Classic Texts in Australian and International Taxation Law

II. Recent Amendments to the Act

19.48. In this section it is proposed to draw attention to some of the more important amendments made in 1973 and 1974 to those provisions of the Act relating to general mining and to offer some commentary upon them. Certain of the Committee's recommendations are also dealt with in this way.

19.49. In expressing its view upon any changes that have been made or that ought to be made in the Act affecting the taxation of mining, the Committee has not lost sight of the fact that political and economic considerations which are not for the Committee to decide must also be taken into account and that such factors have, over a long period of years, occasioned alterations in the legislation (see paragraph 19.53). In some cases the Committee has concluded that for obvious reasons it is not within its terms of reference to pass judgment upon some aspects of the submissions made to it. Finally, the Committee has borne in mind that an examination and report upon the mining industry has been referred to the Industries Assistance Commission.

19.50. Accordingly, the role of overseas finance in an industry involving the investment of immense sums of money, the benefits of attracting foreign technical expertise, the advisability of securing overseas markets through foreign participation in Australian equity capital, and the preservation in Australia of strategic minerals are not matters which govern the Committee's conclusions. The Committee has endeavoured to confine itself to the effects of the Act and the legislative alterations in relation to their impact upon taxation.

19.51. The Committee supports the amendments made to section 6AA of the Act by the Income Tax Assessment Act (No. 2) 1974.

19.52. Section 23 (p), which was repealed in 1973, exempted income derived by a bona fide prospector from the disposition of his rights to mine in a particular area for gold and for any metal or minerals specified in Regulation 4AA of the Income Tax Regulations. The purpose of the section, which had a long history, was to encourage the finding of gold and the specified minerals and enable those prospectors who did not have the capital to develop a mine or to conduct mining operations on a profitable scale to be rewarded for their work and expenditures. A viable mining industry needs a continuity of prospecting, whether some minerals are presently in adequate supply or not. Prospecting today is not limited to companies. The question whether section 23 (p) should be restored to the Act in a revised form as an incentive to individual persons who have devoted their time to bona fide prospecting is a matter that might be considered by the Industries Assistance Commission. The Committee in this connection simply draws attention to a proposal that to the extent to which a prospector has deducted his exploration or prospecting expenditures against his income (if any), the amount of the exemption under section 23 (p) should, on the sale of his right to mine, be reduced by the amount of that deduction, which should be brought to account as income in the year of income in which the disposal takes place.

19.53. Section 23A was repealed in 1974. That section exempted from tax 20 per cent of the net income derived from the mining of the metals and minerals specified in Regulation 4AA of the Income Tax Regulations. The predececessor of section 23A evolved out of the needs produced by World War II and applied to metals and minerals required for the prosecution of the war and was introduced into the Act in 1943.

― 304 ―

It ceased to have any application in 1952. Section 23A was inserted in 1953 to encourage the production of the prescribed metals and minerals in Australia. It was timed to expire in 1960 but in that year the time-limit was removed. Submissions have been made to the Committee that section 23A has played a major role in the expansion of the mining industry over the last decade or so and it has been compared with the provisions operative in the United States which exempt a percentage of income from taxation without regard for the recoupment of particular expenditures in mining operations. Section 23A was brought into the Act as a short-term incentive measure and not for the purpose of providing a depletion allowance in respect of wasting assets. In the opinion of the Committee, the question whether section 23A should be reintroduced into the Act in respect of any category of metals or minerals as an incentive for their production in the Australian mining industry does not depend upon considerations of taxation but is a policy question outside the province of this Committee to determine.

19.54. For a number of years the Act has contained certain tax incentives for shareholders investing in exploration, prospecting and mining operations in Australia and Papua New Guinea for minerals obtainable by prescribed mining operations and for petroleum. These provisions were to be found in a number of sections of a complex nature which from time to time were made the subject of amendment. The concessions provided opportunities for abuse which were widely exploited. Section 77E (inserted in 1973) was enacted for the purpose of counteracting the misuse of the incentives available for bona fide investors. In the Committee's view, to restore the Act to its form prior to 1973 would only be to reopen the door to further abuse of the kind the amendment was aimed to prevent.

