Capital allowances: immediately deductible expenditure - contractor providing geophysical surveying services to entities in the mining and mineral exploration industries

Is a taxpayer contracted to provide geophysical surveying services to entities in the mining and mineral exploration industries carrying on a business of, or a business that included, exploration or prospecting for minerals for the purposes of subparagraph 40-80(1)(c)(iii) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. A taxpayer contracted to provide geophysical surveying services to entities in the mining and mineral exploration industries is not considered to be carrying on a business of, or a business that included, exploration or prospecting for minerals for the purposes of subparagraph 40-80(1)(c)(iii) of the ITAA 1997.

All legislative references are to the ITAA 1997 unless otherwise stated.

The taxpayer carries on a business that provides geophysical surveying services on a contract basis to entities in the mining and mineral exploration industries. The geophysical surveys that the taxpayer conducts for these entities produce results which indicate to those entities whether minerals that are obtainable by mining operations are present at a particular location.

The taxpayer does not hold any mining, quarrying or prospecting rights. The taxpayer does not obtain any interest in minerals, the presence of which may be indicated by the geophysical surveys. The taxpayer does not profit in any way from the minerals obtainable by mining operations that may be indicated as present at the particular location.

The taxpayer incurred expenditure on acquiring a depreciating asset that was necessary to enable the taxpayer to provide some of the geophysical surveying services in the conduct of its business.

The taxpayer first used the depreciating asset to conduct geophysical surveys for a mining and mineral exploration entity (the entity). The entity contracted the taxpayer to provide the geophysical surveying services for the purpose of carrying out the entity's exploration or prospecting for minerals obtainable by mining operations. The depreciating asset is thus first used for that exploration or prospecting and therefore, the first use of the depreciating asset satisfies paragraph 40-80(1)(a).

The taxpayer does not conduct mining operations for the purposes of subparagraph 40-80(1)(c)(i), nor does the taxpayer propose to carry on mining operations for the purposes of subparagraph 40-80(1)(c)(ii).

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)(c) requires that you satisfy one or more of the following subparagraphs at the asset's start time, namely: (i) you carry on mining operations; (ii) it would be reasonable to conclude you proposed to carry on such operations; (iii) you carry on a business of, or a business that included, exploration or prospecting for minerals or quarry materials obtainable by such operations, and expenditure on the asset was necessarily incurred in carrying on that business.

For the purpose of considering whether the taxpayer has satisfied subparagraph 40-80(1)(c)(iii), it is necessary to understand the meaning of the expressions contained in that subparagraph.

Subsection 995-1(1) provides that a 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. The Commissioner does not dispute that the taxpayer is carrying on a business within the meaning of that term in subsection 995-1(1). The taxpayer's business activities consist of contracting with mining and mineral exploration entities to conduct geophysical surveying services for remuneration.

Subsection 995-1(1) also provides that 'exploration or prospecting' has the meaning given by section 40-730. Subsection 40-730(4) provides an inclusive definition of the activities that constitute 'exploration or prospecting'. For mining in general, geophysical surveys are specifically included in exploration or prospecting by subparagraph 40-730(4)(a)(i). Therefore, geophysical surveys such as those conducted by the taxpayer will fall within the definition of 'exploration or prospecting' for the purposes of Division 40.

Apart from the terms 'business' and 'exploration or prospecting', none of the other expressions contained in subparagraph 40-80(1)(c)(iii) are defined for the purposes of the ITAA 1997. For instance, the meaning of the expressions: • 'such operations'; and • 'carry on a business of, or a business that included, exploration or prospecting for minerals or quarry materials obtainable by such operations';

are not defined for the purposes of the ITAA 1997.

For the purposes of considering the meaning of these expressions, it is relevant to consider whether there are any explicit statements in the legislation or the extrinsic material that accompanied it which might provide assistance in establishing the meaning of the expressions (see section 15AB of the Acts Interpretation Act (Cth) 1901 ).

In discussing the wording contained in subparagraph 40-80(1)(c), clause 7.14 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM) makes it clear that the expression 'such operations' in subparagraphs 40-80(1)(c)(ii) and (iii) means 'mining operations'.

Subsection 995-1(1) provides that 'mining operations' has the meaning given by section 40-730. Paragraph 40-730(7)(a) relevantly provides that mining operations means - 'mining operations on a mining property for extracting minerals (except petroleum) from their natural site ... for the purpose of producing assessable income'.

In this case, the taxpayer does not conduct mining operations and therefore does not satisfy subparagraph 40-80(1)(c)(i), nor does the taxpayer propose to carry on mining operations for the purposes of subparagraph 40-80(1)(c)(ii).

