The University of Sydney-    Classic Texts in Australian and International Taxation Law

I. Exploration Costs

Australia

General mining

19.A3. The Income Tax Assessment Act distinguishes petroleum exploration from general mining in its treatment of capital expenditure incurred in such operations. Section 122J allows a deduction for expenditure on exploration or prospecting on any mining tenements held in Australia or Papua New Guinea for minerals obtainable by prescribed mining operations. This allowance is limited to those categories of operations within the purview of the definition of ‘exploration or prospecting’ in subsection (6) of section 122J.

‘Exploration or prospecting’ means any one or more of the following:

• (a) geological mapping, geophysical surveys, systematic search for areas containing minerals, and search by drilling or other means for minerals within those areas; and
• (b) search for ore within or in the vicinity of an ore-body by drives, shafts, cross-cuts, winzes, rises and drilling,

but does not include operations in the course of working a mining property.

19.A4. The expression ‘prescribed mining operations’ is defined in section 122 (1) to mean mining operations on a mining property in Australia for the extraction of minerals … from their natural site, being operations carried on for the purpose of gaining or producing assessable income. The definition excludes gold mining since income derived from gold mining is exempt under section 23 (o).

19.A5. The deduction is allowable only from income derived from the carrying on of a mining business or associated activities and the taxpayer must have been engaged in a mining business. Thus, where a taxpayer does not derive assessable income from a mining business, he will be obliged to defer deduction of any such exploration


  ― 320 ―
expenditure until such time as assessable income is so derived. The amount of the deduction is limited to the amount (if any) of ‘assessable income’ remaining after deducting all other allowable deductions that directly relate to such business. Where the exploration expenditure incurred in the year of income exceeds the amount allowable as a deduction in that year, it is, by virtue of sub-section (4) of section 122J, carried over to the next and successive years in which ‘prescribed mining operations’ are carried on until the entire amount has been absorbed by deduction against mining income.

19.A6. The deduction is not necessarily limited to capital expenditure so that, in some cases, a deduction may be available under section 51 in addition to section 122J. Where both are applicable, the section under which the deduction is allowable depends upon the Commissioner's discretionary decision under section 82 (1) as to which is the more appropriate. This finds significance in the fact that losses resulting from a section 51 deduction are subject to the time-limit on carry-forward, whereas a deduction under section 122J carries no such restriction. In addition, expenditure on ‘plant’ used in exploration activities is deductible under section 122J unless the taxpayer makes an election under section 122H which invokes the general depreciation provisions of the Act (sections 54 to 62) in relation to such plant. Thus, where plant can be said to have been used for the purpose of producing assessable income, an alternative deduction will be available for depreciation.

19.A7. It appears that the section was inserted in the Act (in 1947) to allow a deduction for a class of expenditure that would not otherwise be deductible and to equate the position of such expenditure with petroleum exploration expenditure, which had been deductible since 1939.

Petroleum

19.A8. Expenditure incurred in exploration or prospecting for petroleum is treated on an identical basis to general mining. Under section 124AH of the Act, expenditure incurred in ‘exploration and prospecting’ is an allowable deduction in the year in which it is incurred. The taxpayer must derive assessable income from petroleum in that year and the amount of the deduction is limited to the amount of such income remaining after deducting all other allowable deductions.

19.A9. If the expenditure on exploration or prospecting exceeds the amount deductible in any year, the excess is carried forward for deduction against similar income of the next and subsequent years until the entire amount is absorbed.

19.A.10. ‘Exploration or prospecting’ is defined in section 124AH (7) so as to include geological, geophysical and geochemical surveys, exploration drilling and appraisal drilling but excludes development drilling or operations in the course of working a petroleum field.

Transfer to Purchaser of Benefit of Deduction

19.A11. Where, by virtue of section 122J (4), there is an amount of exploration or prospecting expenditure which is not deductible in the year it was incurred, the taxpayer (vendor) may in effect transfer his entitlement to a deduction by a notice under section 122B (1). A similar provision enables a corresponding deduction to be transferred to the purchaser of a petroleum prospecting or mining right or information (see section 124AB). Transfer under section 122B (or section 124AB) is available where the taxpayer sells a mining or prospecting right or mining or prospecting information. The expenditure by the purchaser on acquiring the mining or prospecting right or


  ― 321 ―
prospecting information will become allowable capital expenditure of the purchaser to the extent of the amount nominated by the seller and the purchaser in a notice given to the Commissioner.

19.A12. It appears that entitlement to deductions for expenditure on exploration or prospecting may be passed on under section 122B, notwithstanding that the expenditure was not incurred in relation to the area to which the mining or prospecting right or mining or prospecting information the subject of the sale relates. The purchaser will be entitled to deductions under section 122D in respect of what is (after the sale) his residual capital expenditure, even though deductions by the seller would have been indefinitely deferred pending his entry on prescribed mining operations.

19.A13. Exploration expenditure which is not the subject of a notice under section 122B or section 124AB remains available for deduction by the taxpayer who incurred it, notwithstanding that he has disposed of the information gained by the exploration operation or has disposed of his right to explore or mine in the area to which it relates. Section 122B was added in 1968 to rectify the discrimination in this regard between general mining and petroleum mining, to which the former section 124DE had applied since 1963.

19.A14. Both provisions enable a vendor to capitalise outgoings incurred by him in exploration and to transfer any accrued income tax benefit to a purchaser and for the latter to claim the benefit of such a deduction although the cost was not originally incurred by him.

United Kingdom

19.A15. Under the United Kingdom Capital Allowances Act 1968, a ‘writing-down’ allowance is available in respect of expenditure on exploration. No distinction is made between the treatment of exploration and development expenditure for the purposes of this allowance, though certain other allowances made in respect of development expenditure (e.g. the initial allowance referred to later) are not made available in connection with exploration expenditure. The writing-down allowance closely resembles section 122D of the Australian Act in that exploration and development expenditure may be amortised over the life of the mine. Further, it is available to taxpayers carrying on a business which consists of or includes the working of a mine. It is computed by applying to the residue of qualifying expenditure the quotient obtained when the output of the mine in the tax period is divided by the total estimated output of the mine (or one-twentieth, whichever is the greater).

