ATO ID 2005/111: Petroleum Resource Rent Tax - Hedging expenses (gains and losses)
Date of decision: 17 March 2005
Year of income: Year ended 30 June 2002
Business line: Public Groups and International

Issue
Are hedging expenses (gains and losses) taken into account for Petroleum Resource Rent Tax (PRRT) purposes?

Decision
No. The hedging expenses are not 'expenses payable' by the taxpayer 'in relation to the sale' of any petroleum or marketable petroleum commodity (MPC) as per section 24(1) of the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTAA). The hedge expenses are not deductible expenditure under the PRRTAA. All deductible expenditure must be either 'general project expenditure' under section 38, 'exploration expenditure' under section 37, or 'closing-down expenditure' under section 39. Hedge expenses cannot be any of these.

Facts
The taxpayer is a joint venture participant in a number of offshore petroleum projects which are subject to Petroleum Resource Rent Tax. The taxpayer produces both oil and gas from these fields. Gas is generally sold on long term contracts resulting in less volatility in the sales price. Oil however, is sold on a spot basis resulting in more volatility in the sales price. The taxpayer actively hedges a specified percentage of future oil sales to attempt to limit these fluctuations. The taxpayer has in place a policy on the maximum level of production that is to be hedged taking account of the time at which the hedging takes place. Hedging involves entry into contracts based on the present and future price of oil that will produce a gain to the taxpayer if oil prices fall from a specified price; some hedges require a fixed initial cost, others produce a loss to the taxpayer so far as oil prices rise, and still others combine cost or loss features. Where the contracts are entered into on a scale no greater than that of the taxpayer's likely sales of oil and gas in the production period, their gains and their costs or losses will limit the taxpayer's overall risk in relation to changes in the price of oil and gas over the production period. So that risk is hedged to the extent that it is limited.

Reasons for decision
Summary: Hedging expenses are not taken into account for PRRT purposes under section 24 of the PRRTAA as reductions to consideration receivable for the sale of petroleum or marketable petroleum commodities in an arm's length transaction. Broadly, under section 24, the sale price brought to account for PRRT purposes is the gross consideration receivable less any expenses payable by the person in relation to the sale. If sold at less than arm's length, the assessable receipts under section 57 of the PRRTAA will be taken to be the amount of receipts expected if the transaction had been at arm's length. Any losses on the hedging contracts do not affect the consideration receivable by the taxpayer when it sells petroleum or marketable petroleum commodities. Nor do such losses alter the costs of that sale. The consideration is not set by reference to the hedging contracts; and if the taxpayer actually sells no petroleum or MPCs the hedging contracts will still produce the same result. As hedges, the contracts produce a result which runs counter to the effect of changes in the price of petroleum or MPCs on the actual sale of the petroleum or MPCs; but they do not change the consideration for or costs of the actual sale. Hedging expenses are not deductible under section 38 of the PRRTAA as they do not fall within the definition of general project expenditure. Nor can they be deductible under section 37 or 39 of the PRRTAA as they do not fall within the definition of exploration expenditure or closing down expenditure.

Legislative references: Petroleum Resource Rent Tax Assessment Act 1987 section 24 section 37 section 38 section 39 section 57
Subject references: Hedging expenses Assessable petroleum receipts