27 December, 2012

 

 

Japanese conglomerate Mitsui & Co (Mitsui) recently lost a $264 million tax dispute relating to its acquisition of an interest in a petroleum field in Australia’s North-West Shelf.

Background

In March 2004, Mitsui purchased from Woodside Energy Limited (Woodside) a 40% undivided interest in production licence WA-28-L and exploration permit WA-271-P.  There were three petroleum fields covered by the two tenements:

  • the Laverda field (within WA-271-P);
  • the Enfield field (within WA-28-L); and
  • the Vincent field (within WA-28-L).

The purchase price payable by Mitsui to Woodside for the acquisition of the two tenements was $624 million.  The sale and purchase agreement made no provision for apportionment of the purchase price among the tenements or the petroleum fields.

For the purposes of completing its tax return for the 2005 year, Mitsui treated the purchase price paid under the sale and purchase agreement in the following way:

  • $72 million was referable to the Laverda field;
  • $288 million was referable to the Enfield field; and
  • $264 million was referable to the Vincent field.

Both the Laverda and Vincent fields were at an exploration stage, whereas the Enfield field had proceeded to development at the time of the acquisition.

Issue in dispute

The cost of acquiring a depreciating asset (including a petroleum tenement) is generally deductible for income tax purposes over the effective life of that asset.  However, special rules exist in section 40-80 of the Income Tax Assessment Act 1997(Cth) which provide an immediate deduction for the cost of acquiring a depreciating asset which is first used for exploration purposes (and not used for operations in the course of working a petroleum field).

The treatment adopted by Mitsui in its 2005 tax return was as follows:

  • $72 million referable to the Laverda field was treated as immediately deductible under section 40-80;
  • $288 million referable to the Enfield field was treated as deductible over 21 years (being its effective life); and
  • $264 million referable to the Vincent field was treated as immediately deductible under section 40-80.

The income tax treatment of the purchase price allocated to the Laverda and Enfields fields was accepted by the Australian Taxation Office (ATO) without challenge.  Only the $264 million referable to the Vincent field was in dispute.  The ATO asserted that this amount should have been treated in the same way as the Enfield field (i.e. deductible over 21 years) on the basis that they were both part of the same production licence.

They key issue which the dispute turned on was whether a production licence was a single depreciating asset or whether a production licence consisted of two separate depreciating assets (i.e. a right to recover and a right to explore) that could have different income tax treatments.

Mitsui’s argument relied on the fact that under the Petroleum (Submerged Lands) Act 1967 (Cth) (PSLA) the holder of a production licence was authorised to both recover petroleum and to explore for petroleum.  Accordingly, Mitsui argued that it had acquired two separate depreciating assets (i.e. a right to recover and a right to explore).  The $264 million referable to the Vincent field was said by Mitsui to be the cost of acquiring the right to explore and, as the right to explore was first used for exploration of the Vincent field, an immediate deduction should be allowed under section 40-80.

On the other hand, the ATO argued that a production licence was a single depreciating asset and, as the licence had been used for operations in the course of working the Enfield field, an immediate deduction was not available under section 40-80.

The decision

Mitsui lost in the Federal Court at first instance and in the Full Court of the Federal Court on appeal.  The Courts held that a production licence is a single depreciating asset and it could not be separated into a right to recover and a right to explore.  It followed that because the production licence had been used for operations in the course of working the Enfield field, an immediate deduction was not available under section 40-80.

Presumably, had there been two separate depreciating assets (either because a right to recover and a right to explore were separate depreciating assets or because the Vincent field was located on a separate tenement), then the amount allocated to the Vincent field would have been immediately deductible as it appears the ATO had accepted that the Vincent field was still in the exploration phase.

Practical Implications

The decision in Mitsui relied heavily on the scheme created by the PSLA, in particular the use of graticular blocks to identify the production licence area.  The issue in dispute would not have arisen if the production licence area had been marked out as commonly occurs under State mining acts (as none of the Vincent field would have fallen within the production licence area).

In addition, despite comments to the contrary by the Court, it is common practice for parties to deal separately, that is, contractually, with the rights granted under a production licence.  It is possible that by separately acquiring the rights granted by a production licence, rather than acquiring the production licence itself, that a different tax outcome might have been reached.  For example, had Mitsui acquired the right to explore in respect of production licence WA-28-L separately from the production licence there would be an argument that the cost of acquisition was deductible under section 40-80. 

 

herbert smith Freehills 

 

For further information, please contact:

 

Nick Heggart, Partner, Greenwood & Freehills

[email protected]

 

 

 

Comments are closed.