19.A16. This allowance extends to abortive exploration expenditure (which is immediately deductible as a business expense if taxpayer carries on a mining business) and expenditure on machinery or plant used for exploration. Where the mine ceases to be worked, the person carrying on the trade may elect that the writing-down allowances, if any, for any assessable year which begins within six years before that event shall be revised. If he so elects, the writing-down allowance for that (or those) period(s) is revised, so that it is computed with the substitution of the actual output of the mine in lieu of the previous estimate.

19.A17. A depletion allowance is available with regard to the costs of acquiring a mine in lieu of a write-off. (The amount of the allowance varies from 50 per cent to 10 per cent of the royalty value of output according to the length of the period between acquisition and production.) However, the cost of acquiring a mine or mining rights


  ― 322 ―
outside the United Kingdom may be made the subject of a write-off allowance under the provisions outlined above.

Canada

‘Principal Business Corporations’

19.A18. The distinction between exploration and development expenditure is preserved under Canadian legislation. Section 66 (15) (h) of the Income Tax Act defines a ‘principal business corporation’ as a corporation whose principal business is (i) production, refining or marketing of petroleum, petroleum products or natural gas or exploring or drilling for petroleum or natural gas; (ii) mining or exploring for minerals; (iii) processing mineral ores to recover metals therefrom; (iv) a combination of (iii) and processing metals recovered therefrom; (v) fabricating metals; or (vi) operating a pipeline for the transmission of oil or natural gas. A ‘principal business corporation’ is allowed to deduct the aggregate of its past exploration and development expenditure incurred in Canada up to a limit represented by the amount of net income for the taxable year before deduction of depletion allowances or losses carried forward, but reduced by deductible dividends received. The provision resembles section 122J of the Australian Act and includes in the base of capital expenditure deductible under this heading the cost of any ‘Canadian resource property’, including amounts paid for the acquisition of mining rights (whether oil, gas or minerals). Any such costs not deducted in the year may be carried forward indefinitely against income from future years.

19.A19. The provision applies to:

• (a) the cost of searching and drilling for petroleum and natural gas; and
• (b) the cost of prospecting, exploration or development expenditure incurred by a taxpayer in searching for minerals.

In Canada the Act accords different treatment to each of the above categories, since exploration and development expenditure incurred with regard to petroleum or natural gas is immediately deductible in the manner indicated above whereas in the case of general mining this provision relates only to exploration and other costs incurred up to the time of development of the mine for production. It appears that the oil and gas allowance is so framed because of the practical difficulty involved in distinguishing petroleum ‘exploration’ from ‘development’ expenditure.

Taxpayers Other than ‘Principal Business Corporations’

19.A20. The deduction for exploration and development expenditure is limited to the amount of income derived from the oil or gas well or mine or royalties therefrom, together with the amount by which a consideration received on sale of a mine exceeds the amount that would ordinarily be allowed as capital expenditure in respect thereof; alternatively, the limit is 20 per cent of the accrued undeducted exploration and development expenses if that amount exceeds the amount of income described above. (If the taxpayer's ‘income from Canadian resources’ is insufficient, he may deduct up to 20 per cent of the allowable expenditure from income derived from other sources.) A similar allowance is available for foreign exploration and development expenses.

19.A21. It will be observed that the provisions outlined above are directed towards enabling immediate write-off of exploration expenditure against income and this appears to have been prompted by the recognition that, in the words of the Carter


  ― 323 ―
Commission (1966): ‘The more uncertain the value of the asset created by a particular expenditure, the more rapidly the cost should be written off. Because the probability of success for a particular exploration venture is usually low, it is reasonable to deduct exploration costs immediately in determining income’.

United States

19.A22. An unlimited deduction against taxable income is available on an optional basis for exploration expenditure (except if incurred on oil and gas) provided that the amount deducted is brought to account as income (or ‘recaptured’) when the mine reaches production or is sold. This is accomplished by the taxpayer electing either to (i) include the previously deducted exploration expenditure chargeable to the mine as income for the year in which the mine reaches production or is sold, increase the ‘basis’ of the property by the amount included as income, and subsequently recover this amount through depletion, or (ii) forgo depletion from the property until deductions forgone equal exploration expenditure previously deducted. Expenses not recaptured by any of these methods are recaptured on the sale or disposition of the mining property.

19.A23. Exploration-type expenditure which is incurred during the development or producing stage of a mine is treated as development expenditure deductible currently, rather than mining exploration expenditure subject to recapture.

19.A24. With regard to oil and gas well drilling expenditure, a taxpayer may elect to treat drilling expenditure as a current expense deductible in the year in which it is incurred or, alternatively, as a charge to capital which is recoverable through depletion or depreciation as ‘intangible drilling and development costs’. If he elects for the latter alternative and the well later proves to be non-productive, he may elect to deduct such costs as an ordinary business loss. Thus, in oil and gas exploration, capital investment is usually recovered in full.

South Africa

19.A25. Exploration or prospecting expenditure may, in certain cases, be deducted in toto from mining income in the year in which it is incurred, or over the life of the mine, according to the discretion of the taxing authority. This twofold approach resembles section 122J of the Australian Act in that an immediate write-off is generally allowed if the mine has reached the production stage. Where a mine has not reached the production stage, no portion of the capital expenditure can be deducted since such expenditure may only be deducted from income derived from mining operations. In such a case, the capital expenditure is accumulated and amortised over the life of the mine.

19.A26. In relation to mines that commence production in any years of assessment after 31 December 1973, capital expenditure (whether on exploration or development) incurred after that date is fully deductible and may, if it exceeds the assessable income of the enterprise, promote an assessed loss. A balance of any assessed loss incurred in a previous year of assessment may be carried forward to the succeeding year of assessment to be set off against income derived from any other business in the Republic. If in any year of assessment the taxpayer does not carry on any other business, he is not permitted to carry forward to this year any balance of assessed loss established in respect of the immediately preceding year of assessment. In this way, the taxpayer forfeits his right to claim a deduction for the accumulated loss.

