Capital Allowances: decline in value - taxable purpose - hobby of prospecting

Can a taxpayer claim a deduction under subsection 40-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the decline in value of depreciating assets they use wholly in a hobby of prospecting?

No. The taxpayer can not claim decline in value deductions under subsection 40-25(1) of the ITAA 1997 for depreciating assets they use wholly in a hobby of prospecting.

The taxpayer carries on a hobby of prospecting for precious metals.

The taxpayer does not conduct these activities as a business or carry on any activities for the purpose of producing assessable income in relation to their prospecting activity. As such, the specific provisions relating to deduction for expenditure on exploration or prospecting and deductibility of cost of depreciating assets in section 40-730 and subsection 40-80(1) of the ITAA 1997 do not apply.

The taxpayer purchases depreciating assets wholly for use in their hobby. They also obtain an exploration licence from a State government. The licence is also a depreciating asset as it is a mining, quarrying or prospecting right under paragraph 40-30(2)(a) of the ITAA 1997.

The taxpayer holds those depreciating assets as the owner under Item 10 of the table in section 40-40 of the ITAA 1997.

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 is held by the taxpayer during that year.

However, subsection 40-25(2) of the ITAA 1997 provides that you must reduce the deduction by the part of the asset's decline in value that is attributable to your use of the asset for a purpose other than a taxable purpose.

A taxable purpose is defined in paragraph 40-25(7)(b) of the ITAA 1997 to be 'the purpose of exploration or prospecting'. Section 995-1 of the ITAA 1997 provides that 'exploration or prospecting' has the meaning given in section 40-730 of the ITAA 1997.

Subsection 40-730(4) of the ITAA 1997 provides that exploration or prospecting includes: (a) for mining in general, and quarrying: (i) geological mapping, geophysical surveys, systematic search for areas containing *minerals (except *petroleum) or quarry materials, and search by drilling or other means for such minerals or materials within those areas; and (ii) search for ore within, or near, an ore-body or search for quarry materials by drives, shafts, cross-cuts, winzes, rises and drilling; and (b) for petroleum mining: (i) geological, geophysical and geochemical surveys; and (ii) exploration drilling and appraisal drilling; and (c) feasibility studies to evaluate the economic feasibility of mining minerals or quarry materials once they have been discovered; and (d) obtaining *mining, quarrying or prospecting information associated with the search for, and evaluation of, areas containing minerals or quarry materials.

Subsection 40-730(4) of the ITAA 1997 is an inclusive definition of the activities that constitute 'exploration or prospecting'. The case of Cohns Industries Pty Ltd v. Deputy Commissioner of Taxation (1979) 9 ATR 759; 79 ATC 4243 ( Cohns' case ) confirms that when a definition uses the word 'includes', the word(s) defined take on their ordinary meaning and also the meaning as described in the provisions.

The ordinary meanings of 'exploration' and 'prospecting' as expressed in the Macquarie Dictionary do not require a significant size or scale and a taxpayer conducting a hobby of prospecting can be exploring or prospecting in the ordinary sense of those words.

However, it was also acknowledged by their honours in Cohns' case that the meaning of 'includes' can sometimes be exhaustive. Whether the meaning is inclusive or exhaustive depends on the terms used in other definitions in the particular legislation and whether meanings other than those listed could ordinarily be regarded as coming within the term defined (YZ Finance Company Pty Ltd v. Cummings (1964) 109 CLR 395; and Re Gray, Adamson and AMWU; Ex parte Marsh and Another (1985) 62 ALR 17).

In section 40-730 of the ITAA 1997 both 'includes' and 'means' are used in different subsections. In subsection 40-730(5) of the ITAA 1997, 'includes' is used to provide an inclusive list. In subsections 40-730(6) and (7) of the ITAA 1997, 'means' is used to provide an exhaustive list.

As 'includes' is used in subsection 40-730(4) of the ITAA 1997 and as the actual wording of subsection 40-730(4) does not intend or imply an exhaustive list, it is considered that exploration or prospecting would incorporate activities within the ordinary meaning of those words and also those listed.

However, the meaning of 'exploration or prospecting' must also be determined by applying the statutory interpretation principle that the Act must be read as a whole and in context (Attorney-General v. Prince Ernest Augustus of Hanover [1957] AC 436 at 461, 473; Maunsell v. Olins [1975] AC 373 at 386; Black-Clawson Ltd v. Papierwerke AG [1975] AC 591 at 613).

In the High Court (Full Court) case of The Metropolitan Gas Co v. The Federated Gas Employees' Industrial Union [1924] 35 CLR 449 ( Metropolitan Gas case ), Isaacs and Rich JJ (at 455) state that: It is a received canon of interpretation that every passage in a document must be read, not as if it were entirely divorced from its context, but as part of the whole instrument...If when so read the meaning of the section is literally clear and unambiguous, nothing remains but to give effect to the unqualified words.

