27 December, 2012


The ATO has recently released a decision impact statement on the Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] HCATrans 194; [2012] FCAFC 5 ‘deductibility’ case.  The position adopted by the ATO in the decision impact statement has significant implication for how agreements (especially service agreements) should be drafted to ensure the parties can obtain Petroleum Resource Rent Tax (PRRT) deductions for liabilities incurred under the agreements.


Esso Australia Resources Pty Ltd (EAR) was engaged in a petroleum project (theProject) involving exploring for, recovering, treating and selling petroleum and natural gas.  The Project was conducted as a joint venture with BHP Billiton Petroleum (Bass Strait) Pty Ltd (BHP) pursuant to an Operating Agreement.  As EAR had no employees or equipment, a Service Agreement between EAR and Esso Australia Ltd (EAL), a related company, provided that EAL make available to EAR trained personnel, equipment and facilities to enable EAR to conduct its petroleum exploration, production and marketing operations (i.e. upstream and downstream) in Australia and on the continental shelf (i.e. not just limited to the Project area).

Under the Service Agreement, EAR agreed to pay: (i) the direct costs EAL incurred in providing the agreed services to EAR; (ii) a share of EAL’s overhead costs proportionate to the services performed; and (iii) a fee of 7.5% of EAR’s share of the overhead costs.

The Commissioner disallowed deductibility of some of the claimed amounts relating to the Service Agreement that can be broadly described as relating to office facility, administrative and accounting expenditure (i.e. the costs falling under item (ii) of the Service Agreement).

The taxpayer was successful at first instance in the Federal Court (30 May 2011).  The Commissioner’s appeal was upheld by the Full Court of the Federal Court (20 February 2012).  The High Court refused an application for special leave to appeal against the decision of the Full Court of the Federal Court (17 August 2012).

Full Court of the Federal Court Judgment

The Full Court of the Federal Court held that the costs relating to office facility, administrative and accounting expenditure were not deductible.  The deductibility of ‘indirect’ type costs has been an area of contention between the ATO and taxpayers for some time and therefore this aspect of the Full Court’s judgment was not entirely surprising.

The surprising (and concerning) part of the judgment was that the Full Court held that all expenditure incurred under the Service Agreement was not deductible, even though the ATO itself had accepted many of these costs as being deductible (such as the costs falling under item (i) of the Service Agreement).  The basis for this finding by the Full Court appears to be that the Service Agreement created an indivisible liability that was not solely related to the Project (as defined under the PRRT Act) as it covered the provision of services to all of EAR’s projects in Australia and on the continental shelf (rather than just the Project) and it included both upstream and downstream operations (only upstream operations are relevant for PRRT).  Although it is not clear, the Full Court appears to have formed the view that that apportionment of such a liability is not possible for the purposes of the PRRT Act and therefore none of the costs under the Service Agreement were deductible.            

ATO Administrative Treatment

The ATO has acknowledged that the Full Court’s views on apportionment are inconsistent with its own previously stated views.  Accordingly the ATO will not seek to disturb assessments for the 2012 financial year and earlier years where taxpayers have self-assessed in accordance with its previously stated views in draft taxation rulings TR 2010/D4, TR 2010/D5 & TR 2010/D6.  Where taxpayers have not self-assessed in accordance with the draft taxation rulings the ATO is giving taxpayers an opportunity to comply with the draft taxation rulings before commencing further compliance activity.  If a taxpayer’s position is found, as part of any subsequent ATO compliance activity, not to be in accordance with the draft taxation rulings the ATO have stated they will apply the law consistently with the views expressed in the Full Federal Court’s decision.  This is essentially ‘blackmailing’ taxpayers into adopting the ATO’s position on all issues covered in the draft taxation rulings.

For 2013 and later years the ATO will be applying the law in accordance with the Full Court’s judgment.  The petroleum industry is lobbying treasury for the PRRT law to be changed so that apportionment of liabilities and expenditure will be permitted under the law.

Practical Implications

If and until a legislative fix is implemented, consideration should be given to the Full Court’s judgment whenever drafting agreements (especially service agreements) that will give rise to deductible expenditure for PRRT purposes.  Best practice will be to ensure the agreement is limited to the project (as defined for PRRT) and is only in respect of upstream operations.  If this is not possible, at a minimum, the agreement should create separate and discrete liabilities – one of which relates solely to the upstream operations of the project.


herbert smith Freehills


For further information, please contact:


Nick Heggart, Partner, Greenwood & Freehills

[email protected]






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