  ― 324 ―

New Zealand

19.A27. The outlay by a mining enterprise on both exploration and development is deductible in the year in which it is incurred. The capital expenditure provisions under relevant New Zealand legislation allow mining companies a deduction for exploration and development expenditure incurred and those companies are subject to income tax on mining income at only two-thirds of the rate applicable to other companies. This includes expenditure incurred as consideration paid or payable for the acquisition of an asset. This situation extends to certain specified minerals and petroleum. In relation to specified minerals, the concession applies to the accumulation, processing to the stage of concentration, and transport of the products to the stage where they are in saleable form and at a location suitable for acquisition by a purchaser or are ready to be processed beyond concentration, or used in a manufacturing operation.

19.A28. There is little restriction on the nature of capital expenditure by a mining company that qualifies for deduction: the entire outlay on exploration and development is deductible. Section 153F (12) requires the salvage value of any mining asset disposed of subsequently (or transferred to non-mining activities) to be returned as assessable mining income at that stage.

Mining Companies

19.A29. Section 153F provides the basis of assessment of mining companies and states that the assessable income is to be divided into mining and non-mining income. These special mining provisions apply only to New Zealand companies whose sole or principal source of income is mining in New Zealand for specified minerals and/or petroleum, or exploration and searching for minerals or petroleum for a reward related to and dependent on production or participation in profits from production of any specified mineral and/or petroleum.

19.A30. Mining expenditure is allowed first against assessable mining income of that same year, and two-thirds of any excess against other assessable income derived in that year. Any excess of non-mining expenditure over non-mining assessable income is allowed in full against mining income.

19.A31. Loss carry-forward. There is no time-limit on the availability of past losses for set-off against subsequent profits. Where mining expenditure is carried forward as a loss against income of a subsequent year, or past non-mining losses are carried forward against mining income, that carried-forward loss takes into account the differential in tax rates between mining and non-mining income. Such losses are offset firstly against the same class of income in that subsequent year and any excess mining loss then allowed against non-mining income. In such an event the balance of any non-mining loss available for carry forward is reduced by 150 per cent of the mining loss deducted from non-mining income.

19.A32. Appropriations. Either a mining company or a non-resident mining operator may appropriate income for expenditure within two years on exploration and development and may elect to claim a deduction of that amount against the income of the year to which those appropriated profits relate. The amount so allowed as a deduction is treated as assessable income of the succeeding year. The relevant expenditure incurred may be claimed as a deduction in that succeeding year, subject to a further right to claim as a deduction in that year any unexpended portion of that initial appropriation and, subject to the same general terms, make any new appropriations in respect of the succeeding two-year period. This will not apply if the result


  ― 325 ―
would be to put the taxpayer into a loss situation for the year's result overall. The effect of this provision, it will be noted, resembles the former section 122G of the Australian Act, except that the latter applied essentially to development expenditure. Such an appropriation provision enables a company to preserve its liquidity during the exploration stage of a mining venture in anticipation of substantial capital outlay.

Mining Operators

19.A33. Section 153J covers the tax position of those New Zealand residents who do not come within the definition of a mining company but are engaged in or propose engaging in mining or associated operations as a business. Exploration and development expenditure is deductible as for mining companies but there is no deduction available for appropriations. The concessional tax rate does not apply to mining income. Mining losses are firstly to be offset against mining income of any year, with any excess available to be offset against other income. There is a restriction that a mining loss can be offset only as to 50 per cent against other income in any income year. Where a non-mining loss is offset against mining income, there is no such restriction.

Non-resident Mining Operators

19.A34. Section 153K covers all non-resident persons (individuals and companies) engaged in New Zealand in a business venture principally involving mining operations. Exploration and development expenditure is deductible in similar fashion to resident mining companies, as also are amounts appropriated for such expenditure in the event that an election to that effect is made. The total income of non-resident operators relating to mining activities is taxable separately at the flat rate of 45 cents in the dollar.

19.A35. It will be observed that the New Zealand provisions do not discriminate between development and exploration costs, as immediate write-off is available in respect of each category. Further, the availability of a limited right of set-off of mining expenditure against non-mining income serves to ensure that mining exploration concessions may be available to, and utilised by, enterprises engaged in other businesses and infant mining enterprises for which the right of unlimited loss carry-forward preserves the value of accrued deductions for exploration expenditure.

II. Capital Expenditure on Plant and Development

Australia

General Mining

19.A36. Deduction for expenditure incurred in extraction, treatment and storage of minerals is provided for under Division 10 of the Act. In general, this Division allows a deduction for the cost of developmental works which would not qualify for any deduction under the normal depreciation provisions. The expenditure qualifying for deductions is provided for under the various categories of ‘allowable capital expenditure’ defined by section 122A. Some of these categories are:

• (a) expenditure incurred in the preparation of a site, on buildings, and other improvements and plant necessary for carrying on the mining operations;
• (b) expenditure on light, water and communications connected with the site and on ‘housing and welfare’ as defined in section 122 (1);
• 
  
  
    ― 326 ―
  (c) treatment plant, storage facilities and buildings/plant connected therewith (‘treatment’ is restrictively defined in section 122(1)); and
• (d) the costs of acquisition of a mining right or prospecting information.

The expenditure must in general be incurred by an enterprise that is in the course of conducting mining operations in Australia for the extraction of minerals, other than petroleum, from their natural site. These mining operations must be carried on for the purpose of producing assessable income; but in contrast to the position with regard to exploration expenditure under section 122J, the deduction is allowed against income generated from activities other than mining. ‘Mining operations’ in general covers the extractive process up to the stage where the mineral is obtained in manageable lumps.

19.A37. The categories of expenditure outlined above may be claimed as a deduction by writing off that expenditure over the estimated life of the mine to which it relates or over a term of twenty-five years, whichever is the less (section 122D).

19.A38. Alternatively, a taxpayer may elect to have the normal depreciation provisions applied to expenditure on a ‘unit of plant’ instead of having that expenditure deducted in accordance with Division 10. The annual rate of depreciation of any unit of plant is determined by the Commissioner on the basis of the effective life of the unit. This rate is increased by 50 per cent if depreciation is claimed on the diminishing value method.

