Income tax: treatment of an amount of 'excess deduction' in the calculation of a loss incurred by a taxpayer carrying on mining, petroleum or quarrying operations

A deduction under sections 122DG, 122JE or 124ADG, of the Income Tax Assessment Act 1936 (the Act) for a taxpayer carrying on prescribed mining or petroleum operations or eligible quarrying operations, is limited by subsections 122DG(6), 122JE(5) or 124ADG(6) to certain amounts of assessable income, if any, available to offset the expenditure. Any expenditure not deducted is deemed by subsections 122DG(7), 122JE(9) or 124ADG(7) to be a deduction that is allowable under subsections 122DG(2), 122JE(1) or 124ADG(2) in the next succeeding year of income. Such an undeducted deemed amount is referred to in this Ruling as an amount of 'excess deduction'.

However, a taxpayer may elect under subsections 122DG(6A), 122JE(6) or 124ADH(1), that the limitation referred to in the previous paragraph shall not apply in a particular year of income. The effect of such an election is the creation or increase of a loss which can be carried forward. In the case of a company, this loss can be transferred to another group company provided the tests in section 80G are met.

This Ruling discusses the treatment of an amount of 'excess deduction' that is deemed to be an allowable deduction under subsections 122DG(7), 122JE(9) or 124ADG(7) for a taxpayer carrying on prescribed mining or petroleum operations or eligible quarrying operations. Specifically, it examines the election provisions in subsections 122DG(6A), 122JE(6) and 124ADH(1) and, in particular, considers whether they allow for the inclusion of an amount of 'excess deduction' in the calculation of any loss.

An election made under subsections 122DG(6A) (general mining), 122JE(6) (quarrying) or 124ADH(1) (prescribed petroleum operations) can only be made in respect of allowable capital expenditure incurred: • in or after the 1985-86 year of income in regard to taxpayers carrying on prescribed mining or petroleum operations; and • after 15 August 1989 for taxpayers carrying on eligible quarrying operations.

The election can only relate to all such allowable capital expenditure that is available for deduction in the year of income in which the election is made.

An amount of 'excess deduction', which is deemed to be an allowable deduction under subsections 122DG(2), 122JE(1) or 124ADG(2) by the operation of subsections 122DG(7), 122JE(9) or 124ADG(7), cannot form part of an election made under subsections 122DG(6A), 122JE(6) or 124ADH(1).

However, subsections 122DG(6C), 122JE(8) or 124ADH(4) preserve the deduction for a proportion of 'excess deduction' in those circumstances where such a proportion would have been deductible if no election under subsections 122DG(6A), 122JE(6) or 124ADH(1) had been made.

This Ruling applies to years commencing both before and after its date of issue. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 21 and 22 of Taxation Ruling TR 92/20).

This Ruling replaces Draft Taxation Determination TD 94/D45 which was withdrawn on 12 June 1996.

Section 122A specifies the type of expenditure that qualifies as allowable capital expenditure for the purposes of Division 10. Section 122DG governs the basis on which deductions are allowable for allowable capital expenditure that is incurred after 19 July 1982. This expenditure is referred to in subsection 122DG(1) as 'allowable (post 19 July 1982) capital expenditure'.

Subsection 122DG(2) formally authorises the allowance of deductions for allowable (post 19 July 1982) capital expenditure.

By subsection 122DG(3) the allowable (post 19 July 1982) capital expenditure that is unrecouped at the end of a year of income is deductible on a straight-line basis. The straight-line basis allows deductions for allowable (post 19 July 1982) capital expenditure based upon the life of the mine or 10 years, whichever is the lesser. Under the straight-line basis each year's expenditure is treated as a separate amount for the purposes of calculating the annual deduction. In this way two or more deductions may be allowable under subsection 122DG(2) in any year of income.

However, subsection 122DG(3) is subject to subsection 122DG(6) which provides that where the remaining assessable income of the year of income is insufficient to fully allow the amount of deduction or deductions allowable under subsection 122DG(2), the total deduction allowed is limited to the amount of that remaining assessable income. The remaining assessable income is so much of the assessable income as remains after deducting all allowable deductions other than deductions allowable under sections 122DG, 122J, 122JE or 122JF.

Where the total of two or more deductions (including any amount that is deemed to be allowable by subsection 122DG(7)) exceeds the amount of that remaining assessable income, each deduction is reduced proportionately so that together they equal that remaining amount. Any amount reduced by subsection 122DG(6) is absorbed into the amount of 'excess deduction'.

The amount of an 'excess deduction' is deemed to be a deduction by subsection 122DG(7) which states that: 'where the whole or a part of a deduction in respect of a year of income is disallowed under subsection (6), that whole or part shall be deemed to be a deduction that is allowable under subsection (2) in respect of the next succeeding year of income.'

