Petroleum resource rent tax: character of expenditure incurred in relation to abandonment, decommissioning and rehabilitation activities undertaken on a part of a petroleum project

This ruling is about the characterisation of abandonment, decommissioning and rehabilitation expenditure (ADRE) incurred on a part of a petroleum project prior to a project being completely closed down.

In particular, we discuss whether ADRE incurred on a part of a petroleum project in such circumstances falls under sections 38 (about general project expenditure) or 39 (about closing down expenditure) of the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA 1987). [1] ADRE that falls under either section 38 or 39 may be deductible.

ADRE will not be closing-down expenditure under subsection 39(1) while the production of petroleum [2] or marketable petroleum commodities [3] continues in another part of the petroleum project.

In the case of a combined project, ADRE activities in one production licence area cannot give rise to closing-down expenditure while production continues in the other production licence areas of that project.

ADRE incurred on activities to partially decommission and rehabilitate the petroleum project will not be expenditure incurred in closing down the entire project as a whole.

Where you make a decision, with a clearly defined plan, to imminently and permanently cease production from the entire project area, we accept that closing down activities may occur progressively and in continuous stages over the project area. In these cases, you must consider all relevant circumstances objectively to determine whether there is closing-down expenditure.

ADRE can be general project expenditure under section 38 while production of petroleum or marketable petroleum commodities continues in another part of the petroleum project.

ADRE activities in one production licence area of a combined project can give rise to general project expenditure while production continues in other production licence areas of the project.

ADRE can be general project expenditure under section 38 to the extent that it is incurred in carrying on or providing the operations, facilities or other things comprising the project and is not excluded expenditure [4] , exploration expenditure [5] or closing-down expenditure. [6]

When discerning whether a payment is general project expenditure under section 38, the taxpayer's purpose in incurring the expenditure is irrelevant. What needs to be determined is whether the liability to make the payment in question has the requisite close and direct connection with the carrying on of the physical activities comprising the project (the nexus test). [7]

To this end, the character of the expenditure is to be ascertained at the time at which the liability to make the payment is incurred by reference to the arrangements under which it is incurred. [8] A liability is incurred when it is a presently existing liability to which the taxpayer is completely subjected and definitively committed. [9]

When the final Ruling is issued, it is proposed to apply both before and after its date of issue. However, the Ruling will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 75 to 76 of Taxation Ruling TR 2006/10).

For the purposes of the PRRTAA 1987, there is a separate petroleum project in relation to each production licence that is in force unless the production licence is specified in a project combination certificate or is part of the Bass Strait project or the North West Shelf project. [10]

The Bass Strait project and the North West Shelf project respectively consist of all the production licences derived from the specified exploration permits for those projects. [11]

Where two or more production licences are specified in a project combination certificate that is in force, they are considered a single petroleum project (the combined project). [12]

The combined project continues to exist in relation to the production licence(s) that remain in force as long as any one or more of the production licences specified in a project combination certificate remain in force. [13]

Subsection 39(1) provides that closing-down expenditure incurred by a person in relation to a petroleum project comprises of payments (not being excluded expenditure [14] ) of a capital or revenue nature to the extent that they are made by the person in carrying on operations involved in closing down the project, including in any environmental restoration as a consequence of closing down the project.

Where closing-down expenditure, after taking into account other deductible expenditure in a year of tax, exceeds a person's assessable receipts in that year, a credit may be available under section 46 in relation to the excess closing down expenditure.

The Explanatory Memorandum (EM) to the Petroleum Resource Rent Tax Assessment Bill 1987 (the 1987 Bill) explains that 'closing-down expenditure incurred by a person in relation to a petroleum project': ...consists of capital or revenue payments ... made in carrying on operations involved in closing down a petroleum project. For this purpose, a project would not be taken to be closing down by reason of a temporary cessation of activities... Expenditure on the removal of, for example, a drilling platform from a production licence area as part of closing-down the petroleum project would ordinarily qualify as closing-down expenditure, although the deductibility of such expenditure (as closing-down expenditure) in relation to a combined project would depend on whether the platform was merely being moved to another production licence area of the project or whether activities for petroleum recovery in all licence areas of the combined project had ceased. [15]

A project is closed down when the last related production licence, and the operations in relation to recovery under it, end. If there is ongoing production in one or more of the production licence areas of a combined project, the combined project is neither closed down nor is it in the process of being closed down. The EM to the 1987 Bill confirms this in its explanation of Division 4 Tax Credits where it states: ...Any credit will only be available where the whole project is being closed down. It would not be available in respect of expenditure on closing down only one of the production licence areas comprising a combined project while petroleum was still being recovered in another of the project's production licence areas.

It is clear from the above that closing-down expenditure will only be incurred in relation to a combined project if petroleum recovery activities in all production licence areas of the project cease. A partial closing down of such a project will not satisfy the requirements for closing-down expenditure in subsection 39(1).

