ATO ID 2006/312: Petroleum Resources Rent Tax: deductibility of legal expenses
Date of decision: 25 August 2006
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Can legal expenses incurred by a taxpayer which are associated with an ongoing dispute between its joint venture partner and another company over a liability to pay private overriding royalties in respect of a production field be claimed as deductible expenditure pursuant to section 38 of the Petroleum Resources Rent Tax Assessment Act 1987 (PRRTAA)?

Decision
No. The legal expenses incurred by the taxpayer are not deductible pursuant to section 38 of the Act in calculating petroleum resource rent tax.

Facts
The taxpayer is in the business of oil and gas production which is subject to petroleum resources rent tax. A royalty agreement was entered into between a joint venturer of the taxpayer in relation to a particular area and another company (company A) which company A asserts requires the payment of an 'overriding royalty' on the gross value of production in respect of petroleum production from that area. The taxpayer's joint venturer disputes it is liable for royalty payments in relation to the particular production field which it claims does not fall within the defined area for the royalty agreement. The taxpayer was not a party to the royalty agreement and it has no legal obligations under that agreement. The taxpayer is obliged under the terms of certain arrangements entered into with its joint venture partner to pay certain amounts which would have the effect of reimbursing its joint venture partner for part of any 'overriding royalty' amount payable to company A on production from the particular production field under the royalty agreement, proportionately to the taxpayer's share of the production from the particular area. The taxpayer and its joint venturer have incurred extensive legal costs in denying the joint venturer's liability.

Reasons for decision
Summary: In order for the legal costs to be deductible as general project expenditure under section 38 of the PRRTAA they would have to be payments liable to be made in carrying on or providing the operations, facilities and other things comprising the petroleum project. Subsection 19(4) of the PRRTAA outlines for the purposes of the Act what is meant by a reference to the operations, facilities and other things comprising the project. These legal costs in relation to liability to contribute to payments of a kind known as private override royalty payments liable to be made by a person and liability for which is disputed would not be payments for operations and facilities and other things comprising a petroleum project as referred to in subsection 19(4) of the PRRTAA. The legal costs incurred by the taxpayer are associated with an ongoing dispute between company A and the taxpayer's joint venture partner over the joint venturer's liability to pay an overriding royalty in respect of a production field. The agreement under which the royalty may arise does not include any aspects which indicate the facilitation of the joint venturers' project for the production of petroleum from the production field. The agreement was no more than antecedent to the carrying on or providing of those operations, facilities and other things comprising a petroleum project, if it has any relationship to them at all. The subsequent legal costs in contesting the override royalty claims are neither precedent to nor otherwise part of the costs of carrying on or providing the operations, facilities and other things constituting the project activities for recovery and qualifying related activities in relation to petroleum from the petroleum project. The connection between those costs and any possible royalty is not sufficient to make those legal costs part of the expenditure deductible in calculating petroleum resource rent tax for the production field. Accordingly, the legal expenses incurred by the taxpayer are not deductible under section 38 of the PRRTAA.

Legislative references: Petroleum Resources Rent Tax Assessment Act 1987 section 19 section 38 section 44
Subject references: Legal expenses Private override royalty payments Petroleum Resources Rent Tax