Issue
In determining whether subsection 40-80(1) of the Income Tax Assessment Act 1997 (ITAA 1997) applies in respect of the decline in value of mining, quarrying or prospecting rights a taxpayer holds, did the taxpayer 'use' the mining, quarrying or prospecting rights in conducting its feasibility studies?
Decision
No. The taxpayer did not use the mining, quarrying or prospecting rights in conducting its feasibility studies because these feasibility studies did not exploit the inherent character of mining, quarrying or prospecting rights and therefore there was no use of the rights for the purposes of subsection 40-80(1) or Division 40 of the ITAA 1997 generally.
Facts
All legislative references are to the ITAA 1997 unless otherwise stated.
The taxpayer purchased a mining exploration project from a vendor pursuant to a sale agreement. The vendor had completed exploration sufficient that they had proved mineral reserves in accordance with the Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves (JORC Code).
The assets acquired by the taxpayer pursuant to the sale agreement included a lease and a licence issued by the relevant State Government Minister which conferred on the registered owner of the lease and the licence the right to explore for mineral deposits suitable for mining (the exploration rights). The exploration rights are mining, quarrying or prospecting rights that are depreciating assets within the meaning of subsection 40-30(2). The taxpayer holds the exploration rights under item 5 of the table in section 40-40.
The mineral deposits to which the exploration rights relate are 'minerals' and are obtainable by 'mining operations' as defined by section 40-730.
The first activities undertaken by the taxpayer after it started to hold the exploration rights were: • the development of a mine plan including consideration of the economic costs associated with all aspects of mine development; and simultaneously • the evaluation of core samples previously obtained by the vendor.
The taxpayer described these activities collectively as feasibility studies (the feasibility studies).
Reasons for Decision
Subsection 40-80(1) provides that the decline in value of a depreciating asset you hold is the asset's cost if the conditions in paragraphs (a), (b) and (c) of that subsection are met.
Paragraph 40-80(1)(a) requires that 'you first use the asset for exploration or prospecting for minerals, or quarry materials, obtainable by mining operations'.
In considering whether conducting the taxpayer's feasibility studies constitutes 'use' of the exploration rights it is necessary to understand what is meant by 'use' in the context of such rights.
'Use' is a word of wide import and its meaning in any particular case will depend on the context in which the word is employed and the purpose for which the thing in question has been acquired or created (see Council of the City of Newcastle v. Royal Newcastle Hospital (1957) 96 CLR 493).
Purpose of mining, quarrying or prospecting rights
The object of the State's mining legislation is to encourage and facilitate the discovery and development of its mineral resources. To this end, the State Government issues exploration rights which permit exploration or prospecting for mineral deposits which are suitable for being mined.
Context of ' use' in Division 40
In the context of Division 40, the use of a depreciating asset requires the employment of the asset in such a way that it can reasonably be expected to decline in value through and over the time of that use.
The degree of physical or active use that is required to constitute use will depend to a certain extent on the nature of the asset and the purpose for which it is created or acquired. For a tangible depreciating asset, physical or active employment of the asset would generally be expected in order for an asset to be considered to be 'used'. For an intangible asset that is a depreciating asset, employment of the asset may not be physical and the asset may be considered to be 'used' in the context of passive use.
In considering the nature of the use of an intangible asset that is a depreciating asset the Commissioner is of the view that exploitation of the inherent character of the asset would generally be expected.
' Use' of mining, quarrying or prospecting rights
The particular mining, quarrying or prospecting rights held by the taxpayer are exploration rights. Exploration rights permit a holder to explore for mineral deposits in a particular defined area. Exploitation of the inherent character of this type of mining, quarrying or prospecting right would require, at a minimum, that a taxpayer use the mining, quarrying or prospecting right to explore for mineral deposits. This would provide the necessary connection between the use of the mining, quarrying or prospecting right and the inherent character of the right.
In this case, minerals capable of being mined were discovered by the vendor prior to the taxpayer's purchase of the exploration rights. Since it started to hold the exploration rights, the taxpayer has undertaken feasibility studies of a kind which do not constitute exploring for mineral deposits. Accordingly, those feasibility studies do not exploit the inherent character of the exploration rights acquired by the taxpayer so far as they are rights to explore for mineral deposits and thus are not a use of them for the purposes of paragraph 40-80(1)(a) or Division 40 generally.
The exploration rights in this example have no other features such that exploiting their inherent character might have included these feasibility studies. Nothing about these feasibility studies depended on the taxpayer holding the exploration rights, though the taxpayer would have been unlikely to incur the cost of these feasibility studies had the taxpayer not also held the exploration rights.
The inclusion of 'feasibility studies to evaluate the economic feasibility of mining minerals or quarry materials once they have been discovered' in exploration or prospecting by reason of the definition of exploration or prospecting in subsection 40-730(4) does not mean that conducting those activities automatically constitute a use of an exploration right which a taxpayer holds. Exploration or prospecting may include activities which do not depend on, and which do not exploit the inherent character of exploration rights (generally or of a particular kind).
The above conclusion does not mean the Commissioner is of the view that feasibility studies cannot satisfy the definition of 'exploration or prospecting' in subsection 40-730(4). The inclusion of 'feasibility studies to evaluate the economic feasibility of mining minerals or quarry materials once they have been discovered' in the definition of 'exploration or prospecting' allows the expenditure incurred on those activities to fall for consideration as deductible under section 40-730.
In circumstances where a taxpayer carries out activities which are feasibility studies that do not fall within the definition of 'exploration or prospecting' in subsection 40-730(4), the capital expenditure incurred on those activities may still fall for consideration as a project amount under section 40-840.