The application of subsection 122DG(6) can be illustrated in the following example: • A taxpayer incurs allowable (post 19 July 1982) capital expenditure of $100,000 during the 1991-92 year of income in respect of a mine which has a life in excess of 10 years. The deduction available under subsection 122DG(3) is $10,000 in each year. • The taxpayer has no remaining assessable income during the period from the 1991-92 year of income to the 1994-95 year of income. In the 1995-96 year of income the taxpayer has remaining assessable income of $5,000 after taking into account the deductions described in subsection 122DG(6), i.e., all allowable deductions, other than deductions allowable under sections 122DG, 122J 122JE or 122JF. • If no election is made under subsection 122DG(6A), the taxpayer's situation is: Year 122DG(3) Amount Remaining Income Deduction Available Deduction Allowed 122DG(7) Excess 91-2 10,000 nil 10,000 nil 10,000 92-3 10,000 nil 20,000 nil 20,000 93-4 10,000 nil 30,000 nil 30,000 94-5 10,000 nil 40,000 nil 40,000 95-6 10,000 5,000 50,000 5,000 45,000 • In the 1995-96 year of income total deductions available consist of two amounts, i.e., $10,000 being that year's deduction calculated under subsection 122DG(3) and $40,000 being the previous year's accumulated excess deduction calculated under subsection 122DG(7). • However, the company only has remaining assessable income of $5,000, so its total deduction is limited by subsection 122DG(6) to $5,000. Moreover, subsection 122DG(6) provides that where the total of two or more deductions exceeds the amount of remaining assessable income, each deduction is reduced proportionately so that together they equal that remaining amount. • This means that the subsection 122DG(3) deduction of $10,000 is reduced to $1,000 [10,000/50,000 x 5,000] and the subsection 122DG(7) excess deduction brought forward of $40,000 is reduced to $4,000 [40,000/50,000 x 5,000], making a total deduction in that year of $5,000. • Because subsection 122DG(6) has applied to disallow a part of the section 122DG(3) and a part of the subsection 122DG(7) deduction in that year, the total of the amounts disallowed, i.e., $45,000, becomes the new subsection 122DG(7) excess deduction to be allowed in the next succeeding year of income.

In 1984 the group loss provisions in section 80G were introduced to allow, commencing with the 1984-85 year of income, transfers of losses within a company group. To remove any disadvantage to mining companies in not being fully able to utilise mining deductions for the purpose of the group loss provisions, the mining provisions were amended, with the introduction of subsections 122DG(6A), (6B) and (6C) with effect from the 1985-86 year of income.

Under subsection 122DG(6A), a taxpayer may elect in relation to a year of income that subsection 122DG(6B) shall apply in relation to all allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income. The effect of subsection 122DG(6B) applying is that 'subsection (6) does not apply to limit or reduce the amount of the deduction' in relation to that expenditure.

The advantage in not having subsection 122DG(6) apply to limit or reduce the amount of the deduction is that a loss situation is created or increased which can be transferred to another company within the group under the group loss provisions (provided the requirements of those provisions are met).

If the taxpayer in the example at paragraph 16 of this Ruling made an election under subsection 122DG(6A) in the 1995-96 year of income, three alternative consequences are possible: (a) a loss of $45,000, by deducting that year's subsection 122DG(3) deduction of $10,000 and the subsection 122DG(7) excess deduction of $40,000, from the remaining assessable income of $5,000; or (b) a loss of $5,000, by only deducting that year's subsection 122DG(3) deduction of $10,000 from the remaining assessable income of $5,000; or (c) a loss of $9,000, by deducting from the remaining assessable income of $5,000 that year's subsection 122DG(3) deduction of $10,000 and the proportion of the subsection 122DG(7) excess deduction that would have been allowable if no election had been made of $4,000.

In the Commissioner's view the third consequence, i.e., a loss of $9,000, is the correct position obtained by the application of subsections 122DG(6A) to (6C).

Throughout section 122DG there are two distinct kinds of deduction, namely, allowable (post 19 July 1982) capital expenditure and an 'excess deduction'. While subsection 122DG(2) is the operative subsection under which deductions are allowed, the amounts allowed for allowable (post 19 July 1982) capital expenditure and an 'excess deduction' are ascertained under separate subsections, i.e., subsections 122DG(3) and 122DG(7), respectively.

The distinct treatment of allowable (post 19 July 1982) capital expenditure and an 'excess deduction' throughout section 122DG is further highlighted in subsections 122DG(4), (5), (8) and (9).

Subparagraph 122DG(4)(a)(i) has the effect of excluding an amount of 'excess deduction' in arriving at the unrecouped allowable (post 19 July 1982) capital expenditure. Subparagraphs 122DG(4)(a)(ii) and 122DG(4)(b)(ii), in conjunction with subsection 122DG(5), perform a similar task where property is disposed of or an amount is specified in a notice lodged under section 122B. The combined effect of subsections 122DG(4) and 122DG(5) is that an amount of 'excess deduction' is never part of unrecouped allowable (post 19 July 1982) capital expenditure to be deductible in future years.

