taxpayers actual mining property.

In his principal judgement in the Pine Creek Case Gyles J said at paragraph 72 onwards: 'The respondent relies upon the decision of the Canadian Supreme Court in Johns-Manville, a decision referred to by the trial judge. In that case, the taxpayer operated an open-pit mine. The facts are adequately summarised in the following passage from the leading judgment, at DLR 212: ...the law of gravity being what it is, the hole dug in the ground in order to remove the ore must be conically shaped and must expand outwards but on the same slope as the hole is deepened by the removal of the ore. Hence the required enlargement of the diameter of the hole at the top of the mining pit necessitates the purchases of land at the periphery of the pit and the removal therefrom of the soil and rock to a substantial depth. The evidence was that for almost 40 years mining operations have required a progressive acquisition of land so as to maintain the walls of the conically-shaped mining pit at a safe angle. As the pit deepens in the course of mine operations its mouth at the surface must widen in order to maintain a safe angle of slope. Consequently, additional land was regularly acquired and any buildings thereon were removed. The soil was then stripped away so that the wall of the pit was pushed back or outwards from its prior location. In the conventional sense of "land", all that remains of the acquired area is a part of a sloped wall, well below the original surface, between the top of the mine and the exposed ore body at the bottom of the pit. As additional land was acquired, the sloping wall was pushed further outward and consequently the actual location of the surface of each acquisition moves down the wall although the sloped angle of the surface remains generally constant. Any roadways located on the "steps" cut into the face of the wall likewise disappear on each enlargement of the pit and are re-established on the new sloping wall after the surface of the additional lands has been stripped off. All of these changes proceed as the removal of the ore body progresses.'

In his review of the facts Gyles J concluded that even though the outlay was deductible under Canadian law the result had little relevance to the case before him. 'I would find it hard to accept everything that was said in the principal judgement in that case, which was plainly heavily influenced by the court's view that any factual ambiguity should be resolved in favour of the taxpayer, particularly where the taxpayer did not qualify for the Canadian equivalent of deductions under Div.10.'

In Mount Isa Mines Ltd v. Federal Commissioner of Taxation (1992) 110 ALR 29; (1992) 176 CLR 141; 24 ATR 261; (1992) 67 ALJR 89; 92 ATC the High Court referred to the danger of applying the simple "purpose of the expenditure" test noting that it too readily invited the answer that the purpose was to increase trading profits.

In the present case the purpose for the land acquisition expenditure was to obtain the key which unlocks the ability to mine, and buying that key, or having it cut, is capital not income.

Gyles J at paragraph 95 of the Pine Creek Case stated that: 'The Explanatory Memorandum to the bill by which section 122A was inserted into the ITAA 1936 was in the following terms: Paragraph (a) includes capital expenditure of a general kind incurred by a mine-owner in carrying on "prescribed mining operations"...[T]his term covers the process of extracting a mineral from its natural site by mining operations for the purpose of earning assessable income. Expenditure on opening up the ore body or in the construction of drives in removing the ore and other expenditure of a like nature will qualify under this paragraph.'

At paragraph 97 of the Pine Creek Case he concludes his findings in the case by referring to the fact that the expenditure in question was not incurred "in mining operations" but rather in putting the taxpayer in the position to conduct mining operations by removing the constraints upon those operations. He continues by saying: 'The proper question posed by the statue in the present case is whether this was capital expenditure incurred for the purpose of carrying on mining operations for the extraction of minerals from their natural site for the purpose of gaining or producing assessable income on the existing mining property.'

Gyles J concluded the answer in the affirmative and in so doing dismissed the appeal insofar as it challenged the finding that the respondent was entitled to a deduction under Division 10.