Private ruling: First Use under section 40-80
Published: September 2011

Ruling: Q1: Did the Company first use the tenement for exploration and prospecting for the purposes of paragraph 40-80(1)(a) of the Income Tax Assessment Act 1997 ('ITAA 1997')? | A1: Yes. | Q2: If yes to Question 1, when the Company first used the tenement, did the Company use it for operations in the course of working a mining property for the purposes of paragraph 40-80(1)(b) of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: The Company acquired all the shares in the Second Company which held an Exploration Licence over a tenement. The Second Company had made an application for a Mining Licence over the tenement. The Company formed an income tax consolidated group with the Second Company a subsidiary joining member of the group. In a period following the acquisition, the Second Company continued the extensive exploration drilling programmes across different parts of the tenement including certain advanced drilling activities and made a decision to invest capital expenditure into mining the tenement. The Mining Licence was also granted.

Relevant legislative provisions: Income Tax Assessment Act 1997 - section 40-80

Reasons for decision: Detailed Reasoning - Reasons for decision: The terms 'mining right' and tenement are used interchangeably for the relevant depreciating asset. | Detailed Reasoning - Subsection 40-80(1): 1 Subsection 40-80(1) provides that the decline in value of a depreciating asset you hold is the asset's cost if each of the conditions in paragraphs (a), (b) and (c) of the subsection is met. The tenement is a depreciating asset as an intangible asset that is a 'mining, quarrying or prospecting right'; paragraph 40-30(2)(a). When the Company formed its consolidated group, it was taken to hold the tenement for the purposes of section 40-40. The cost of the depreciating asset includes the amount that the Company is taken to have paid in relation to starting to hold the depreciating asset where the amount is directly connected with holding the asset; subsection 40-180(3). Pursuant to the consolidation tax cost setting rules and for the application of Subdivisions 40-A to 40-D (which includes section 40-180 in Subdivision 40-C and 40-80 in Subdivision-B), the Company is taken to have acquired the tenement when the company formed its consolidated group for a payment equal to its tax cost setting amount; subsection 701-55(2). Paragraph 40-80(1)(a) 2 Paragraph 40-80(1)(a) sets out the requirement that the depreciating asset is first used by the Company for exploration or prospecting for minerals, or quarry minerals, obtainable by mining operations. | Detailed Reasoning - Exploration and Prospecting: 3 The term exploration or prospecting is defined under subsection 40-730(4) to include: '(a) for mining in general, and quarrying: i. geological mapping, geophysical surveys, systematic search for areas containing minerals (except petroleum) or quarry materials, and search by drilling or other means for such minerals or materials within those areas; and ii. search for ore within, or near, an ore-body or search for quarry materials by drives, shafts, cross-cuts, winzes, rises and drilling; and 4 The activities undertaken by the Company constitute exploration and prospecting activities consisting of exploration drilling for minerals mining as defined by subparagraph 40-730(4)(a)(ii) of the ITAA 1997. | Detailed Reasoning - Minerals: 5 Subsection 40-730(5) provides that the term 'minerals' includes petroleum. Although minerals is not petroleum, it is a 'mineral' within the ordinary meaning of the word. The primary definition of the word 'mineral' in the Macquarie Dictionary Online is 'a substance obtained by mining'. 6 Obtainable by mining operations Paragraph 40-730(7)(a) provides that the term 'mining operations' means 'mining operations on a mining property for extracting minerals … from their natural site'. 7 To satisfy paragraph 40-80(1)(a) of the ITAA 1997 the holder of the depreciating asset is required to first use the asset for exploration or prospecting for minerals, or quarry materials, obtainable by mining operations. The tenement contains minerals obtainable by mining operations. 8 In considering whether the Company first used the assets acquired for exploration or prospecting, it is necessary to understand what is meant by the word 'use' in the context of such rights which is illustrated in ATO Interpretative Decision 2010/64 (ATO ID 2010/64). ' Use' of mining, quarrying or prospecting rights 9 ATO ID 2010/64 states that an intangible asset that is a depreciating asset is 'used' when the inherent character of the asset is exploited. At a minimum, this requires that a taxpayer uses the mining, quarrying or prospecting right to explore for mineral deposits. This provides the necessary connection between the use of the mining, quarrying or prospecting right and the inherent character of the right. The Company's first use of the Tenement - mining, quarrying or prospecting rights 10 The Company states that the drilling undertaken after the acquisition constitutes exploration drilling. 11 The drilling activities fall within the permitted activities under the Exploration Licence. 12 Accordingly, the drilling activities exploit the inherent character of the tenement held by the Company so far as it contains rights to explore for mineral deposits and thus are a 'use' of the tenement for the purposes of paragraph 40-80(1)(a) and Division 40 generally. | Detailed Reasoning - Question 2: Paragraph 40-80(1)(b) 13 Paragraph 40-80(1)(b) of the ITAA 1997 requires that when the tenement asset was first used for exploration or prospecting, it was not also used for operations in the course of working a mining property. 