It was necessary to enact subsections 122DG(8) and (9) to remove any deduction entitlement under subsection 122DG(7) where property has been disposed of, etc., or where a section 122B notice has been given. This was because subsection 122DG(7) treats an amount of 'excess deduction' as something apart from allowable (post 19 July 1982) capital expenditure. It would not have been necessary to have these subsections if an amount of 'excess deduction' was part of allowable (post 19 July 1982) capital expenditure because any loss of deduction entitlements would be covered by subsections 122DG(4) and (5).

The distinction between allowable (post 19 July 1982) capital expenditure and an excess deduction was maintained in the enactment of subsections 122DG(6A) to (6C) and different treatment specified for each kind of deduction.

Under subsection 122DG(6A) a taxpayer may elect in relation to a year of income that subsection 122DG(6B) shall apply in relation to all allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income.

Where subsection 122DG(6B) applies, it removes the limitation contained in subsection 122DG(6). However, subsection 122DG(6B) does not remove the limitation in respect of all allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income; its application is restricted to amounts which come within paragraph 122DG(6B)(b).

The amounts which come within paragraph 122DG(6B)(b) are those amounts where: 'subsection (6) would apply to limit or reduce the amount of a deduction otherwise allowable under subsection (2) in relation to the year of income in relation to an amount of expenditure of that kind'.

Paragraph 122DG(6B)(b): (i) ensures that the election applies to deductions allowable in the year of election only and not to the whole amount of expenditure incurred in relation to allowable (post 19 July 1982) capital expenditure that was incurred after the 1984-85 year of income; and (ii) excludes any amount of 'excess deduction' from the paragraph by limiting its application to an amount of expenditure that would have been an allowable deduction in that year of income in relation to allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income, if subsection 122DG(6) did not apply.

Paragraph 122DG(6B)(b) ensures that the election applies to deductions allowable in the year of income only and not to the whole amount of expenditure incurred. It does this by its direct reference to the amount of deduction otherwise allowable under subsection 122DG(2) in relation to the year of income, i.e., the year of the election.

An amount of an 'excess deduction' is excluded by paragraph 122DG(6B)(b) because an 'excess deduction' in relation to the year of income in which the election is made is not the 'kind' of expenditure identified in the paragraph. The 'kind' of expenditure the paragraph identifies is expenditure that would have been allowed as a deduction in the year of income in relation to allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income if subsection 122DG(6) did not apply.

The reference to the 'year of income' is a reference to the year of income in which the election under subsection 122DG(6A) is made. An amount of 'excess deduction' may have originated as allowable (post 19 July 1982) capital expenditure but to the extent that subsection 122DG(6) applied to it in any past year, it would cease to be allowable (post 19 July 1982) capital expenditure and become for all future purposes an 'excess deduction'. Thus, in the year in which the election is made, an 'excess deduction' is not expenditure of the kind referred to in paragraph 122DG(6B)(b).

It should be remembered that the election contained in subsection 122DG(6A) was introduced at a time when losses could only be carried forward for a period of seven years. The policy at that time was to protect any 'excess deduction' from the seven year limitation.

The effect of a subsection 122DG(6A) election in the circumstances outlined in the example in paragraph 16 above is to make subsection 122DG(6) incapable of operating according to its tenor. This is because subsection 122DG(6) is subject to subsection 122DG(6B). Subsection 122DG(6) states that the deductions under subsection 122DG(2) shall not exceed the remaining income (which in the example is $5,000). As the effect of an election is to remove the limitation on the current year deduction in relation to allowable (post 19 July 1982) capital expenditure (which in the example is $10,000), the deduction will now exceed remaining income and subsection 122DG(6) cannot operate.

While the making of an election means that the allowable (post 19 July 1982) capital expenditure available as a deduction in that year will now be deductible in full, a question remains as to what is to be the treatment of any 'excess deduction'. This question is resolved by subsection 122DG(6C) which was inserted specifically to provide for the treatment to be applied to an 'excess deduction'.

Subsection 122DG(6C) states: 'Where, apart from subsection (6B), subsection (6) would apply to limit or reduce the amount of a deduction otherwise allowable in relation to a year of income in relation to an amount of expenditure in respect of which a taxpayer has not made an election under this section in relation to the year of income, nothing in subsection (6B) affects the application of subsection (6) in relation to that year of income in relation to that amount.'

