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);
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(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).
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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.
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(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;
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(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.’
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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
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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.
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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.
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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
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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.