ATO ID 2009/130: Capital Allowances: depreciating asset - mining, quarrying or prospecting right
Date of decision: 16 September 2009
Year of income: Year ended 31 March 2005
Business line: Administration, Business and Personal Taxes Centre of Expertise

Issue
Are the right to recover petroleum and the right to explore for petroleum under a production licence granted by the relevant State Department to the taxpayer, separate depreciating assets from the production licence within the meaning of that term in section 40-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The right to recover petroleum and the right to explore for petroleum under a production licence are not separate depreciating assets from the production licence within the meaning of that term in section 40-30 of the ITAA 1997.

Facts
All legislative references are to the ITAA 1997 unless otherwise stated. A production licence was granted by the relevant State Department to the taxpayer to recover petroleum from the production licence area (right to recover petroleum). It was a condition of the grant of the production licence that the taxpayer continued to appraise and explore the production licence area to determine whether additional recoverable petroleum existed in the area and to exploit such petroleum where commercially viable (right to explore for petroleum). The exploration permit previously granted by the relevant State Department to the taxpayer to explore for petroleum in respect of the production licence area was extinguished in respect of that area when the production licence was granted. The production licence granted by the relevant State Department to the taxpayer is a mining, quarrying or prospecting right within the meaning of that term in subsection 995-1(1). As the production licence authorises the taxpayer to recover petroleum in the production licence area, the production licence is an asset described in column 2 of item 2 of the table in subsection 40-95(10) as 'a mining, quarrying or prospecting right relating to mining operations to obtain petroleum'.

Reasons for decision
Summary: A depreciating asset is broadly defined in subsection 40-30(1) as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Whether a composite item is itself a depreciating asset or whether its components are separate depreciating assets is a question of fact and degree to be determined in light of all the circumstances of the particular case (subsection 40-30(4)). Paragraph 1.15 of the Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001 (the EM) indicates that the functionality test should be applied when identifying particular depreciating assets. Paragraph 1.15 of the EM states: Taxpayers will be required to exercise judgment in identifying the depreciating asset where the asset itself is made up of different parts and components. In doing this, the ' functionality' test that is used as a basis of identifying a 'unit of plant' in the existing plant depreciation rules can be used. (Specific reference to a 'unit' or an 'item' is not necessary to attract the test, as the definition of a depreciating asset is based on a life in effective use and the depreciating asset must be identifiable as having its own life in such use.) [Schedule 1, item 1, subsection 40 - 30(4)] (emphasis added) The Commissioner's views in Taxation Ruling TR 94/11 are a guide to what represents a separate unit or item, and are relevant in determining whether, as a question of fact and degree, a composite item is itself a depreciating asset. An item is generally itself a single item (rather than a number of separate units) if it has one or more of the characteristics listed in paragraph 3 of TR 94/11. The basic test put forward in TR 94/11 is a 'function test'. The ruling contains guidelines about the function test and explains how it must be applied to the particular factual circumstances of each case. A composite item is itself a depreciating asset that has a separate function, and is functionally complete in itself, even though it may not be self-contained or isolated. The function of the thing being considered need only be separately definable or identifiable rather than be self contained or isolated, and be capable of performing its own intended discrete function. The relevant types of function that the item performs are those that are sufficiently complete, definable and identifiable so as to give the item subjected to those uses the characteristics of a single depreciating asset in the taxpayer's operations. Factors such as physical separability and whether an item can be separately acquired also need to be considered in deciding whether an item may be a separate depreciating asset. In this case, the thing that might be considered a composite item is the production licence granted by the relevant State Department to the taxpayer (the production licence) which may be made up of different components, being the right to recover petroleum and the right to explore for petroleum in the production licence area. It is therefore necessary to determine whether the production licence is the relevant depreciating asset within the meaning of that term in section 40-30 or alternatively, whether its components, being the right to recover petroleum and the right to explore for petroleum in the production licence area, are the relevant depreciating assets. It is considered that both the right to recover petroleum and the right to explore for petroleum in the production licence area are solely derived from the grant of the production licence by the relevant State Government to the taxpayer. This view is reinforced by the fact that the rights are not, of themselves, functionally discrete or capable of separation from the production licence, nor are they items that can be acquired independently of the production licence. For example, once the production licence has been granted to the taxpayer, there are no residual rights from the exploration permit to explore the production licence area for petroleum. It follows that the right to explore for petroleum is solely derived from the grant of the production licence and that right has no independent function or existence from the production licence. It is considered that the production licence is a separately identifiable item that performs its own intended discrete function and is therefore, functionally complete in itself. The function of the production licence is to allow the taxpayer to recover petroleum and to explore for petroleum within the production licence area. Based on this functionality, the production licence, rather that its component rights, is itself the depreciating asset in these circumstances. It is the production licence, and not the rights to recover and explore for petroleum in the production licence area, that is the asset which is identifiable as having its own life in effective use. As the production licence is a mining, quarrying or prospecting right that authorises the taxpayer to recover petroleum in the production licence area, it is an asset described as a mining, quarrying or prospecting right relating to mining operations to obtain petroleum. The effective life of such an asset is described in column 3 of item 2 of the table in subsection 40-95(10) as the taxpayer's estimate of the period until the end of 'the life of the petroleum field or proposed petroleum field to which the right relates'. The production licence is therefore an asset that has a limited effective life and can reasonably be expected to decline in value. Accordingly, the production licence is itself the depreciating asset within the meaning of that term in section 40-30.

Legislative references: Income Tax Assessment Act 1997 section 40-30 section 40-30(1) section 40-30(4) section 40-95(10) section 995-1(1)
Related public rulings and determinations: Taxation Ruling TR 94/11
Other references: Revised Explanatory Memorandum to the New Business Tax System (Capital Allowances) Bill 2001
Subject references: Depreciating assets Mining & petroleum Mining & exploration licences & permits