14 In order to understand the meaning of the expression, operations in the course of working a mining property, quarrying property or petroleum field, it is necessary to determine whether the Company had a mining property. Mining property 15 As set out in ATO Interpretative Decision 2010/67(ATOID 2010/67), the term 'mining property' is not defined for the purposes of the ITAA 1997. Further, there are no explicit statements in Division 40 or in the Explanatory Memorandum to the New Business Tax System ( Capital Allowances ) Bill 2001 , which introduced Division 40, which might provide assistance in establishing the meaning of the term. 16 The meaning of the term mining property was considered by the Full High Court in Federal Commissioner of Taxation v. Broken Hill Pty Co Ltd (1969) 120 CLR 240; (1969) 69 ATC 4028; (1969) 1 ATR 40 in the context of interpreting former subsection 122(1) of Division 10 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). Former subsection 122(1) of the ITAA 1936 allowed a deduction where a person, in connexion with the carrying on by that person of mining operations upon a mining property in Australia or the Territory of New Guinea for the purpose of gaining or producing assessable income, incurred certain capital expenditure. 17 In Federal Commissioner of Taxation v. Broken Hill Pty Co Ltd (1969) 120 CLR 240; (1969) 69 ATC 4028; (1969) 1 ATR 40 the majority of the court said at CLR 271; ATC 4030; ATR 43: '… as a prerequisite of the operation of the sub-section, the taxpayer must have what is described as a mining property. It is not sufficient that the taxpayer has rights over mineral bearing land. There can be no mining property without some activity to attract the description of mining to the property. To have 10,000 acres of bushland to be developed into a grazing property is not, of itself, enough to make a grazing property, and similarly to have mining rights, either by way of ownership or otherwise, over an area containing thousands of tons of ironstone is not, without something more, to have a mining property. Actual mining may not be necessary but steps for mining, at least, must have been taken.' 18 This judicial consideration of the meaning of the term mining property has modern significance. In these circumstances and in respect of the current provisions, we are of the view that a mining property does not require extraction of minerals to be actually taking place on the land the subject of the Assessment Lease. A mining property may exist if steps for mining, that is, activities directed toward preparing a site for those operations are taking place on the subject land. 19 In this case, when the Company is taken to hold the tenement, the Commissioner concludes that the Company had taken steps for mining and therefore had a mining property because the Company: · Disclosed to shareholders that part of the tenement was in development; · Had taken steps to progress the activities undertaken by the Second Company and awaited certain approvals; · Continued with certain negotiated outcomes for transport and power with the relevant authorities; and · Was finalising funding arrangements to mine and capital expenditure budget. Operations in the course of working a mining property 20 Paragraph 40-80(1)(b) specifies that when you first use the [depreciating] asset, you do not use it for: i. 'development drilling for petroleum; or ii. operations in the course of working a mining property, quarrying property or petroleum field.' 21 Subparagraph 40-80(1)(b)(i) is not relevant to the Company's acquisition of the tenement. As set out in ATO Interpretative Decision 2010/66 (ATOID 2010/66), apart from the word petroleum none of the expressions contained in these subparagraphs are defined for the purposes of the ITAA 1997. For the purpose of considering the meaning of these expressions, it is relevant to consider whether there are any explicit statements in the legislation or in the associated extrinsic material which might provide assistance in establishing their meaning. 22 Paragraph 7.10 of the Explanatory Memorandum to the New Business Tax System ( Capital Allowances ) Bill 2001 , which introduced section 40-80, states that: 'The meaning of exploration or prospecting is not defined exhaustively and so takes its ordinary meaning. It does not, however, include expenditure on developing or operating a mining or quarrying field or site. The point at which a decision to proceed to actual mining operations has been made, is the dividing line between exploration and prospecting on the one hand, and development and operation on the other.' 23 Paragraph 1.70 of the Explanatory Memorandum states that: 'The decline for a depreciating asset you hold will be the assets cost, if the asset is for exploration and prospecting. This means you must first use the asset for exploration and prospecting for things you can get by mining operations. But you must not use the asset for petroleum development drilling, or for operations in the course of working a mining or quarrying operation These restrictions mirror the current law; see the former section 330-15 and subsection 330-20(2).' 