FEDERAL COURT OF AUSTRALIA
Esso Australia Resources Pty Ltd v Commissioner of Taxation [2012] FCAFC 5
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| VID 631 of 2011 |
| ESSO AUSTRALIA RESOURCES PTY LTD (ACN 091 829 819) Appellant | |
| AND: | Respondent |
| DATE OF ORDER: | |
| WHERE MADE: | bRISBANE |
THE COURT ORDERS THAT:
1. The appeal by Esso Australia Resources Pty Ltd be dismissed.
2. The cross-appeal by the Commissioner be allowed and the judgment below set aside.
3. Esso Australia Resources Pty Ltd pay the Commissioner’s costs of the appeal and cross-appeal, with such costs to be taxed in default of agreement.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
| IN THE FEDERAL COURT OF AUSTRALIA | |
| VICTORIA DISTRICT REGISTRY | |
| GENERAL DIVISION | VID 630 of 2011 VID 631 of 2011 |
| ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA |
| BETWEEN: | Esso AUSTRALIA RESOURCES PTY LTD (ACN 091 829 819) Appellant |
| AND: | COMMISSIONER OF TAXATION Respondent |
| JUDGES: | KEANE CJ, EDMONDS, PERRAM JJ |
| DATE: | 20 fEBRUARY 2012 |
| PLACE: | BRISBANE |
REASONS FOR JUDGMENT
KEANE CJ AND EDMONDS J:
1 The Petroleum Resource Rent Tax Act 1987 (Cth) (PRRT Act) under s 4 imposes tax “in respect of the taxable profit of a person of a year of tax in relation to a petroleum project”. Section 5 of the PRRT Act establishes that the rate of tax is 40%. The Petroleum Resource Rent Tax Assessment Act 1987 (Cth) (the Act) determines the extent of the liability to tax. Under the Act the taxable profit of a person is the excess of assessable receipts over, among other things, deductible expenditure incurred by the person in relation to the project.
2 Esso Australia Resources Pty Ltd (EAR) has for many years been engaged in a petroleum project involving exploring for, recovering, treating and selling petroleum and natural gas in Bass Strait. The project has been conducted as a joint venture with BHP Billiton Petroleum (Bass Strait) Pty Ltd (BHP). EAR is the manager of the joint venture pursuant to an agreement described as the “Operating Agreement”. The project is referred to as the Bass Strait Joint Venture or the Gippsland Basin Joint Venture, and includes an area known as the Blackback Field. We will refer to the project as the Bass Strait project.
3 EAR is also party to a longstanding Service Agreement with Esso Australia Ltd (EAL). Under the Service Agreement, EAL makes available to EAR trained personnel, equipment and facilities to enable EAR to conduct its petroleum exploration, production and marketing operations in Australia, and on the continental shelf. In return EAR agrees to pay EAL the costs EAL incurs in providing the agreed services to EAR, a share of EAL’s overhead costs proportionate to the services performed by EAL for EAR under the Service Agreement, and a fee of 7½ % of EAL’s overhead.
4 For the years of income ending 30 June 2003 and 30 June 2004, EAR claimed amounts attributed to its liability to EAL under the Service Agreement as deductible expenditure for the purposes of the calculation of EAR’s taxable profit relating to the Bass Strait project. EAR’s claims were allowed, in part, by the Commissioner of Taxation (the Commissioner) but were rejected to the extent that the Commissioner was not satisfied that they were payments of liabilities incurred by EAL in carrying on the operations comprising the Bass Strait project. EAR objected to the Commissioner’s decision and this objection was disallowed by the Commissioner. EAR then appealed to the Federal Court of Australia.
5 The learned primary judge upheld EAR’s appeal on this issue (to which we will refer as “the Service Agreement issue”): see Esso Australia Resources Pty Ltd v The Commissioner of Taxation [2011] FCA 565 (Reasons).
6 There was also a contest between EAR and the Commissioner as to whether the payment of a fee, described as a Mutualised Research Charge (MRC), to the Exxon Mobile Upstream Research Company (the URC), in return for the right to use intellectual property and research by the URC to assist EAR in carrying on its business, was deductible in calculating EAR’s taxable profit of the Bass Strait project. This issue (to which we will refer as “the MRC issue”) was resolved by the primary judge in favour of the Commissioner.
