Exploration and Prospecting Expenditure

19.78. As with minerals in the earth's surface, deposits of petroleum in volume profitable to mine are difficult to find and the methods employed to discover these depend upon a variety of factors. A general survey of a wide area is first undertaken employing the techniques of photogeology, gravimetry and magnetometry. When sufficient and satisfactory general information has been obtained, the land search is pursued in the field by geological mapping and seismic work, and the offshore search is carried out by seismic work. The third stage is exploration by drilling, and offshore drilling is conducted by means of a floating rig. Only by means of drilling can the existence of a petroleum field be definitely established and the results obtained from this drilling be subjected to regular testing. If a field has been located by the exploration (or ‘wildcat’) well, it becomes necessary to mark out the field; for this purpose a number of other ‘step-out’ wells must be drilled. The field may be comprised by one large and profitable area or it may be distributed over a number of marginal or submarginal areas and questions will arise in relation to economic recoverability. Once it has been established that a viable field exists, a number of production wells are drilled to permit a flow of petroleum in profitable volume. A quantity of necessary equipment is then installed to separate the oil from the other constituents mixed with the mining product. When the production of petroleum is offshore, the installation of all this technical equipment must be effected upon a production platform. The petroleum must then be transported, whether from the land or offshore site, to a central storage facility. The expenses of the discovery of a profitable field and its subsequent development to the stage of commercial production need no emphasis.

19.79. Under section 124AH of the Act, expenditure incurred in ‘exploration or prospecting’ is an allowable deduction in the year in which it is incurred. The amount

  ― 310 ―
of the deduction is limited to the amount of net assessable income derived from petroleum operations in that year.

19.80. ‘Exploration or prospecting’ is defined in section 124AH (7) so as to include geological, geophysical and geochemical surveys, exploration drilling and appraisal drilling, but to exclude development drilling or operations in the course of working a petroleum field. The definition became necessary as a consequence of the distinction in treatment accorded exploration as distinct from development expenditure.

19.81. If the amount of exploration or prospecting expenditure exceeds the amount deductible in any year, the excess is carried forward for deduction against similar income of subsequent years until the entire amount is absorbed. The provisions therefore enable swift recoupment of exploration and prospecting expenditure against petroleum income but do not permit of such recoupment where the taxpayer does not derive assessable income from petroleum. The taxpayer may recoup his capital expenditure at an early stage without the need to match his prospecting and exploration expenditure with revenue derived from exploitation of reserves in that area (for example, on a life-of-field basis). However, allowance is made for the deduction of abortive or non-productive expenditure only where petroleum income is subsequently derived.

19.82. No distinction is seen by the Committee in the features of petroleum exploration vis-a-vis general mining exploration so far as taxation treatment is concerned. Hence the Committee confirms the comments and recommendations made in paragraphs 19.19–19.20 in relation to general mining: that is, such expenditure should be immediately deductible in full in the year in which it is incurred from income derived from any source.

19.83. Certain items of capital expenditure incurred in carrying on ‘prescribed petroleum operations’ are deductible over the life of the petroleum field on the same basis as for general mining. Some of these items are set out in section 124AA and include those costs incurred in providing light, power or water to the site, the cost of providing residential accommodation and amenities for employees. Refinery plant, ships and transport facilities of the nature described in section 124AA (2) (f), (g) and (h) are specifically excluded.

19.84. As with general mining, accrued undeducted allowable capital expenditure is translated into ‘residual capital expenditure’ under section 124AC and the balance is divided by the number of years of the estimated life of the field, or twenty-five, whichever is the less. The amount of the deduction in any one year is limited to the amount of assessable income from petroleum that remains after allowing all other deductions except in respect of development or exploration expenditure. This position is in contrast to that obtaining with respect to general mining, where the deduction for accrued residual capital expenditure is available against income derived from any source. Any amount excluded from the deduction allowed in any year falls into residual capital expenditure to be deducted in future years. Where the estimated life of the field exceeds twenty-five years, the upper limit of the deduction allowed in any year is 4 per cent of the undeducted expenditure on a reducing-balance basis. The Committee confirms the comments made in paragraph 19.21 with regard to the reducing-balance basis.

19.85. The treatment of all petroleum exploration and development expenditure prior to the 1974 amendments was characterised by immediate deductibility of such expenditure from income when derived from petroleum so that any such income

  ― 311 ―
when derived was exempt until all past expenditure had been recouped. This approach did not require that only expenditure incurred in the year of income should be deductible: it allowed a deduction for all such accrued undeducted expenditure, regardless of when it was incurred. These provisions constituted far more of an incentive than the general mining provisions of Division 10, except that recoupment was available only from profits generated by petroleum operations and associated activities, whereas the deductions available under section 122D or section 122E are available against income derived from any source. Under section 124AG a taxpayer who incurs allowable capital expenditure on plant may elect to have the normal depreciation provisions apply as an alternative to a life-of-field basis of deductibility. The depreciation deduction is, of course, available against income derived by a taxpayer from any source.