19.55. If a policy is to be followed for the encouragement of Australian investment in the mining of Australia's natural resources, any form of taxation incentives for that investment is a matter for consideration by the Industries Assistance Commission.

Exploration Expenditure by General Mining Companies

19.56. Formerly, section 122J of the Act allowed an immediate deduction for ‘exploration or prospecting’ expenditure, subject to two main conditions. These were that the enterprise conducting the exploration should be carrying on a mining business and that the deduction for exploration expenditure incurred in a year of income should be allowed only against income derived from that business or associated activities in that year. The restriction of the amount of the deduction to the amount of net assessable income from mining derived in the year in which the expenditure was incurred has been retained in the 1974 amendment.

19.57. The significant change lies in the treatment of the amount by which the expenditure incurred exceeds the amount of net assessable income from mining. Under the former provision, any such excess qualified as “allowable capital expenditure’ of the taxpayer for amortisation over the life of the mine under section 122D. The 1974 amendment allows this excess to be deducted against net mining income in subsequent years in which prescribed mining operations are carried on, until the entire amount has been absorbed. Thus, provided that the mining enterprise generates income from its operations and acquires a mine, it may recoup all its exploration expenditure as a prelude to generating taxable income.

19.58. This treatment of exploration and prospecting expenditure does to some extent recognise the principle that such expenditure should be immediately written off against profits, since this expenditure does not of itself generate income, is a capital

― 305 ―
outgoing and is recognised by Division 10 as such. It may be argued that such costs should be amortised by way of deduction against future income of a mine; but this approach encounters a difficulty in that in many mining ventures at the exploratory stage it is impossible to predict with any certainty that the mine will generate income sufficient to recoup the exploration expenditure. It would appear that the 1974 amendment recognises this difficulty.

19.59. So far as abortive exploration expenditure is concerned, no such expenditure will be deductible unless a mine is ultimately acquired. It should be noted that such treatment is contrary to conventional accounting practice which dictates that such expenditure be immediately written off.

19.60. The amendment runs contrary to the recommendation of the Committee in this area since, though permitting an immediate write-off to some extent, it allows recoupment only if the conditions mentioned above are met. As mentioned in Section I, the Committee regards such expenditure as a business expense of a mining enterprise, and, consistently with that view, it has recommended that an immediate write-off be allowed in full against income derived from any source. Consequently there is no difference in the treatment of such expenditure according to whether or not it is successful; nor is it necessary to endeavour to match the expenditure against any income later derived by the mine to which it may have related. The restriction of the deduction to mining income may be viewed as operating unfairly against the enterprise with no mining income which chooses to invest its capital in mining exploration and discriminating in favour of established mining companies.

19.61. In summary, if deduction in full is allowed in the year in which the expenditure is incurred, the mining taxpayer may recoup his costs from income or he may precipitate a loss under section 80, in which event he is subject to the same treatment accorded any other taxpayer. If exploration and prospecting expenditure may be fairly regarded as a business expense of a mining enterprise, then no restriction should be placed upon the class of income against which the deduction will lie.

Allowable Capital Expenditure: Costs of Company Formation and Capital-raising

19.62. Under the former section 122A (1) (e), costs of company formation and capital-raising incurred by a mining company which conducted ‘prescribed mining operations’ (as defined in section 122 (1) ) were classified as “allowable capital expenditure’ and were therefore immediately deductible under section 122E or on a life-of-mine basis under section 122D, subject to the conditions appearing in those sections. Section 122A (1) (e) had a relatively brief existence: it was specifically added as a category of allowable capital expenditure in 1969 but has now been deleted. There is provision for the retention of a transitional measure in relation to such expenditure between 17 September 1974 and 30 June 1976, provided it is incurred under a contract entered into on or prior to 17 September 1974. The Committee supports this amendment: this category of expenditure cannot be regarded as being peculiar to mining or justifying the taxation treatment formerly accorded it under Division 10.