The purpose of subsection 122DG(6C) is to preserve the deduction for a proportion of an 'excess deduction' in those circumstances where such a proportion would have been deductible if no election under subsection 122DG(6A) had been made. This is the extent to which the legislation allows part of an 'excess deduction' to be included in the calculation of a loss where an election under subsection 122DG(6A) is made. Subsection 122DG(6C) can be explained as follows: • In the year of income, an election is made in respect of that year's deduction for allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income and thus subsection 122DG(6) does not apply by reason of the operation of subsection 122DG(6B). • While this is the actual situation, the opening words of subsection 122DG(6C) state that 'Where, apart from subsection (6B), subsection (6) would apply'. The use of the verb form 'would apply' shows that the subsection is dealing with a hypothetical situation. Subsection (6) does not, in fact, apply because an election has been made and as a consequence subsection (6B) has negatived the application of subsection (6). Nevertheless, if, forgetting about subsection (6B) for the moment, subsection (6) would have applied, then subsection (6C) operates to ensure that nothing in subsection (6B) affects what would have been the application of subsection (6). • Subsection (6C) speaks of subsection (6) applying to limit or reduce the amount of a deduction otherwise available: • in relation to a year of income; • in relation to an amount of expenditure in respect of which a taxpayer has not made an election under section 122DG in relation to the year of income. • The reference in subsection 122DG(6C) is to an amount in respect of which the taxpayer has not made an election. By using the indicative mood of the verb 'to have', the subsection is now referring, not to a hypothetical situation but to an actual situation, i.e., an amount of expenditure in respect of which no election had in fact been made. This would be the amount of an 'excess deduction' ascertained under subsection 122DG(7). • When subsection 122DG(6C) provides that 'nothing in subsection 6B) affects the application of subsection 6': • in relation to that year of income; and • in relation to that income; the reference to 'that amount' is clearly a reference to the amount of expenditure in respect of which no election has been made, i.e., an 'excess deduction'.

In the example at paragraph 16 above, if an election is made, 'the amount of deduction otherwise allowable' is the proportional part of the 'excess deduction', i.e., the $4,000. The deduction for the $4,000, together with the current year's deduction for allowable (post 19 July 1982) capital expenditure of $10,000, is deductible from the remaining income of $5,000. This results in a loss of $9,000 that is available for transfer within the group under the group loss provisions. The amount of 'excess deduction' that is deductible in the subsequent year of income is now $36,000.

The election provisions in subsections 122JE(6) and (7) (quarrying) and subsections 124ADH(1) to (3) (petroleum mining) operate in much the same way as subsections 122DG(6A) and (6B) (general mining), discussed above. For petroleum mining the election applies to all allowable capital expenditure incurred after the 1984-85 year of income, while for quarrying it applies to all allowable capital expenditure incurred after 15 August 1989.

An election, if made, will apply to all amounts which: • meet the description of allowable capital expenditure; and • were incurred after the relevant dates; and • are available for deduction in that year of income.

A taxpayer cannot elect in relation to some amounts of qualifying allowable capital expenditure and not others. Nor can a taxpayer elect in respect of an amount which is deemed to be an allowable deduction under subsection 122JE(9) or subsection 124ADG(7), i.e., an amount of 'excess deduction'.

An amount of an 'excess deduction' that is deemed to be an allowable deduction by subsection 122JE(9) or subsection 124ADG(7) is not the same 'kind' of deduction that is identified in paragraphs 122JE(7)(b) or 124ADH(3)(b). However, subsection 122JE(8) or subsection 124ADH(4) will apply to allow a part of an 'excess deduction' to be taken into account in calculating a loss incurred where circumstances analogous to those outlined in paragraph 38 above are present.

The alternative view concerning the mining provisions is that allowable deductions which result from a subsection 122DG(6A) election include an amount of 'excess deduction' deemed to be allowable under subsection 122DG(7) (the 'excess deduction' had to arise from expenditure incurred after the 1984-85 year of income). Similar arguments apply to the petroleum and quarrying provisions.

Those who support this view maintain that the effect of subsection 122DG(6B) is that the limitation in subsection 122DG(6) does not apply, in a year when an election under subsection 122DG(6A) is made, to relevant deductions allowable in that year under subsection 122DG(2); deductions include deemed deductions under subsection 122DG(7). They claim support from the fact that subsection 122DG(6) refers to all deductions allowable under subsection 122DG(2), including any amount that is deemed to be a deduction under subsection 122DG(7).

This view fails to recognise that subsection 122DG(6B) does not refer to all deductions available under subsection 122DG(2). It only refers to an amount of expenditure that would have been an allowable deduction in that year of income as allowable (post 19 July 1982) capital expenditure incurred after the 1984-85 year of income, if subsection (6) did not apply. Moreover, this view fails to apply the legislative intention behind the enactment of subsection 122DG(6C).

If you wish to comment on this Draft Ruling, please send your comments by 14 March 1997, to: Contact officer details have been removed following publication of the final ruling.