Similarly, closing-down expenditure in relation to a single production licence petroleum project will only be incurred if the whole project is closing down. Closing down of some wells and rehabilitation activities in that area while production from other wells is to continue will not give rise to closing-down expenditure.

Expenditure that does not qualify as closing down expenditure could, however, be general project expenditure under section 38.

Subsection 38(1) provides that 'general project expenditure incurred by a person in relation to a petroleum project' comprises payments (not being excluded expenditure, exploration expenditure or closing-down expenditure) of a capital or revenue nature to the extent they are made by the person, among others, in carrying on or providing the operations, facilities and other things comprising the petroleum project.

A payment is taken to be made by a person when that person becomes liable to make the payment. [16]

Subsection 19(4) defines the 'operations, facilities and other things comprising the petroleum project' to include operations and facilities carried on or provided for an environmental purpose, in relation to the carrying on or provision of the operations, facilities and services referred to in section 19.

The EM to the Petroleum Resource Rent Tax Assessment Amendment Bill 2011 does not explain exhaustively when operations and facilities are carried on or provided for an environmental purpose. However, the EM makes it clear that environmental requirements must be met and as such environmental expenditure can be incurred before, after and throughout the life of a petroleum project when certain environmental requirements must be complied with. [17]

'Requirements' in this context includes 'exigencies' and 'expediencies', whether of a commercial, social or ethical nature, rather than being strictly limited to 'legal or contractual obligations'. [18]

The Commissioner takes the view that an 'environmental purpose' is to be construed broadly such that abandonment, decommissioning and rehabilitation activities that can be undertaken for an environmental purpose can include the: • removal of property brought into the relevant permit, lease or licence area • plugging and closure of wells in the relevant permit, lease or licence area • conservation and protection of natural resources in the relevant permit, lease or licence area, and • making good of any damage or disturbance to the seabed or subsurface in the relevant permit, lease or licence area.

Petroleum Co holds an interest in a petroleum project comprised of PL1, which has two operating wells. Petroleum Co incurs ADRE to plug and abandon one of the wells after it is depleted. Petroleum recovery operations continue at the other well.

Petroleum Co, through its participation in the ABC joint venture also holds an interest in a combined petroleum project comprising production licences PL2, PL3 and PL4. The joint venturers decide to cease further petroleum production from the production licence area bounded by PL4 as it is no longer economic, and they commence abandonment, decommissioning and rehabilitation activities in that area.

Petroleum production from PL2 and PL3 continues. Petroleum Co incurs its share of ADRE for the PL4 area. These activities are carried out in a manner that ensures the ongoing petroleum recovery and processing operations involving PL2 and PL3 can safely continue.

The ADRE incurred by Petroleum Co on both the first well in PL1 and in PL4 will not constitute closing-down expenditure under subsection 39(1). This is the case despite it permanently ceasing petroleum recovery from one of the wells on PL1 and from PL4 and the expenditure is incurred on environmental restoration as a consequence of petroleum recovery operations undertaken at these sites.

The ADRE is not closing down expenditure for the purposes of subsection 39(1) because: • when the ADRE is incurred, production has not ceased from the entire project, or all the production licences comprising the project specified in the project combination certificate (in the case of the combined project), and • there is no decision or plan to close down the entire project permanently.

The ADRE is incurred by Petroleum Co in carrying on or providing the operations, facilities or other things comprising the project (or combined project). The ADRE is not exploration expenditure or closing-down expenditure. The ADRE is incurred for an environmental purpose in relation to the carrying on, or provision of, the operations, facilities and other things comprising the particular project.

In light of the above, the ADRE incurred by Petroleum Co on the first well in PL1 and in PL4 will constitute general project expenditure of each respective project under section 38, to the extent the ADRE does not comprise excluded expenditure.

You are invited to comment on this draft Ruling. Please forward your comments to the contact officer by the due date.

A compendium of comments is prepared for the consideration of the relevant Public Advice and Guidance Panel or relevant tax officers. An edited version (names and identifying information removed) of the compendium of comments will also be prepared to: • provide responses to persons providing comments, and • be published on the ATO website at www.ato.gov.au. Please advise if you do not want your comments included in the edited version of the compendium. Due date: 8 January 2018 Contact officer details have been removed following publication of the final ruling.

The following is a detailed contents list for this Ruling: Paragraph Summary - what this ruling is about 1 Ruling 3 Closing down expenditure 3 General project expenditure 7 Date of effect 12 Appendix 1 - Explanation 13 What is a petroleum project? 13 Closing-down expenditure 17 Meaning of closing down a project 19 General project expenditure 24 Meaning of 'operations, facilities and other things comprising the petroleum project' 26 Meaning of 'environmental purpose' 27 Example 30 Appendix 2 - Your comments 37 Appendix 3 - Detailed contents list 39