19.A39. Certain categories of expenditure are expressly excluded from the ambit of the provisions outlined above:

• (a) ships, railway rolling stock or road vehicles, or railway lines, roads, pipelines or other facilities used for the transportation of minerals (other than wholly within the mine site);
• (b) buildings or other improvements in port facilities and other facilities for ships and port employees; and
• (c) office buildings not on or adjacent to the site of mining operations.

Some of these items are depreciable in accordance with the normal depreciation provisions but others, particularly those items of expenditure under categories (b) and (c), are not deductible at all.

19.A40. The amortisation deduction under section 122D is a manifestation of the recognition that the profits of a mining venture cannot be effectively gauged for accounting or tax purposes until provision has been made for the recoupment from profits of capital employed in the venture.

19.A41. Under section 122 (3), the taxpayer has a distinct ‘residual capital expenditure’ in respect of each mining property on which he carries on prescribed mining operations. The deduction allowed under section 122D may not exceed net assessable income unless the taxpayer so elects, thereby allowing himself access to the loss provisions under section 80.

19.A42. Railways, roads, pipelines. Division 10AAA provides for deductions to be allowed over a period of twenty years for capital expenditure incurred on certain facilities used primarily and principally to transport minerals or products of minerals mined in Australia or Papua New Guinea for the purpose of producing assessable income. These facilities are defined in section 123 (2).

  ― 327 ―

19.A43. The deduction is available in respect of the undeducted capital expenditure incurred after 17 September 1974 on the cost of an eligible railway, road, pipeline or other facility used for the transport of minerals. If such expenditure was incurred between 1 July 1961 and 17 September 1974, it is deductible over a ten-year period under section 123B (1). Expenditure on earthworks, bridges, tunnels and cuttings necessary for a railway, road, pipeline or other facilities is deductible as is that incurred in obtaining a right to install a railway, etc. on land owned by another. Compensation payments (for damage or loss due to construction of a railway, etc.) fall within the ambit of this Division and are deductible. Deductions are available for the transport facilities even though they are used to transport materials resulting from the treatment or further processing of certain minerals.

19.A44. The cost of transport facilities used wholly within the mine site which is deductible under Division 10 is not deductible under Division 10AAA; nor are petroleum transport facilities where the transport forms part of petroleum mining operations which are deductible under Division 10AA (see below).

19.A45. A taxpayer may claim a deduction under Division 10AAA even though not himself engaged in mining operations which produce the minerals being transported.

19.A46. Any expenditure eligible for deduction under this Division is deductible in equal instalments over twenty years, commencing with the first year in which the facility is used to transport minerals or their products for the purpose of gaining assessable income.

19.A47. Expenditure on railway rolling-stock, road vehicles and ships is specifically excluded from the application of the Division. If rolling-stock and vehicles are used for transport wholly within the mine site, a deduction may be available under Division 10; if not, they (in addition to ships) are depreciable under sections 54 to 62.

19.A48. No deductions are available with respect to expenditure on ports and port facilities.

Petroleum

19.A49. The provisions relating to expenditure incurred in prospecting and mining for petroleum are set out in Division 10AA. As with general mining, this applies to operations conducted on the continental shelf, as the definition of ‘Australia’ includes the Australian continental shelf, Papua New Guinea and the continental shelf of that Territory.

19.A50. The scheme of the deductions for capital expenditure incurred in development is the same as that applying under Division 10 in relation to general mining. Certain items of capital expenditure incurred in carrying on prescribed petroleum operations are deductible over the life of the petroleum field, or twenty-five years, whichever is the less. These items are set out in section 124AA and include:

• (a) The cost of acquiring a ‘petroleum prospecting or mining right’ or ‘petroleum prospecting or mining information’, where the parties to the sale have elected that the deduction entitlement should be transferred from the vendor to the purchaser.
• (b) Capital expenditure incurred at any time in prospecting or mining operations in Australia for the purpose of obtaining petroleum or on plant necessary for carrying out these operations. This embraces development expenditure incurred in drilling and pumping.
• 
  
  
    ― 328 ―
  (c) The cost of providing residential accommodation for employees when that accommodation is situated on or adjacent to the site.
• (d) The cost of providing health, educational, recreational or other similar facilities or facilities for the supply of meals on or adjacent to the site (where provided principally for employees and their dependants and not for the purpose of profit-making).

19.A51. The categories of expenditure not allowed are set out in section 124AA and include:

• (a) costs incurred on transport facilities which qualify for deduction under Division 10AAA (see above); and
• (b) ships, railway rolling-stock and road vehicles used for the purpose of transporting petroleum, and refinery plant. These items are subject to depreciation under the normal provisions relating to depreciation.

19.A52. The deduction for accrued residual capital expenditure in any year is limited to the amount of net assessable income from petroleum derived in that year. Any excess is added to the residual capital expenditure deductible in future years. As with general mining, a taxpayer may elect, under section 124AG, that the normal depreciation provisions apply to plant.

19.A53. Sale of prospecting or mining rights or information. As with the general mining sections, provision is made whereby the parties to the sale/acquisition of mining rights or information may elect to transfer from the vendor to the purchaser an amount of undeducted allowable capital expenditure up to or equivalent to the consideration paid by the purchaser.

19.A54. Section 122B (general mining) and section 124AB (petroleum mining) were added to enable the purchaser of a mining right or information to obtain a deduction in respect of at least some part of the cost incurred by him. Under both sections, by giving notice to the Commissioner, certain allowable capital expenditure which would eventually have been deductible by the vendor will, to the extent of the amount nominated, but not exceeding the purchaser's expenditure in acquiring the mining rights, be deductible by the purchaser over the life of the mine or petroleum field, as the case may be. The vendor's allowable capital expenditure is correspondingly reduced.

19.A55. Disposal of mining and petroleum mining assets. Sections 122K and 124AM provide for balancing adjustments where assets in respect of which deductions have been granted on one of the special bases are sold, lost or destroyed.

United Kingdom

19.A56. The writing-down allowance mentioned in connection with exploration expenditure is also available for the amortisation of capital expenditure incurred in developing a mine and plant, machinery and works acquired or constructed for the purpose of mining, providing the latter are likely to be of little or no value when the mine is no longer worked. In addition, an initial allowance of 40 per cent of the expenditure incurred is given for expenditure on construction of works of a similar nature.

