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Development Expenditure

19.86. A number of difficulties arise with the life-of-field basis of deductibility in relation to petroleum development expenditure. The Committee has been assured that it is almost impossible to estimate with any accuracy the amount of recoverable reserves in, and hence the estimated life of, a field. This will depend upon the data available as a result of exploration and the adequacy of the production techniques employed to tap the field. A change in economic conditions may also affect the estimate, since an enterprise will undertake and continue extraction only where and when profitable.

19.87. As stated in paragraph 19.84, the deductions available to a petroleum mining enterprise in respect of its development expenditure are different from those accorded its general mining counterpart in two respects:

  • (a) the deduction for unrecouped capital expenditure is available only against income derived from petroleum operations; and
  • (b) the petroleum enterprise cannot elect to claim its entitlement to the full ‘unrecouped capital expenditure’ deduction to precipitate a loss which would provide access to the loss carry-forward provisions of section 80.

As to the latter, it has been suggested that this facility has been withheld because the petroleum enterprise will not, as a general rule, be able to recoup its losses within the period prescribed under section 80. This reason should not, however, stand in the way of granting the option. There does not appear to be any sound reason for according the differentiation in tax treatment in either of the two respects mentioned above.

19.88. The petroleum well or field, like the mine, is a wasting asset and the revenue it generates is partly income and partly capital in character. The process of exhaustion of the field necessitates an approach to taxation of the revenue which distinguishes and focuses upon the income element. Development costs are part of the asset subject to the process of waste and, for this reason, they should be recouped over the life of the field so that each barrel sold bears a proportionate share of the development cost. This treatment is framed towards the proper matching of expense with revenue derived from the field. The life-of-field method of amortisation embraces the time basis of amortisation so that development expenditure carried forward is allocated to each income tax year during the estimated life of the field. This method would be appropriate where time is the controlling factor in the consumption, or economic usefulness, of a reserve; but it may not be appropriate where rates of production or sale fluctuate according to changes in world market conditions or production techniques. This feature may be said to be more pronounced in petroleum mining than in general


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mining. Accordingly, the production basis of amortisation, whereby expenditure is amortised according to the ratio of production in a tax year to total estimated reserves, may be viewed as more appropriate. In addition, where the amortisation allowance is based upon actual production, it increases in periods of peak production and eases as mining operations near termination when income is correspondingly less. This achieves greater matching of costs and revenue. However, the time basis is more readily administrable and may be preferable from that point of view. The Committee makes no specific recommendation on this issue.

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