Subparagraph 40-80(1)(c)(iii) will therefore be satisfied if the taxpayer is carrying on a business of, or a business that included, exploration or prospecting for minerals or quarry materials obtainable by mining operations , and expenditure on the asset was necessarily incurred in carrying on that business. (emphasis added)

In discussing the wording contained in paragraph 40-80(1)(c), clause 7.14 of the EM provides no assistance in establishing the meaning of the expression 'carry on a business of, or a business that included, exploration or prospecting for minerals or quarry materials obtainable by [mining] operations' for the purposes of subparagraph 40-80(1)(c)(iii). All clause 7.14 of the EM does is paraphrase the expression, which does not assist in understanding its meaning.

Nor does the expression gain meaning by a consideration of the definitions of the terms 'business'; 'exploration or prospecting'; or 'mining operations'.

As noted above, the definition of 'exploration or prospecting' in subsection 40-730(4) is an inclusive definition which identifies a list of activities that are included in the definition of 'exploration or prospecting'. One such activity is geophysical surveys.

Subparagraph 40-80(1)(c)(iii) requires that a taxpayer 'carry on a business of ... exploration or prospecting for minerals ... obtainable by mining operations ...'. It is the Commissioner's view that to carry on such a business of exploration or prospecting would require a taxpayer to be doing more than simply conducting one of the activities listed in the definition of 'exploration or prospecting'.

For instance, it does not necessarily follow that a taxpayer who does not conduct exploration or prospecting activities in the form of geophysical surveying for minerals on their own account, but as a service on a contract basis for other entities is itself carrying on a business of, or a business that included, exploration or prospecting for minerals or quarry materials obtainable by mining operations for the purposes of subparagraph 40-80(1)(c)(iii).

Australian courts have on many occasions considered the use of a purposive approach to statutory interpretation, saying that statutory provisions should be interpreted in a way that promotes the objects of the provision.

Support for adopting an interpretation of a statutory provision which conforms with the legislative intent can be found in the High Court decision in Cooper Brookes (Wollongong) Pty Ltd v. Federal Commissioner of Taxation (1981) 147 CLR 297; 81 ATC 4292; (1981) 11 ATR 949, and the subsequent line of authority in Australia in which narrow literal interpretations have been avoided in favour of purposive ones that allow the recognised legislative intent to operate.

The purposive approach is founded on the notion that the intent of the Legislature is to be ascertained from, amongst other things, the context of the provision in question. In CIC Insurance Ltd v. Bankstown Football Club Ltd (1997) 187 CLR 384 at 408; [1997] HCA 2, Brennan CJ, Dawson, Toohey and Gummow JJ said: [T]he modern approach to statutory interpretation (a) insists that the context be considered in the first instance, not merely at some later stage when ambiguity might be thought to arise, and (b) uses 'context' in its widest sense to include such things as the existing state of the law and the mischief which, by legitimate means such as those just mentioned, one may discern the statute was intended to remedy. Instances of general words in a statute being so constrained by their context are numerous.

Further, as McHugh, Gummow, Kirby and Hayne JJ noted in Project Blue Sky Inc v. Australian Broadcasting Authority (1998) 194 CLR 355 at 381; [1998] HCA 28 at [69] (footnotes omitted): The primary object of statutory construction is to construe the relevant provision so that it is consistent with the language and purpose of all the provisions of the statute. The meaning of the provision must be determined 'by reference to the language of the instrument viewed as a whole'. In Commissioner for Railways (NSW) v. Agalianos , Dixon CJ pointed out that 'the context, the general purpose and policy of a provision and its consistency and fairness are surer guides to its meaning than the logic with which it is constructed'. Thus, the process of construction must always begin by examining the context of the provision that is being construed.

Section 15AA of the Acts Interpretation Act 1901 directs that in the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.

Section 15AB of the Acts Interpretation Act 1901 permits reference to extrinsic material in the interpretation of a provision of an Act to confirm the meaning of that provision taking into account its context and the underlying object or purpose of the Act.

In Australia, mining and mineral exploration is regulated by State Governments. The object of each 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. The exploration rights are mining, quarrying or prospecting rights that are depreciating assets within the meaning of subsection 40-30(2).

Broadly speaking, before an entity begins exploration or prospecting for minerals, they must be granted an exploration right by the relevant State Government. Carrying on a business of exploration or prospecting for minerals is a high-risk undertaking, with the risk borne by the holder of the exploration right. It is recognised that the success rate for exploration or prospecting programmes is very low. Accordingly, it is uncertain whether the holder of an exploration right will see any return on the expenditure they incur on exploration or prospecting for minerals obtainable by mining operations.