19.A57. Certain categories of expenditure are expressly excluded from the ambit of the provisions outlined above, namely:

• (a) costs of acquiring a site or right to mine inside the United Kingdom;
• 
  
  
    ― 329 ―
  (b) expenditure on works constructed wholly or mainly for processing raw product;
• (c) office buildings; and
• (d) facilities for occupation by or the welfare of, workers.

An industrial buildings allowance is granted in respect of buildings provided for occupation or use by mining workers.

19.A58. Where a taxpayer engaged in a mining business incurs capital expenditure on a mineral asset, and the acquisition of that asset entitles him to work a mine, oil well or other source of mineral deposits of a wasting nature, he is entitled to a depletion allowance in respect of the expenditure. The amount of depletion allowance is computed by reference to a variable fraction of the royalty value of the output of the mine in a taxable year:

• (a) where the first working of the mine after the expenditure was incurred (i.e. acquisition of the mine) is less than ten years before the end of the taxable year, one-half of the royalty value of the output;
• (b) where that first working is less than twenty but not less than ten years before the end of the taxable year, one-quarter;
• (c) in any other case, one-tenth.

19.A59. ‘Royalty value’ in relation to any output from a mine means the amount of royalties that would be payable on that output if the person working the mine were a lessee under a lease for a term expiring immediately after the output was produced, granted to him at the date when the expenditure was incurred (i.e. date of acquisition), and providing for the payment of such royalties on output from the source as might reasonably have been expected to be provided for by such a lease, but reduced by the amount of any royalties. The allowance is limited to the amount by which capital expenditure on acquisition exceeds aggregate depletion allowances for prior years. Balancing charges and allowances are provided where operations are terminated, calculated by appraising the market value of the land as notionally restored to its original condition.

19.A60. It appears that the depletion allowance was instituted in an attempt to equate the position of a taxpayer who acquired land for mining purposes with that of a taxpayer who works a mine on a royalty basis and thereby obtains a deduction from profits for royalties paid by him. Further, it was recognised that a proper ascertainment of mining profits must give some allowance or relief in respect of the wastage of capital expenditure on the purchase of the land.

19.A61. The equation of the treatment of mining leases or rights to ordinary leases for tax purposes was expressly repudiated by the Royal Commission on the Taxation of Profits and Income (1955):

‘The problem of allowance for mining depletion cannot be governed by the tax treatment of premiums paid for the acquisition of leases. The special treatment of such premiums is partly a product of the special conceptions of the tax on the annual value of land under Schedule A, under which the primary subject of taxation is the income that is inherent in the right of occupation of land. But a mining venture is taxed on the profits (if any) which arise from the venture itself, the mineral areas acquired being merely a part of the whole assets committed to the venture.’

  ― 330 ―

Canada

Depletion Allowances

19.A62. A taxpayer operating certain classes of mine may deduct one-third of all his profits for the taxation year reasonably attributable to production from the mine. The classes of mine are:

• (a) oil and gas wells;
• (b) bituminous sand deposits;
• (c) base and precious metal mines; and
• (d) certain specified mineral deposits.

This excludes industrial minerals contained in bedded deposits (for example, sand and gravel pits, salt and stone quarries). ‘Operator’ includes a person who carries on extracting operations, persons who have an interest in the proceeds of production or a right to share in profits.

19.A63. A ‘non-operator’ who receives a rental or royalty or otherwise has an interest in production from a mine is entitled to a deduction equal to 25 per cent of the amount included in computing his income.

19.A64. Where the output of gold is 70 per cent or more of the aggregate output from all the mines operated by the taxpayer, the deduction allowed is the greater of (i) 40 per cent of the aggregate of the net profits reasonably attributable to all mines owned by him, or (ii) $4.00 per ounce of gold produced in the year.

19.A65. The computation of ‘production’ requires deduction from production profits of all production losses or outgoings, exploration and developmental expenses otherwise deductible, the capital cost allowance (referred to below), exempt income, and any interest paid on the purchase price of property used for exploration or production purposes. It would appear that this allowance tends to favour the profitable mining venture. A deduction equal to 10 cents per ton of coal mined is granted to a taxpayer who operates a coal mine.

19.A66. Until the end of 1973, a mine was granted a ‘tax holiday’ whereby its income was exempt for a three-year period commencing when the mine came into reasonable commercial production.

19.A67. After 31 December 1976 the depletion allowance (permitted under section 65(1) of the Act) will be computed on an ‘earned depletion’ basis under which, in general, taxpayers are entitled to deduct in computing income $1.00 for each $3.00 of specified eligible expenditures incurred by them after 7 November 1969. The automatic deduction allowed to operators and non-operators of (respectively) one-third and one-quarter of production profits will cease to apply. All taxpayers will be entitled to deduct one-third of their ‘resource profits’ for the year to the extent of their earned depletion base at the end of the year. The term ‘resource profits’ will include profits from the kinds of activities which prior to 1977 would attract the depletion allowance. Only where the taxpayer has incurred qualifying expenditures after 7 November 1969 will he be entitled to a depletion allowance.

19.A68. Thus, any expenditure incurred in exploration for and development of minerals, oil and gas wells is a constituent of the earned depletion base which forms the ceiling limit of the depletion allowance.

19.A69. It appears that the purpose of the amendments was to promote a direct relationship between the extent of expenditure on exploration and development and


  ― 331 ―
the quantum of the incentive being offered: the previous system of depletion allowances under which deductions were related to profits or the volume of production was said to encourage exploration and development only indirectly. The deduction is designed to operate as a pure incentive and not merely to recognise expenses that ought to be taken into account in accurately measuring income.

19.A70. Certain categories of expenditure are not included in the ‘earned depletion base’. These are the cost of a Canadian resource property, interest on money borrowed for the purpose of exploration, prospecting or development and post-production exploration and development expenditure. The cost of ‘processing property’ is included in the earned depletion base: this encompasses all plant employed in processing mineral ores up to the prime metal stage or its equivalent.

Additional Allowances

19.A71. As seen earlier, a ‘principal business corporation’ may deduct the aggregate of its Canadian exploration and development expenses to the end of the taxable year to the extent that they have not been deducted previously.