Immediate Write-off Provisions

19.63. The operation of the immediate write-off provisions of section 122E or section 122G has been terminated in relation to eligible expenditure incurred after 17 September 1974. Under section 122E the mining enterprise which has incurred capital expenditure within one of the categories of allowable capital expenditure under

― 306 ―
section 122A(1) (other than on acquiring a mining right or prospecting information or on ‘housing and welfare’) may elect to deduct the amount of such expenditure from income derived from any source during that year in lieu of a life-of-mine basis under section 122D. It will be recalled that most of the categories of allowable capital expenditure are deductible only where such expenditure is incurred in connection with the carrying on by the taxpayer of ‘prescribed mining operations’.

19.64. Section 122G allows a mining enterprise to appropriate income of any year to meet allowable capital expenditure to be incurred in the following year. If such an appropriation is made, the taxpayer may elect to claim a deduction in the year of appropriation for the amount so appropriated. As with section 122E, this does not apply to an appropriation for expenditure on ‘housing and welfare’ or on the acquisition of ‘mining information’ or a ‘mining or prospecting right’. The deduction allowable is equal to so much of the amount appropriated as the Commissioner is satisfied has been or will be expended as allowable capital expenditure in the succeeding year. Where a deduction has been allowed in an income year for an appropriation, an amount equal to that deduction is included in the assessable income of the next succeeding year. The amount so included in the assessable income is offset by the deduction allowable in that year for expenditure incurred out of the appropriated income. The facility afforded by these sections is usually employed in the ‘further development’ stage of an established mining operation when it is generating sufficient income to absorb available deductions.

19.65. Under the 1974 amendment, all items of allowable capital expenditure (section 122A (1) ) will be deductible over the life of the mine in accordance with section 122D. As mentioned earlier, the assessable income against which such items can be deducted may be derived from any source. As an alternative, the mining enterprise may still elect to claim depreciation in respect of certain items of mining plant under the depreciation provisions of sections 54 to 62.

19.66. The major effect of the amendment will be to preclude a mining enterprise from availing itself of an accelerated amortisation allowance in respect of any class of allowable capital expenditure. Mining enterprises would thus obtain no differential treatment under the Act for such expenditure beyond the fact that certain items of capital expenditure may be written off over the life of the mine to which they relate, or twenty-five years, whichever is the less.

19.67. These amendments may be endorsed from a strict accounting point of view, since they give effect to the principle that the costs of developing a mine should be carried forward for amortisation during the production phase and matched with revenue earned. However, they ignore the practical problems that have been continually impressed upon the Committee in submissions as being the justification for the immediate write-off provisions. These concern the vastness of mining exploration and development expenditures compared with those incurred in other industries, the extreme difficulties involved in financing these operations and the fact that all such expenditures are of a wasting nature. The Committee has been informed that these sections of the Act have assisted the mining enterprise greatly in the past by alleviating its cash-flow problems during the development stage when substantial sums are being expended before peak profit levels have been attained. Perhaps the most important feature is that these sections also permitted a major portion of the total capital cost to be financed by short- and medium-term borrowings instead of by equity capital: limited funds are available in Australia for investment in high risk activities such as mining. It would not have been possible to service the repayment of

― 307 ―
these borrowings without provisions permitting immediate or accelerated write-off of the capital expenditure financed in this way.

19.68. Submissions have indicated that a substantial reduction in the return on investment in mining operations may be anticipated as a result of the 1974 amendments and that, as a consequence, some projects will require review where the major part of the capital expenditure in those projects would have qualified for deduction under sections 122E or 122G. One submission has presented calculations showing that the abolition of accelerated depreciation under section 122E has reduced the after-tax return on equity invested from 17.7 per cent to 10.2 per cent. These sections, it is said, reduced the dependence of mining enterprises on outside sources of finance, assisted in meeting interest commitments on loans raised in respect of a project, and accelerated development and expansion by providing a certain and, in some cases, substantial cash-flow in the early years of a mining project. The loss of the facility increases the requirement for funds in two ways. Firstly, additional equity capital is required in a project to fund the increased initial cash-flow requirements for which loan funds are rarely available. Secondly, lenders require the investing of additional equity capital to ensure that the project has an adequate margin for interest and loan repayments; they also have an additional risk factor in that the period of repayment is extended since earnings from the project are diminished. These submissions have also argued that, in view of the additional uncertainty associated with mining projects, rates of return on investment should be commensurately higher than those for other industries. One submission has stated that it is unlikely that a project promising an after-tax return on equity of less than 15 per cent would be acceptable and that the minimum return employed as a guideline by an industry reflects the risk of investment in a project. It has also been noted that the gradual exhaustion of richer mineral deposits is accompanied by an increase in production costs for those remaining.