7 EAR appeals in relation to the MRC issue, and the Commissioner has brought a cross-appeal on the Service Agreement issue.
8 To aid an appreciation of the arguments advanced in this Court, we propose first to set out the factual and statutory background to both issues. We will then summarise the reasons of the primary judge and the arguments of the parties on appeal. We will then make some general observations about the operation of the Act before proceeding to consider the issues in turn. Having resolved those issues we will then conclude with some additional observations.
FACTUAL BACKGROUND
The Service Agreement Issue
9 The Service Agreement between EAR and EAL was entered into on 22 December 1966.
10 The obligations assumed by EAL under the Service Agreement were not limited to petroleum exploration or production in respect of the Bass Strait project; indeed EAL’s obligations extended to all EAR’s exploration, production and marketing operations in Australia. The recitals and cl 1 of the Service Agreement provided:
WHEREAS [EAR] is a Corporation with interests in certain petroleum exploration permits and licences and will have further interests covering parts of Australia including the Continental Shelf and carries on the business of exploring, discovering and developing petroleum and natural gas and related hydrocarbons and is about to commence production and marketing; and
WHEREAS [EAR] does not possess the trained personnel, the equipment or facilities necessary to carry out all its operations and desires [EAL] to make available to it certain services; and
WHEREAS [EAL] has agreed to make available the services to [EAR] subject to the terms and conditions hereinafter contained.
…
1. [EAL] agrees to provide all technical, operational, financial, accounting, advisory and related services which are required from time to time by [EAR] for its exploration, producing and marketing operations in Australia and its Continental Shelf. Without limiting the generality of the foregoing such services shall include, but not be limited to such matters in connection with [EAR’s] operations as technical assistance and advice relating to new exploration acquisitions, sales, business planning, business analysis, development and execution of investment programs, organizational planning, public relations programs and advertising, preparation and control of budgets, utilization of computers and data processing, equipment and staff assistance in the areas of taxation and law.
11 The primary judge identified at [7] that on 4 March 1983 an addendum to the Service Agreement added specifically to EAL’s obligations the performance of works:
…offshore, Gippsland and Westernport in connection with continuing the development of [EAR’s] petroleum interests and at other onshore locations … and services being provided as incidental to the performance of that work.
12 Clauses 4 and 5 of the Service Agreement provided for EAL’s remuneration. At the material time they were in the following terms:
4. [EAR] agrees to pay [EAL] for the services provided hereunder the following:
(a) All direct costs incurred by [EAL] on behalf of [EAR] in the performance of services hereunder; and
(b) That portion of the cost of maintaining [EAL’S] office facilities and staff of personnel which is properly allocable to the performance of services hereunder; and
(c) A fee of seven and a half (7½%) per cent of net charges under (b) of this Clause.
5. Charges under sub-paragraph 4(b) hereof shall be based upon an equitable formula to be agreed upon by the parties and confirmed by letter. The formula shall be designed to effect a reasonable and just charge to [EAR] for services performed by [EAL] hereunder. The method of calculating charges and fees shall be reviewed by the parties from time to time and may be changed by subsequent agreement in writing between the parties.
13 In 1978 another agreement between EAR and EAL provided that EAL was entitled to charge EAR interest on “charges levied pursuant to the Service Agreement”.
14 Clause 6 of the Service Agreement provided that EAL would render invoices to EAR on a monthly basis. However, no invoices from EAL to EAR were adduced in evidence in this case. As we will explain, EAR sought to make good its claims for deductions by reference to entries in EAL’s “Wizard” accounting system which reflected the results of a process of dissection, apportionment and allocation of EAL’s costs attributable to the Bass Strait project, including its business support or overhead costs.
15 Notwithstanding the means by which EAR sought to prove its claims for deductions, EAR’s claims were founded on the proposition that EAR’s liability to EAL under cl 4 of the Service Agreement was one indivisible liability. The Commissioner did not accept that cl 4 of the Service Agreement gave rise to an indivisible liability but seized upon the process of apportionment and attribution in an endeavour to make the case that EAL’s book entries were not truly liabilities of EAR under subcll 4(b) and (c) of the Service Agreement and, if they were, they were for excluded expenditure by EAR which did not qualify for deductibility under the Act.