The basis of the concessional treatment of exploration or prospecting expenditure, including of the cost of depreciating assets first used for exploration and prospecting, is and has always been that the rewards from the exploitation of the results of exploration or prospecting are inherently uncertain. Subsection 40-80(1) reflects the Parliament's adoption of the recommendations of the Review of Business Taxation, which included in its recommendations ( A Tax System Redesigned, Report July 1999, Section 4 : Core concepts and principles , at p167): Mining and quarrying exploration and prospecting expenditure Applying the recommended treatment of expenditure and assets without recognising the valuation difficulties associated with the results of exploration and prospecting expenditure would mean that the tax treatment of this expenditure would depend on the results of the exploration or prospecting activity. Unsuccessful expenditure would be deductible at the time the activity was abandoned, while successful expenditure would enter the cost base of the project. That is the accounting approach. It has long been a feature of the current law to allow an immediate deduction for exploration and prospecting expenditure. Allowing continuation of immediate deductibility is justified on the basis that the value of the associated asset cannot be immediately measured.

The most recent expression of this policy was in the Policy Transition Group : Report to the Australian Government : Mining and Petroleum Exploration published in December 2010 where it was stated that: Under Division 40 of the Income Tax Assessment Act 1997 expenditure incurred in exploring or prospecting for minerals, petroleum and quarry materials can be immediately deducted subject to the taxpayer passing certain tests. Expenditure on depreciating assets that are first used for exploration can also be written off immediately. These tax concessions acknowledge the high-risk nature of exploration and economic benefits that result from it.

Considered together, the provisions of subparagraphs 40-80(1)(c)(i) and 40-80(1)(c)(ii) are designed to allow the holder of a depreciating asset an immediate deduction for the asset's cost if the holder is engaged in risk based on the uncertainty of being able to profitably exploit the results of the exploration or prospecting activities in which the asset was first used.

In distinct contrast, where the holder of a depreciating asset that is an exploration right contracts another entity (the contractor) to conduct the exploration or prospecting activities, such as geophysical surveys, the contractor does not engage in any risk based on utilising the results of the exploration or prospecting activities.

Irrespective of whether the contractor's business exclusively or partially involves the provision of exploration or prospecting activities on a contract basis, a contracted supplier of geophysical surveying services would not profit from the exploitation of the results of their exploration or prospecting activities, nor would they be rewarded through the sale of the results of those activities. They are rewarded, not by exploiting or selling the results of their exploration or prospecting activities, but by being remunerated for the service they provide to other entities (who in turn may or will exploit and profit from the results of the exploration or prospecting activities).

Having regard to the statutory context, purpose and the policy intent of subsection 40-80(1), to construe the meaning of the expression 'carry on a business of, or a business that included, exploration or prospecting for minerals or quarry materials obtainable by [mining] operations' for the purposes of subparagraph 40-80(1)(c)(iii) as extending to a taxpayer which carries on a business that provides exploration or prospecting activities on a contract basis is incorrect.

The better construction is that subparagraph 40-80(1)(c)(iii) only extends to entities who bear the economic risks of exploration or prospecting. The Commissioner considers that subparagraph 40-80(1)(c)(iii) recognises and assists entities in mineral exploration industries, such as 'junior explorers', who explore or prospect for new mineral discoveries in the hope of marketing those discoveries to larger mining concerns, as opposed to developing or exploiting what is found themselves. That is, mineral exploration companies who, as part of their business model, do not seek to involve themselves in mining operations. These are perhaps the entities in the mining and minerals exploration industry that proportionally bear the greatest risk of all and who accordingly attract immediate deduction in respect of the cost of the depreciating assets they first use in their exploration or prospecting activities.

This construction would make the interpretation of the meaning of subparagraph 40-80(1)(c)(iii) consistent with the statutory context evidenced in subparagraphs 40-80(1)(c)(i) and 40-80(1)(c)(ii) as discussed above. It is also consistent with the underlying policy intent of subsection 40-80(1) and gives effect to the intention to provide immediate deductions for the cost of depreciating assets first used for exploration or prospecting to taxpayers whose return on that expenditure depends on the uncertain value of the results of exploration or prospecting.

In this case, the taxpayer as a contractor is rewarded regardless of the results of their exploration or prospecting activities. This form of reward for services is not consistent with the nature of the engagement with risk and the uncertainty of reward that is evident when considering all of the subparagraphs of paragraph 40-80(1)(c) as a whole, nor with the underlying policy intent of subsection 40-80(1), which as noted above is to acknowledge the high-risk nature of exploration or prospecting and economic benefits that result from it.

Accordingly, a taxpayer contracted to provide geophysical surveying services to entities in the mining and mineral exploration industries is not considered to be carrying on a business of, or a business that included, exploration or prospecting for minerals for the purposes of subparagraph 40-80(1)(c)(iii).