Deductions for depreciating assets – no guarantee that the reasoning in Shell Energy applies

The ATO has issued its decision impact statement (DIS) about a year after the Full Federal Court decision in Shell Energy Holdings Australia v Commissioner of Taxation [2022] FCAFC 2 (Shell Energy). The Full Federal Court decision is important for those making deductions under s40-80 and s40-25 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). It will be of interest to those who are also grappling with the complexities of statutory interpretation in taxation law.

The DIS outlines the areas where the Commissioner of Taxation (Commissioner) will distinguish the application of Shell on the basis of the facts and circumstances of the case. In addition, the Commissioner advises of the matters where his approach to statutory interpretation differs to the reasoning of the Full Federal Court.

In 2012, Shell and Chevron Australia Pty Ltd (Chevron) were both participants, with others, in a petroleum venture known as the Browse Project. The participants in the Browse Project were together the legal holders of an exploration permit and 6 retention licences (Statutory Titles) which gave permission or authority to explore for petroleum.

Shell had purchased an interest in various Statutory Titles from its fellow participant, Chevron, for $2.3b and had claimed deductions under s40-80 and s40-25 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) for the cost of acquiring “mining, quarrying or prospecting rights” (MQPR) in the form of the additional proportional interest in the Statutory Titles. Shell argued that it first used those MQPR for exploration or prospecting on acquisition from Chevron. Under the terms of the agreement, once the dealing between Shell and Chevron had been approved and registered under the relevant Petroleum legislation, the agreement was to have retrospective effect from 1 June 2012. Registration and approval occurred in November 2012.

In a judgement written by Davies J (Allsop CJ and Thawley J agreeing), the Full Federal Court unanimously allowed the taxpayer's claim for deductions relating to the decline in value of a depreciating asset.

Points of interest arising from the DIS include:

• In relation to MQPR, whereas the Full Federal Court found that a commensurate proportional interest in the Statutory Titles had been acquired, the Commissioner is of the view that it would be wrong to assume this to be the case prima facie. Whether, and to what extent, a party to a joint venture has an interest in joint venture property, and the nature of any such interest will depend upon the facts and circumstances of each case.
• As to whether activities conducted by a joint venture were activities of exploration, the Commissioner accepts that it was open to the Full Federal Court to conclude that the terms “explore” and “exploration” had a wider meaning under the relevant Petroleum Acts, and also for the purposes of Div 40 of the ITAA 1997. However, the Commissioner’s position is that having regard to the statutory context and legislative history, a more limited meaning was intended for the purposes of the ITAA 1997 (except for the particular express provisions in s 40-730(4)(a) to (d)).
• In considering the concept of “first use” for the purposes of s 40-80 as it relates to intangible assets, the Commissioner does not consider “mining, quarrying or prospecting information” is a bundle of rights and will continue to apply their view in TR 2019/4. The Commissioner is of the view that the comments made by Davies J that a “bundle of rights is installed ready for use once held for use” is limited to the particular circumstances of the Shell case,  and accordingly it cannot be assumed that they will apply by analogy to other intangible assets. It will depend upon the nature of the relevant intangible asset, the operation of any relevant legislation and the facts and circumstances of each case.

Key considerations

The DIS signals that the Commissioner’s longstanding position that the meaning of exploration expenditure is to be confined to activities relating to the discovery of the resource, and not more broadly to those activities directed to ascertaining whether the resource is commercially recoverable will continue. Taxpayers with such expenditure should carefully review historical positions in light of the Full Federal Court decision and the Commissioner’s DIS, and their appetite for controversy and formulate an engagement strategy.

For more information please get in touch with Annemarie Wilmore.