19.A72. A taxpayer may deduct such expenses which have been incurred in connection with certain mines from the profits reasonably attributable to the operation in Canada of that mine. These include oil and gas wells and precious and base metal mines. The allowance in any year is limited to 25 per cent of the aggregate of all expenses reasonably attributable to the prospecting and exploration for and development of the mine prior to its coming into production in reasonable commercial quantities. This does not include:

• (a) exploration and development expenses which may be claimed under other provisions;
• (b) expenses deducted in computing the income of the taxpayer in the year they were incurred;
• (c) the cost of properties in respect of which capital cost allowance may be claimed; and
• (d) the cost of leasehold interests.

19.A73. After 1 January 1977 taxpayers deriving income from oil or gas mining operations may deduct all drilling and exploration expenses from current and earlier years to the extent not deducted previously.

Capital Cost Allowances

19.A74. Certain assets qualify for accelerated capital cost allowances. The assets must be acquired before a new mine produces in commercial quantities or the major expansion of an existing mine. This replaced a three-year exemption for the income of new mines. In general terms, assets qualifying for this allowance are ordinarily depreciable and comprise:

• (a) a building (except an office building not situated on the mine property);
• (b) mining machinery and equipment;
• (c) electrical plant; and
• (d) community and transportation facilities—for example, airport, dam, hall, hospital, house, power-line, recreational facilities—analogous to the ‘housing and welfare’ deductions under the Australian Act.

  ― 332 ―

The rate of depreciation which may be claimed is 30 per cent of the undepreciated balance of each class of asset. Alternatively, taxpayers may claim a deduction for the full amount of the undepreciated capital cost up to the amount of income from the mine (before deducting depletion or any other allowance).

United States

Depletion Allowances

19.A75. A deduction for depletion of a natural resource (including mines and quarries) is allowed to the owner of such a resource and it is directed towards allowing recovery of the cost over the life of the resource.

19.A76. The basic method of computing depletion is known as cost depletion. Determination of cost depletion requires first an estimate of the number of units (tons, barrels) which make up the deposit. Then that part of the cost of the property which is attributable to the depleted reserves is divided by the number of units. The quotient is the cost depletion per unit. This amount, multiplied by the number of units extracted and sold during the year, determines the cost depletion deductible for the year. Each year the ‘cost basis’ of the property is reduced, but not below zero, by the amount of depletion deducted for that year, whether cost or percentage depletion was used. The remaining basis is used in computing cost depletion for the next year.

Example

Taxpayer purchases a mine for $10,000 and estimates that there are 100,000 tons of ore to be extracted. During the first year he mines 7,500 tons and sells 7,000 tons. Depletion for the first year would be computed as follows:

Rate of depletion per ton = $10,000 ÷ 100,000 = 0.10 cent

Depletion for year (0.10 cent × 7,000) = $700

The next year taxpayer sells 6,000 tons. However, a revised estimate at the end of the year indicates that there are 180,000 tons unextracted. Depletion for the second year would be computed as follows:

               

Revised estimate of unextracted tonnage	180,000
Tons mined during the year	6,000
Total tonnage to be used on computing new rate	186,000
Original cost	$10,000
First year's depletion	$700
Remaining cost	$9,300
New rate of depletion per ton = $9,300 ÷ 186,000 =	0.5 cent
Depletion for year (0.5 cent × 6,000) =	$300

Percentage Depletion

19.A77. An alternative method of computing a deduction is available for all depletable property except timber. Under this method a flat percentage of gross income from the property is taken as the depletion deduction. The percentage depletion may not exceed 50 per cent of the taxable income from the property, computed without regard to the depletion allowance. However, if cost depletion would result in a greater deduction, it must be used. Percentage depletion ordinarily permits recovery of much more than cost and is allowed at varying percentages of gross income from the property. For example, the depletion rate is 22 per cent in the case of uranium, oil, gas and sulphur, and 15 per cent in the case of gold, silver and iron.

  ― 333 ―

Development Expenditures

19.A78 Expenditure incurred for the development of a mine or other natural deposit after the existence of minerals has been disclosed is fully deductible in the year in which incurred. Alternatively, the taxpayer may elect to treat it as deferred expenditure to be deducted rateably as and when the mineral or ore is sold. The election to defer deductions may be made for each year while the mine or deposit is in the development stage, but must be for the total amount of net development expenditure made in that year with respect to the mine.

19.A79. The normal depreciation provisions apply to improvements in the case of mines or oil and gas wells: the taxpayer may elect to employ the straight-line, fixed percentage or reducing-balance method of depreciation. In addition, the normal depreciation charges apply to all depreciable property used in drilling and development.

19.A80. It will be noted that the taxpayer's deduction for wasted capital may exceed his actual unrecovered capital cost. This arises because a large part of the capital expenditure is permitted to be deducted as incurred, and then (percentage) depletion is allowed as a percentage of receipts without regard to the remaining unrecovered capital expenditure.

South Africa

19.A81. Persons carrying on mining operations on a mine which commenced production after 1 January 1974 may deduct from income derived from mining in each year the whole of the capital expenditure incurred by them in the carrying on of such mining operations.

19.A82. Capital expenditure, in order to qualify for the deduction, must fall within one of the following categories:

• (a) Expenditure on shaft sinking and mine equipment—i.e. ‘all the apparatus (including buildings) necessary for carrying on mining’—and the cost of laying pipelines from the site to the marine terminal or refinery. Equipment under this category must exceed a certain cost (R40,000).
• (b) Expenditure on development, general administration and management (including interest on loans utilised for mining purposes) prior to the commencement of production or during any period of non-production.
• (c) In the case of deep-level gold mines, new gold mines, and natural oil mines, a special allowance of 5 per cent per annum of unredeemed expenditure incurred on a number of items: for example, expenditure incurred during any period of production on development of any reef on which, at the date of such development, stoping had not commenced. This deduction is available from the end of the month in which the expenditure is incurred up to the end of the year of assessment immediately preceding that in which the determination of the taxable income derived from the working of the mine does not result in an assessed loss.

