Further changes to the Petroleum Resource Rent Tax Assessment Act on the way

The Petroleum Resources Rent Tax (PRRT) is clearly on the Albanese Government's agenda in FY24 with a number of legislative amendments recently announced. In a 15 January press release, the Albanese Government noted the new amendments are designed to modernise the PRRT and to strengthen anti-avoidance laws. This is to be effected via:

• a proposed deductions cap for expenditure incurred in relation to LNG petroleum projects which was introduced into Parliament on 16 November 2023;
• draft regulations to "better account" for the business practice of "tolling" in the offshore LNG sector;
• proposed amendments to the PRRT anti-avoidance rules with the aim to bring the PRRT anti-avoidance rules in line with income tax anti-avoidance rules; and
• proposed amendments to clarify the tax treatment of "exploration" and mining, quarrying and prospecting rights.

The recently announced proposed reforms form part of the Government's response to the Treasury Gas Transfer Pricing Review and the Callaghan Review and seek to ensure that offshore LNG players pay tax sooner in Australia.

Tolling arrangements

Overview of the tolling arrangement reforms

Treasury released an exposure draft of Petroleum Resource Rent Tax Assessment Regulations 2023: Tolling Arrangements (2023 Regulation) on 22 December 2023 which makes amendments to the Petroleum Resource Rent Tax Assessment Regulation 2015 (2015 Regulation) with respect to the calculation of the gas transfer price in an integrated gas to liquid (IGTL) operation. The intention of the amendments is to ensure that Australia receives an equitable share from gas used in LNG Projects, with a focus on revenue received from tolling arrangements.

At a high level, the gas transfer pricing rules are used to determine the arm's length price of sales gas in an LNG project using one of three methods:

• Advanced pricing arrangement rules;
• Comparable uncontrolled price rules; and
• Residual pricing method (RPM).

The 2023 Regulation seeks to address problems that arise in relation to the RPM which requires a taxpayer to have access to complete cost information of the tolling facility (including historical costs of the construction of the facility that performed the tolling service). The exchange of this information is often not commercially practical, given the participants in these operations are often market competitors. The 2015 Regulation currently does not allow for the tolling fee to be used as a basis for calculating the gas transfer price.

The changes will allow PRRT taxpayers who pay a commercial tolling fee for another entity to process their sales gas into LNG to independently apply those toll fees when applying the RPM, despite not having complete historical cost information for all phases of the LNG operation. This removes the need to exchange information (ie. historical cost information) between potential competitors.

Practicalities

Key to the amendments is that a "commercial tolling fee" is paid between the parties. The 2023 Regulation introduces the defined term of "commercial tolling fee" to mean, amongst other things, a fee that must be paid under a tolling arrangement and must be a reasonable arm's length price having regard to the entire commercial context of the tolling arrangement, including the following factors:

• Functions performed by the parties
• Assets used by the parties
• Risk borne by the parties
• Characteristics of the services provided
• Terms of any relevant contracts between the parties
• Economic circumstances
• Business strategies of the parties to the tolling arrangement.

If the ATO forms the view that the toll fee is not a "commercial toll fee", the complete cost information of the tolling facility will be required to be exchanged between entities and used when applying the RPM.

Key takeaways

The exposure draft was available for consultation until 9 February 2024. No publicly available submissions were received.

At first glance, from a compliance perspective, this amendment may be seen to be welcome by the LNG industry. However, how this plays out in practice is yet to be seen. Documentation of each of the above commercial factors in the context of the tolling arrangement will be important to ensure that there is evidence that the tolling fee is a commercial rate. It is likely that experts will be required to be engaged to prepare such documentation, increasing the compliance burden for clients.

Anti-avoidance

Overview of the PRRT anti-avoidance proposed amendments

Treasury has released an exposure draft of the Treasury Laws Amendment (Measures for Consultation) Bill 2023: PRRT anti-avoidance rules (PRRT Bill), which proposes to amend the anti-avoidance provisions in the PRRTA Act. This will bring the PRRT anti-avoidance provisions in line with the general anti-avoidance rules in the Income Tax Assessment Act 1936 which were amended in 2013 to address weaknesses with the provisions that came to light following a number of court decisions where taxpayers successfully argued that a "tax benefit" was not obtained on the basis that without the scheme, they would not have entered into an arrangement that attracted tax.

The PRRT Bill proposes corresponding amendments be made to the PRRTA Act to ensure the same argument cannot be used with respect to PRRT.

The amendments apply in relation to arrangements that have been entered into or carried out on or after 1 July 2023.

The PRRTA Act anti-avoidance provisions apply to arrangements which artificially reduce assessable receipts or increase deductible expenditure.

Key takeaways

The exposure draft was available for consultation until 9 February 2024. No publicly available submissions were received.

It is difficult to opine on the effectiveness of the suggested amendments to the PRRT anti-avoidance provisions as the courts are yet to address the current PRRT anti-avoidance provisions as drafted.

However, given the changes, if passed, will have effect from 1 July 2023, practitioners and LNG producers should consider any arrangements entered into after this date that may fall foul of the new PRRT anti-avoidance rules.

Tax treatment of "exploration" and mining, quarrying and prospecting rights (MQPR)

Background – Commissioner of Taxation v Shell Energy Holdings Australia Limited [2022] FCAFC 2

The Shell decision settled debate that the term "exploration" should be given a broad meaning for the purpose of the Income Tax Assessment Act 1997 (ITAA 1997).

In 2012, Shell purchased an interest in retention leases and an exploration permit from Chevron relating to the Browse Joint Venture in the waters off Western Australia. Shell paid $2.3 billion for those assets. Shell was already a participant in the Browse Joint Venture, such that by purchasing the interests from Chevron, Shell was enlarging its pre-existing interest in the joint venture assets.