This statutory principle, expressed in the Metropolitan Gas case , says that we need to read the Act as a whole and therefore, those activities considered to be 'exploration or prospecting' can only be done in a context which is provided for in Division 40 of the ITAA 1997.

'Exploration or prospecting' appears in section 40-730 of the ITAA 1997 and subsection 40-80(1) of the ITAA 1997. Section 40-730 of the ITAA 1997 provides for an immediate deduction for certain expenditure on exploration or prospecting. Subsection 40-80(1) of the ITAA 1997 provides that the decline in value of certain depreciating assets first used for exploration or prospecting is their cost. However, in order for those provisions to apply, the taxpayer must satisfy the following: • the taxpayer must carry on mining operations • it must be reasonable to conclude that the taxpayer proposes to carry on such operations; or • the taxpayer must carry on a business of, or a business that includes, exploration or prospecting for minerals or quarry materials obtainable by such operations, and the expenditure is necessarily incurred in carrying on that business.

The meaning of 'mining operations' is contained in subsection 40-730(7) of the ITAA 1997 and covers certain mining and quarrying operations carried on for the purpose of producing assessable income.

In the context in which 'exploration or prospecting' is used in section 40-730 of the ITAA 1997 and subsection 40-80(1) of the ITAA 1997, the exploration or prospecting activities need to be carried out by a taxpayer carrying on, or proposing to carry on, mining operations or by a taxpayer carrying on a business of exploration or prospecting.

'Exploration or prospecting' also appears in sections 40-735 and 40-755 of the ITAA 1997, which provide immediate deductions for certain expenditure incurred on mining site rehabilitation and environmental protection activities, respectively. These sections take the meaning of 'exploration or prospecting' from subsection 40-730(4) of the ITAA 1997.

The meaning of 'mining site rehabilitation' in subsection 40-735(4) of the ITAA 1997 is, broadly, the rehabilitation of a site to the condition it was in before mining operations, exploration or prospecting or ancillary mining activities (such as preparing a site for the taxpayer to carry on mining operations) were first started.

The deduction for environmental protection activities is only allowable in respect of pollution or waste resulting from an earning activity, being an activity the taxpayer carries on, carried on, or proposes to carry on: • for the purpose of producing assessable income (except a capital gain) • for the purpose of exploration or prospecting • for the purpose of mining site rehabilitation; or • for purposes that include one or more of these purposes.

'Exploration or prospecting' appears in sections 40-735 and 40-755 of the ITAA 1997 amongst other activities which all relate to mining operations or a purpose of producing assessable income. Therefore, in the context in which it appears in those sections, it is inconceivable that 'exploration or prospecting' could include exploration or prospecting carried out by a hobbyist prospector.

It is clear from paragraph 7.16 of the Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 that the inclusion of 'the purpose of exploration or prospecting' in the meaning of taxable purpose in subsection 40-25(7) of the ITAA 1997 was to deal with situations such as where exploration or prospecting is carried out preliminary to the earning of assessable income through mining operations or a business of exploration or prospecting. Without paragraph 40-25(7)(b) of the ITAA 1997, the decline in value of depreciating assets used for exploration or prospecting, preliminary to the earning of assessable income, would not be fully deductible under Subdivision 40-B of the ITAA 1997. In the case of a hobbyist prospector, exploration or prospecting is not carried out prior to the earning of assessable income as income that might be earned will not be assessable.

The whole basis of the tax system in Australia is that taxable income is worked out by deducting from a taxpayer's total assessable income all general and specific deductions (section 4-15 and Division 8 of the ITAA 1997). All deduction provisions (except for a few specific deduction provisions such as those in relation to gifts) require some connection with the earning of assessable income. Division 40 of the ITAA 1997 itself contains such requirements, for example, subsection 40-25(2) of the ITAA 1997 reduces a taxpayer's deduction for the decline in value of a depreciating asset if the asset is used other than for a taxable purpose.

Therefore, it is irreconcilable that 'the purpose of exploration or prospecting', as it appears in the meaning of taxable purpose in subsection 40-25(7) of the ITAA 1997, could include the purpose of a hobbyist prospector carrying out exploration or prospecting activities.

Considering the context in which 'exploration or prospecting' appears in Division 40 of the ITAA 1997, an entity will only be conducting 'exploration or prospecting' for a taxable purpose where: • a mining operation is being carried on by that entity • it would be reasonable to conclude that the entity proposes to carry on such operations, or • the entity carries on a business of, or a business that includes, exploration or prospecting for minerals or quarry materials obtainable by such operations, and the expenditure is necessarily incurred in carrying on that business.

As the taxpayer is conducting a hobby, they will not be conducting 'exploration or prospecting' for a taxable purpose and therefore, the decline in value deduction is reduced to nil under subsection 40-25(2) of the ITAA 1997.