24 As these restrictions were clearly intended to retain the policy intent of prior provisions, it is also relevant to have regard to the context in which the expressions in paragraph 40-80(1)(b) arose in prior statutory provisions dealing with the same subject matter. This is because the courts may have regard to the history of the legislative scheme in order to enable them to work out what the legislation is intended to achieve. 25 Division 40 is a legislative scheme mainly based on deductions for decline in value of depreciating assets. The provisions relating to the general mining, quarrying and petroleum resources sector which existed before it were expenditure based. The expressions under consideration here were contained in the definition of exploration or prospecting in former section 330-20 of the Income Tax Assessment Act 1936 . In Division 40, the expressions have instead been placed into the operative provision of subsection 40-80(1). Irrespective of that change, the expressions still retain the same meaning under Division 40 as they did under former Division 330. The Explanatory Memorandum to the Income Tax Assessment Bill 1996 which introduced Division 330 is silent on the meaning of these expressions, therefore it is necessary to consider that Division's predecessor provisions in the Income Tax Assessment Act 1936 (ITAA 1936). 26 The predecessor to the mining and quarrying provisions in Division 330 was the mining and quarrying provisions in Division 10 of Part III of the ITAA 1936. 27 Former subsection 122J(6) of Division 10, Subdivision A of the ITAA 1936 contained the definition of exploration or prospecting in the context of general mining. The definition specifically excluded operations in the course of working a mining property. 28 The Explanatory Memorandum to Income Tax Assessment Bill (No. 2) 1968 , which introduced the definition of exploration or prospecting in former subsection 122J(6) of the ITAA 1936, stated that: 'The definition does not extend to normal mining operations which are directed towards the extraction of minerals as opposed to the discovery of mineral deposits.' 29 Former subsection 122JF(12) of Division 10, Subdivision B of the ITAA 1936 contained the definition of exploration or prospecting in the context of quarrying. Also excluded from that definition were operations in the course of working a quarrying property. 30 The Explanatory Memorandum to Taxation Laws Amendment Bill ( No.2 ) 1990 , which introduced the definition of exploration or prospecting in former subsection 122JF(12) of the ITAA 1936, provided that: 'The definition does not extend to normal quarrying operations which are directed towards the extraction of quarry materials as opposed to the discovery of deposits of quarry materials.' 31 Former subsection 124AH(7) of Division 10AA (Prospecting and Mining for Petroleum) of the ITAA 1936 contained the definition of exploration or prospecting in the context of petroleum. Excluded from that definition was development drilling or operations in the course of working a petroleum field. 32 The Explanatory Memorandum to Income Tax Bill ( No.2 ) 1974 , which introduced the definition of exploration or prospecting in former subsection 124AH(7) of the ITAA 1936, stated that the definition: '… does not include development drilling or operations in the course of working a petroleum field. Capital expenditure incurred on the items specifically excluded from the definition will qualify as allowable capital expenditure and be deductible over the estimated life of the field or, in the case of plant, as depreciation if the taxpayer so elects.' 33 The statements explaining the meaning of the expressions development drilling for petroleum and operations in the course of working a mining property, quarrying property or petroleum field in the abovementioned Explanatory Memoranda make it clear that the expressions cover the items of expenditure which, under the predecessor provisions to Division 40, qualified for deduction as allowable capital expenditure. This included, but was not limited to, mining operations which were directed towards the extraction of minerals, quarry materials or petroleum. 34 The concept of allowable capital expenditure existed under the former Divisions 10 and 10AA of the ITAA 1936 and former Division 330. The various deductions provided under those former Divisions depended on whether the expenditure incurred by the taxpayer fell within one of the classes of expenditure specified for deduction. To determine the class of expenditure specified for deduction, it was first necessary to have regard to the meaning of exploration or prospecting expenditure and allowable capital expenditure under those former Divisions. 35 Assistance in determining whether expenditure incurred by a taxpayer was deductible as exploration or prospecting expenditure or allowable capital expenditure is provided by Taxation Ruling TR 98/23 : Income tax : mining exploration and prospecting expenditure (TR 98/23). In particular, paragraph 55 of TR 98/23 states that: 'It is understood that once an ore body, quarry materials or a petroleum field has been discovered and delineated, generally two types of expenditure are incurred. The first relates to project evaluation expenditure such as feasibility studies, pilot plant and environmental impact studies. The second relates to the establishment of access facilities and other infrastructure to carry out properly the mining or quarrying project. Often, the latter type of infrastructure put in place during this stage is of such a scale it is far in excess of that required to complete the project evaluation and essentially has an enduring benefit to the mine.' 36 Further, paragraph 56 of TR 98/23 provides that: 'In these circumstances, it is important first to determine the predominant purpose of establishing infrastructure. In doing so, regard could also be had to the scale of the operations undertaken. If the establishment of infrastructure is to such a degree as to be commensurate with preparing the site for eligible mining or quarrying operations, or the work is more concerned with establishing the permanent extractive facilities for ore or quarry materials rather than with whether to mine or quarry, then the expenditure incurred would more properly be classified as allowable capital expenditure rather than exploration or prospecting expenditure.' 