Shell claimed an immediate deduction for the purchase price under the former version of section 40-80 of the ITAA 1997.

The entitlement to claim a deduction under this section required Shell to demonstrate that it first used those assets for "exploration".

While focused on the former provisions, the Shell case was relevant in determining what the ordinary meaning of "exploration" meant for the purposes of the ITAA 1997 and PRRT Act. The ATO's case was that the meaning of "exploration" is confined to discovering the existence of the resource, and does not extend to activities directed at evaluating whether the resource is commercially recoverable.

The first instance Judge and the Full Court both found that the expression "exploration for petroleum" is wide enough to include activities undertaken for the purpose of appraising the recovery of petroleum on a commercial basis.

This meant that surveys undertaken by the joint venturers which assisted in identifying the optimal location for infrastructure and the optimal design for infrastructure were "exploration".

Therefore, Shell was entitled to an immediate deduction for the $2.3 billion purchase price of the assets.

The case did not involve a consideration of the meaning of "exploration" within the context of the PRRT Act. However, commentary since this judgment was released has considered that this judgment would be instructive in interpreting the meaning of "exploration" for the purposes of the PRRT Act.

It is significant on the basis that exploration expenditure is deductible expenditure under the PRRT Act and is offset against available assessable PRRT receipts. It is also available to be transferred to other petroleum projects of the entity or group companies.

Overview of changes

In response to the Shell decision, an exposure draft was released on 15 January 2024 proposing key changes to the PRRT Act and ITAA 1997, including:

Clarification of the meaning of "exploration for petroleum" in the PRRT Act

The exposure draft proposes to amend PRRT Act to clarify that "exploration for petroleum" does not include activities engaged in for the purpose of determining whether the recovery of petroleum is commercially, economically or technically feasible, or how to recover petroleum.

The intention of these amendments is to limit the meaning of "exploration for petroleum" to activities that are part of, or in connection with, the discovery and identification of the existence, extent and nature of petroleum.

The explanatory materials suggest that feasibility and environmental studies and other preparatory activities may still be "in connection with exploration for petroleum" (and therefore fall within the PRRT Act) where there is a reasonably direct relationship between those things and exploration for petroleum.

This narrower meaning will apply retrospectively to expenditure incurred from 21 August 2013.

Clarification of the meaning of "first use" of "mining, quarrying and prospecting rights"

An MQPR is a depreciating asset for the purposes of Division 40 of the ITAA 1997. Depreciating assets you hold start to decline in value from when they are first used or installed ready for use. An immediate deduction is available for the cost of an MQPR if the asset is first used for exploration or prospecting in mining and quarrying operations.

The effect of the Shell decision was that an MPQR would be seen to be "first used" when it is held ready for use.

Following the Shell decision the ATO withdrew Taxation Determination TD 2019/1 which had set out the previous view that MQPR were not first used until the holder did something that was permitted or authorised under the MQPR, ie. that merely holding it was not enough.

The amendments announced in the FY24 Budget and introduced in the exposure draft are intended to restore the policy intent of the law to clarify that rights cannot be depreciated until they are used (rather than merely held). That is, that the mere holding of a MQPR without commencing activities authorised by the right is not enough to constitute "first use" for the purposes of Division 40 of the ITAA 1997 (and therefore obtaining an immediate deduction for the asset's costs).

The explanatory material provides that whether an activity involves exercising rights conferred by the asset will depend on the facts and circumstances, but explains that activities that are not permitted or authorised by the MQPR, or that could be legally undertaken without holding the MQPR, are not intended to be a use of the MQPR.

These amendments will apply to MQPRs that an entity started to hold after budget night (7:30pm on 9 May 2023).

Key takeaways

The exposure draft was available for consultation until 9 February 2024. No publicly available submissions were received.

If the changes are passed, PRRT taxpayers should ensure their former PRRT expenditure since the 1 July 2013 PRRT year is compliant with the updated definition of "exploration". While the changes to the meaning of "exploration" are a substantial shift from the view taken by the Full Federal Court in Shell, they are consistent with the Commissioner's administrative treatment of the provisions as set out in Taxation Ruling TR 2014/9, which applied from 21 August 2013. Therefore, any taxpayers who relied on TR 2014/9 should not be impacted greatly.

As to taxpayers and practitioners who did not rely on TR 2014/9, while the ATO's view in Taxation Rulings is not binding, they do provide a taxpayer with certainty of the ATO's interpretation of how the law should apply.

Therefore, these changes are a useful reminder to taxpayers that while case law can clarify uncertainty or contention about how the law operates in practice, if the ATO ultimately does not agree with the legal precedent set by the courts, it can seek legislative change from the parliament to reflect its view of how the law should operate.

PRRT taxpayers proposing to claim a full deduction for the cost of an MQPR will also be required to ensure that they have actually commenced activities authorised by the MQPR beyond merely holding the asset.

It is important to note that the Shell decision related to the former version of s 40-80 of the ITAA 1997. In 2014, significant amendments were made to s 40-80 which meant that the immediate deduction for the purchase price of MQPRs could only be claimed where the MQPRs were acquired from a government entity. These changes were introduced as an integrity measure to address instances of outright deductions being claimed for the cost of acquiring MQPRs where the price paid reflected the value of resources that had already been discovered, as opposed to allowing this significant concession to taxpayers who were contributing to resources exploration. This means that if the Shell transaction were to occur today, Shell would not be entitled to a section 40-80 deduction as the MQPR was purchased from a third party for the purpose of enlarging Shell's interests in the Browse Joint Venture.