19.69. In summary, the accelerated depreciation allowances are said to match the unique requirements of the mining industry and that the loss to the Revenue of interest on tax deferred should be weighed against the prospect of a lesser amount of overall investment in mining projects by reason of the reduction in its attractiveness.

19.70. The Committee has taken the view that the deductibility of capital expenditure incurred in development of a mine should be by way of amortisation over the life of the mine and that this treatment is necessary to yield a true income profit. There are many features of the mining industry that may be said to require a unique approach under the income tax laws, not only for the purpose of revealing a true income profit but also in recognition of the structural peculiarities referred to earlier. The question of the nature and extent of any concessions, such as accelerated depreciation or investment allowances, is more appropriate for study by the Industries Assistance Commission. The Committee would point out, however, that sections 122E and 122G have appeared to serve a useful purpose in the past and that, assuming the taxation system to be an appropriate vehicle for granting these concessions, consideration might be given to the institution of some form of accelerated depreciation in recognition of the considerations outlined earlier.

Housing and Welfare Expenditure.

19.71. ‘Housing and welfare’ is defined in section 122 (1) and encompasses all infrastructures erected to house and service the requirements of mine employees and all other essential personnel in the vicinity of the mine site. The 1974 amendments terminated the option of the taxpayer under section 122F to write off such expenditures over a period of five years.

― 308 ―

19.72. The option of a five-year write-off facility was obviously provided as an incentive to the furnishing of suitable and adequate amenities in remote locations and by way of recognising the substantial costs involved in erecting them. For example, it has been estimated (in a submission to the Committee) that the cost of erecting a house in the Pilbara area is two-and-a-half times that incurred in erecting the same house in Perth. The Committee has been given other examples of this type of discrepancy. The fact that expenditure on such infrastructures is deductible is attributable to its minimal or nil residual value when mining operations are terminated; and since the practical utility of these amenities is linked with the rate of exhaustion of the deposit, it is appropriate to write off such expenditures over the life of the mine. The five-year write-off facility may, like sections 122E and 122G discussed earlier, be viewed as an accelerated amortisation provision, the main effect and benefit of which is to provide a source of cash-flow in the early years of production which itself may be used to service loans raised to finance the erection of the infrastructures. It differs from the life-of-mine amortisation approach now remaining in that, while the latter enables computation of profit in an accounting sense, it does not provide any recognition of, nor alleviate, the practical burden confronting a mining enterprise in obtaining the capital, labour and amenity resources necessary to develop its mine. The Committee considers that, while the same comments may be made as those raised in relation to accelerated depreciation allowances in paragraphs 19.66–19.70, it is not appropriate for the Committee to make any recommendation as to the nature and extent of any concession to be granted in this area.

Transportation Expenditure: Division 10AAA

19.73. Prior to the 1974 amendments, expenditure on a large range of transport facilities was deductible over ten years; this expenditure did not have to be incurred by a mining enterprise as such and was deductible in equal annual instalments over a period of ten years commencing with the first income year in which the facility was used primarily and principally for the transport of minerals. It was not necessary for the person incurring the expenditure to own the facility: the deduction was available to a contributor. The range of facilities included in this special deduction included railways, roads and pipelines. The allowance under Division 10AAA was obviously framed as an incentive provision to enable accelerated amortisation of the substantial capital expenditure involved in servicing the mine in light of the fact that such facilities may have little value when mining operations are terminated.