19.A83. Capital expenditure deductible is ‘net’: that is, where a capital asset falls within the description of an allowable category, any amount obtained as a result of its sale must be deducted in order to arrive at net expenditure. The cost of acquisition of a mining right does not form part of the capital expenditure ranking for redemption.

19.A84. Computation of deduction. Formerly, accumulated (net) capital expenditure together with 75 per cent of the capital expenditure incurred in the year of income were aggregated and the aggregate amount was divided by the estimated life


  ― 334 ―
of the mine (but not exceeding thirty years) and the resulting quotient was the redemption allowance for the year of assessment. Twenty-five per cent of the capital expenditure for the year was immediately deductible. After deducting the allowance from the aggregate amount, the portion remaining represented the unredeemed balance of capital expenditure and was carried forward to the next year of assessment to form the basis of a fresh calculation for that year.

19.A85. It will be observed that the provision resembled the Australian section 122D in relation to accumulated capital expenditure. Special provisions existed in relation to gold mines, diamond mines and natural oil mines.

19.A86. In relation to years of assessment after 31 December 1973, capital expenditure incurred after that date is fully deductible and may, if it exceeds the assessable income of the enterprise, promote an assessed loss. A balance of any assessed loss incurred in a previous year of assessment may be carried forward to the year of assessment to be set off against income derived from any other trade in the Republic. If in any year of assessment the taxpayer does not carry on a business, he is not permitted to carry forward to this year any balance of assessed loss established in respect of the immediately preceding year of assessment. In this way, the taxpayer forfeits his right to claim a deduction for the accumulated loss. (On 14 August 1974, the Minister of Finance announced proposals to allow taxpayers operating a mine to write off all balances of unredeemed capital expenditure over a period of five years expressly for the purpose of financing expansion.)

19.A87. Closing down of mine. As under the Australian provisions, where the mine is closed down, any balance of unredeemed capital expenditure remaining is lost unless the mine is ultimately reopened by the taxpayer. Further, similar to section 122K of the Australian Act, if, as a consequence of sale, recoupments of capital expenditure are in excess of unredeemed capital expenditure, such excess is brought to account as income.

19.A88. Change of ownership. A purchaser may claim a deduction for capital expenditure computed as being the effective value to him at the time of purchase of the preliminary surveys, boreholes, shafts, development and equipment included in the assets purchased. Whatever amount is allowed to rank as capital expenditure for redemption by the new owner is deemed to be a recoupment from capital expenditure by the previous owner. ‘Effective value’ is determined by the Government Mining Engineer.

New Zealand

19.A89. As noted earlier, no distinction is made under New Zealand tax legislation between exploration and development expenditure: an immediate write-off is allowed in respect of both categories in the manner indicated.

19.A90. Where a landowner derives income by way of royalties from the sale of non-specified minerals extracted from his land or by way of mining, he is assessable on the profits. However, the New Zealand Act allows for the ‘commodity cost’ of the minerals realised to be deducted in ascertaining that income. This is in effect a depletion allowance of the cost type, as it allows miners to reckon their tax profits from the enterprise after deducting all working expenses and ‘an amount equal to the cost of’ those minerals. This involves matching the depletion allowance on the wasting mineral resource to the rate of production. The capital figure requiring amortisation is the cost of the resource plus developmental outlays.

  ― 335 ―

III. Investment INCENTIVES

Australia

Deductibility of Capital Subscription

19.A91. The Income Tax Assessment Act formerly allowed the deduction from assessable income of the owner of shares (other than redeemable shares) in a company of certain moneys paid by him to the company in respect of such shares, and applied by the company towards the paid-up value of the shares, where the company was carrying on a business of mining or prospecting in Australia or Papua New Guinea for certain minerals (including petroleum) and it had made a declaration that it proposed to spend or had spent the moneys on mining or prospecting outgoings. The owner must have been a resident of Australia or Papua New Guinea. To the extent that the deductions were available to shareholders, there were reductions of the deductions for capital expenditure available to the company under Division 10. (See section 77D). The section enabled in effect a transfer of the deduction for ‘allowable capital expenditure’ on mining (section 122A), on petroleum mining (section 124DD) and exploration expenditure (section 122J). It did not include expenditure on transport facilities deductible under Division 10AAA nor that incurred in acquiring a mining right or information. ‘Moneys paid on shares’ meant moneys paid by a company towards the paid-up value of the share, whether paid on application/allotment or to meet calls. See also section 122Q providing for the reduction of moneys otherwise deductible by the company.

19.A92. Further, section 77C of the Act allowed a deduction for moneys paid by shareholders as calls on shares in such companies. Such deductions, which were also available to a non-resident shareholder, did not involve any reduction of the deductions for capital expenditure allowable to the company under Division 10. The deduction was available when the company to which calls had been paid lodged a declaration stating that the money received would be spent on exploration or prospecting in Australia or Papua New Guinea for minerals (including petroleum). If these conditions were satisfied, one-third of so much of the calls as was included in the declaration lodged by the company was deductible from the assessable income derived by the person paying the calls. This did not include moneys paid on application or allotment.

19.A93. The differences between the section 77C deduction and the section 77D deduction were as follows:

• (a) The declaration under section 77C must have related to exploration or prospecting expenditure. The declaration under section 77D could relate to such expenditure or other mining expenditure within Division 10, except expenditure in the acquisition of a mining or prospecting right or mining or prospecting information.
• (b) The deduction to the shareholder under section 77C was one-third of calls, which excluded moneys paid on application or allotment which moneys were included under section 77D.
• (c) As mentioned earlier, the deduction to the shareholder under section 77C did not involve any reduction in the deductions available to the company, as did the deduction under section 77D.

  ― 336 ―

Exempt Income

19.A94. Section 23 (o) exempts income derived from the working of a mining property in Australia or Papua New Guinea where, throughout the working life of the mine, it has been mined principally to obtain gold or gold and copper and where, in the latter case, the value of the gold obtained from the property is not less than 40 per cent of total output.