37 Whilst Division 40 retains the concept of allowable capital expenditure, the items of expenditure which previously fell within that concept now fall within the definition of the new term mining capital expenditure in section 40-860. 38 Notwithstanding these changes, we are of the view that for the purposes of paragraph 40-80(1)(b), the meaning of the expression 'operations in the course of working a mining property, quarrying property or petroleum field' (and the meaning of the expression 'development drilling for petroleum') have not changed since the introduction of the definitions of exploration or prosecting in the former provisions of Division 10 and Division 10AA of the ITAA 1936. 39 Given the history of the legislative scheme, we consider that these expressions have been inserted into paragraph 40-80(1)(b) to ensure that a taxpayer will not be entitled to an immediate deduction for the cost of a depreciating asset where their first use (or their first use together with a concurrent other use) of the asset is in an activity, expenditure on which could give rise to incurring capital expenditure that is mining capital expenditure as defined in section 40-860. 40 As per ATO ID 2010/66, we are of the view that the exclusion in paragraph 40-80(1)(b) is not limited to actual extraction activities and includes the developmental work such as preparing a site for mining operations and providing water, light and power for use on the site for future mining operations as specified in section 40-860. The only difference in relation to the operation of the exclusion in paragraph 40-80(1)(b) is that the exclusion applies where a taxpayer first uses or concurrently uses a depreciating asset for mining operations or development drilling purposes. Application of subparagraph 40-80(1)(b)(ii) to the Company's circumstances 41 The work on the tenement comprises of different stages. At the time of acquisition, it was intended that the mining would take place in different stages using specified mining methods. 42 When the Company became the holder of the tenement, the part of the tenement on which advanced drilling activities were continuing to take place was in the preparatory stages of mining operations. 43 From the information provided, the Second Company was conducting a program of drilling activities in different parts of the tenement. This program of drilling activities continued after the date of acquisition. The drilling program included advanced drilling activities in part of the tenement. 44 In this case, it is reasonable to conclude that the Company continued 'operations in the course of working the tenement once it became the holder of the mining right depreciating asset. This is supported by the following actions and activities: · A draft feasibility study, · The Company disclosed to shareholders that part of the tenement was in development; · The Company had taken steps to progress the activities undertaken by the Second Company including advanced drilling activities in part of the tenement and awaited certain approvals; · The Company continued with certain negotiated outcomes for transport and power with the relevant authorities; and · The Company was finalising funding arrangements to mine and capital expenditure budget. It is reasonable to conclude that the Company did not cease the drilling programmes at the time of the acquisition. Further, it is reasonable to conclude that the drilling undertaken by the Company after the date of acquisition continued the program of drilling activities including advanced drilling activities undertaken by the Second Company. The conclusion is supported by other factors including the statements made by the Company to shareholders as to its expectations for certain approvals and when mining was to commence as well as other statements concerning the drilling program. The outcome of the conclusion is stated in the Reasons set out in ATO ID 2010/67: 'The taxpayer's first use of the exploration right meets the qualifying condition in paragraph 40-80(1)(a). However, the disqualifying condition in paragraph 40-80(1)(b) is that the taxpayer's first use cannot also be, or include another use of the relevant depreciating asset which is … operations in the course of working a mining property, quarrying property or petroleum field.' That is, the tenement mining right was a single depreciating asset for which the Company had concurrent uses at the time of acquisition: · In one part of the tenement, there was a continuing use of the tenement which constituted 'operations in the course of working a mining property'; and · Exploration drilling in another part of the tenement. Therefore, subparagraph 40-80(1)(b)(ii) operates to exclude the Company from obtaining a deduction for the cost of the tenement under subsection 40-80(1). | Detailed Reasoning - Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

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