Australia: ATO accepts deductibility of exploration costs in pivotal Shell Energy Federal Court decision


After the High Court dismissed the Australian Tax Office’s (ATO’s) application for special leave to appeal, the ATO has released a draft decision impact statement (DIS) on the Federal Court case involving Shell Energy.

Very broadly, the Shell Case and the subsequent draft DIS should be of particular interest to taxpayers in the mining, oil and gas industries. They concern the application of the uniform capital allowance rules and more specifically, the availability of an immediate deduction for certain intangible assets (including mining, quarrying and prospecting rights) that are first used in exploration.

Comments on the draft DIS are due by March 3 2023. The ATO has also withdrawn Taxation Determination (TD) 2019/1 with effect from February 2 2023, given that that the TD is now inconsistent with the Federal Court’s decision on the concept of ‘first use’.

Shell Energy Holdings Australia Limited v FCT (2022)

In 2012, Shell and Chevron Australia (Chevron) were both participants in a petroleum venture known as the Browse Project. Relevantly, the participants in the Browse Project were the legal holders of an exploration permit and numerous retention leases (the statutory titles) which gave permission to the holders to explore for petroleum.

Subsequently, Shell acquired Chevron’s participating interest in the Browse Project for approximately $2.3 billion and claimed a deduction for this amount under sections 40-80 and 40-25 of the Income Tax Assessment Act 1997 (1997 Act). This was for the cost of acquiring ‘mining, quarrying or prospecting rights’ (MQPRs) in the form of an additional proportional interest in the statutory titles, and based on Shell ‘first using’ those MQPRs for ‘exploration or prospecting’.

In May 2021, the Federal Court affirmed Shell’s entitlement to most of its deductions. The Commissioner appealed this decision in the Federal Court but his appeal was dismissed, with the ruling in favour of Shell and all its claimed deductions. The Commissioner’s subsequent application for special leave to appeal was dismissed by the High Court in September 2022.

ATO releases draft DIS on the Shell case

Meaning of ‘exploration’

A key issue in the Shell case was whether ‘exploration’ was merely limited to activities that related only to the discovery of resources, or whether the determination of the commercial viability of resources also constituted ‘exploration’.

In the Federal Court decision, the judges adopted a wider meaning of ‘exploration’ and held that it should not be limited to the discovery of petroleum. Instead, activities directed at investigating the commercial recoverability of petroleum should also be included. Importantly, the extended meaning of ‘exploration’ is equally applicable to both the relevant petroleum legislation and the 1997 Act.

In the DIS, the Commissioner accepts that given the history of the relevant petroleum Acts, it was open for the Federal Court to conclude that ‘explore’ and ‘exploration’ had a wider meaning. The identification of the characteristics of the petroleum field or whether the identified resource was commercially recoverable were therefore found to have met the definition of ‘explore’ or ‘exploration’ under the relevant petroleum Acts.

However, the Commissioner cautions that this more expansive view of ‘exploration’ may not apply in all cases, and that a more limited meaning may be intended for the purposes of the 1997 Act.

Concept of ‘first use’

The Federal Court held that the ‘first use’ and ‘start time’ of the MQPRs (viewed as a bundle of rights) commence once the rights are held for use.

As set out in the DIS, the Commissioner’s view is that the principles expounded by the Federal Court are limited to the circumstances of the Shell case. Therefore, whether other intangible assets will also have a start time once they are held for use, will depend on the nature of the assets and the operation of any relevant legislation.

The Federal Court held that by acquiring Chevron’s participating interest in the joint venture, Shell also acquired a commensurate additional proportional interest in the statutory titles.

The Commissioner is reluctant to wholly endorse this approach and cautions taxpayers not to assume this to be case in every scenario. Whether and to what extent a joint venture party has an interest in joint venture property, and the nature of any such interest, will depend on the facts of each case.

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