19.A95. This exemption was expressly inserted as an incentive to gold mining. Until 1973 the exemption extended to such exempt income (less outgoings incurred in its production) distributed by way of dividend to the shareholders of a company. It should be noted that a deduction for exploration and prospecting expenditure under section 122J and for capital expenditure under section 122D is not available where the expenditure is incurred in prospecting or mining for gold, since these deductions related only to assessable income. Furthermore, where mining operations are carried on for the production of income exempt under section 23 (o) in addition to (other) assessable income, apportionment of expenditure is provided for under section 122P. This latter section excludes from the deductions allowable in relation to income from pyrites (which is assessable) expenses that would have been incurred even had the income from pyrites not been derived. The form of the section has led to some consequences which were not intended but which, in any event, appear to be anomalous. Income derived from the ‘working of a mining property’, where the output of gold is of the required percentage of the total value of the output of the mine and is extracted by a cyanide process from soil which has been raised from the beds of gold mines and from which the visible gold has been removed, has been held to be exempt^note. On the other hand, there is the case of the holder of a gold-mining lease who crushed ore from his own gold-mining lease, and also ore he had purchased from other such leases in which he held an interest, upon a surface machinery area lease also held by him. After extraction of the gold by crushing, the residues were run off in the form of slimes or tailings which the taxpayer collected in dumps and by means of a cyanide process extracted the residual gold from them. This process, in so far as it was applied to the ore obtained from the other leases, was held not to be the ‘working of a mining property’ and the income derived from it was held to be taxable. A distinction was drawn between the phrases ‘the working of a mining property’ and ‘mining operations’. In the case in question, Dixon, C. J. observed:

‘The various provisions of the Income Tax Assessment Act 1936–1943 relating to mining were introduced on different occasions and do not pursue a policy worked out with precision. They must be construed as they are expressed.’^note

Without casting any doubt upon the correctness of the two decisions, the criticism of the distinction between them implicit in the remarks of Dixon, C. J. illustrates the incongruity of the results produced by section 23 (o) in its present form. It is reasonable to suppose that the legislature, in enacting section 23 (o) was really aiming at encouraging the winning of gold in Australia. It was not concerned whether the gold was extracted by the taxpayer from ore taken from the soil of the mining lease held by him or was extracted by the taxpayer from ore taken from the soil of other mining leases.

Losses Incurred in Gaining Exempt Income

19.A96. Section 77 provides for the allowance from assessable income of a deduction for losses incurred in carrying on a business in Australia or Papua New Guinea, the proceeds of which are or would be exempt income. Where a deduction has been allowed for a loss and there are subsequent profits from the exempt business, those profits will be assessable to the extent of the deduction so allowed. Such profits are only assessable where the previous loss, for which a deduction had been allowed, was incurred within the three years of income immediately preceding the year of income in which the profit was derived.

  ― 337 ―

19.A97. A deduction under section 77 is set off against other income in the following order:

• (a) personal exertion income;
• (b) income from property other than dividends;
• (c) income from dividends.

United States

19.A98. As already indicated, a depletion allowance is available to taxpayers deriving income from an oil or gas well or mineral property: either the cost depletion or percentage depletion method may be employed. There appear to be no other distinctive incentives similar to those provided under Australian legislation.

Canada

19.A99. Under former legislation, the income of a mine was exempt for a period of three years from the time when the mine commenced reasonable commercial production. This has been replaced by the earned depletion allowance. Similarly, prospectors and contributors were exempt from tax on sale of mining properties in certain circumstances. Under present legislation, they continue to receive special treatment, but it is by way of deferment of tax and capital gains treatment rather than exemption from tax. This special treatment is provided only if they receive shares in consideration of the transfer of their interest in the mining property.

19.A100. If cash or another asset is received, it may be treated as property income or capital according to general law principles.

19.A101. A prospector must be an individual while a contributor (or ‘grubstaker’) may be an individual or a corporation. Such persons, if they acquire an interest in a mining (not oil or gas) property through the prospecting or financing activity and dispose of that interest to a corporation for its shares, are not required to include in income any amount in respect of the shares received. However, the shares are deemed to have a zero cost to the recipient and the issue of shares is regarded as a zero cost to the acquiring corporation. Thus, subsequent sales (i) of the shares by the prospector or contributor, and (ii) of the mining interest by the corporation, are more heavily taxed than they otherwise would be. Further, the corporation is not entitled to any deduction in respect of its costs of acquiring the mining right.

New Zealand

19.A102. A concession exists similar to the former section 77C of the Australian legislation, in that sections 129BB and 129C of the Land and Income Tax Act 1954 allow a deduction of one-third of the amounts contributed by a shareholder to the paid-up value of shares held by him in a mining company. Any premiums paid on the issue of shares are not deductible under these provisions. If a mining company does


  ― 338 ―
not within a reasonable time use for mining purposes amounts it receives from its shareholders, the Commissioner may disallow the deduction for calls paid on shares to shareholders in the mining company or holding company as the case may be.

19.A103. Where under the general law profits on the sale of mining shares are assessable, then, in determining the amount of the profit, the cost price of the shares is to be reduced by any deduction allowed to the taxpayer in respect of calls on those shares. A similar situation applies when calculating losses.

19.A104. Where the assessable profit on sale of mining shares is made by a company, and that company ploughs the profit back into further investment in mining or exploring for petroleum or specified minerals, the assessment of those profits (‘reinvestment profits’) is deferred. The company is allowed six years to reinvest the profits for mining purposes. The profits are in general assessed when the new mining investment is realised; but again there will be opportunity to reinvest in other mining activities, with a consequent further deferment of taxation of the profit so invested. The reinvestment profit can be invested by way of equity or loan capital; and if any portion of that amount is diverted for non-mining purposes within the six-year period, the relevant amount becomes assessable income of that year of diversion or expiry.

19.A105. Attention has already been drawn to the recent amendments to the income tax legislation conferring special tax treatment upon the income from mining derived by various classes of taxpayer: for example, mining companies pay tax on mining income at two-thirds of the normal company rate and non-resident mining operations are taxed at 45 per cent on their entire mining venture income.

South Africa

19.A106. There appear to be some exemptions available akin to those provided under the Australian Act. The profits of mining under a lease granted under section 46 of the Precious and Base Metals Act 1908 of the Transvaal are exempt from income tax.

19.A107. In general, exemptions are limited to operations deriving income from the production of particular minerals and afford little basis for comparison with the incentive provisions operating in the other countries mentioned above.