16 BHP was content to accept the invoices produced to it by EAR which were compiled in reliance upon the process of apportionment, allocation and attribution adopted by EAL. The Operating Agreement between EAR and BHP provided relevantly that:
2.01 Each Party shall own 50% of all right, title and interest in and to the Subject Area, subject to Government Royalty and subject to the 2½% overriding royalty in favour of Oil Basins Incorporated described in the Basic Agreement.
…
4.01 … [EAR] shall be Operator.
4.02 The Operator shall direct the Joint Undertaking in a good and workmanlike manner and consistent with good oilfield practice, and shall ensure compliance with all applicable laws and regulations and with the provisions of this Agreement.
4.03 The Operator shall prepare and submit to the Supervisory Committee annually, at such time, prior to the commencement of the annual period, as the latter shall determine, a capital expenditure budget and an operating program. Approval by the Supervisory Committee of budgets and operating programs shall authorize the Operator to make expenditures in furtherance thereof.
4.04 The Operator shall have the following specific powers and duties in addition to those enumerated elsewhere or implicit herein:
(a) To make monthly reports to the Non-Operator with respect to the Joint Undertaking, including production, costs and progress of programs.
(b) To consult with the Non-Operator, unless impracticable, prior to making a decision whether to complete or abandon a well.
(c) To furnish all information reasonably requested by the Non-Operator with respect to the Joint Undertaking.
(d) To consult with the Non-Operator with respect to wage rates and other employment conditions and practices and to fix such rates, conditions and practices after giving consideration to the rates, conditions and practices of Non-Operator and its Affiliates.
(e) To engage legal counsel and, subject to consultation with the Supervisory Committee, prosecute and defend lawsuits arising out of the Joint Undertaking.
(f) To purchase from Australian manufacturers or suppliers and within such requirement to purchase from the Parties and their Affiliates, equipment, materials, supplies and services needed for the Joint Undertaking, provided that they are reasonably competitive with other sources from the standpoint of delivery time, price, quality and suitability.
(g) To carry and maintain for the Joint Undertaking all insurance required by law or regulation or requested by the Supervisory Committee.
4.05 Employees, agents and servants of the Operator shall be under the sole direction and control of the Operator and shall never be considered to be employees, agents or servants of the Non-Operator.
…
17 Article 8 of the Operating Agreement provided relevantly:
8.01 All expenditures made for the Joint Undertaking shall be borne equally by the Parties.
8.02 The manner of determining and allocating expenditures and costs … shall be set out in the Accounting Manual which shall also govern billing, accounting and similar principles and procedures.
…
18 Article 10.02 of the Operating Agreement provided:
The Operator shall arrange for an annual audit by a firm of chartered accountants of the accounting records for the Joint Undertaking maintained pursuant to the Accounting Manual. The cost of such audit will be shared equally by the Parties and a copy of the audit report shall be furnished to each of the Parties.
19 The Accounting Manual referred to in the Operating Agreement states that “it sets forth the procedures to be followed in maintaining proper control and detailed records of the accounting required under the Operating Agreement. It also sets forth the charges and credits that are attributable to the various operations in order to establish the amounts owing between the Parties hereto”.
20 Sub-clauses 1.1 and 1.2 of the Accounting Manual made the following provision for the keeping of accounting records:
1.1 The Non-Operator will not ordinarily be furnished with copies of invoices or supporting documents relating to expenditures incurred by the Operator. However, upon request by the Non-Operator, the Operator will provide Non-Operator with such invoices and other supporting documents or copies thereof as may reasonably be required.
…
The Operator will maintain the Joint Account in a manner which will reflect separately the individual interests of each of the Parties to the Joint Undertaking, in accordance with the provisions set forth in the Operating Agreement.
1.2 Statements and Billings:
Within thirty days following the end of each calendar month, the accumulated charges and credits in the Joint Account will be determined, and the Operator shall invoice the Non-Operator for its share of the total net charges incurred by the Operator on behalf of the Joint Undertaking during such calendar month subject to the exclusion of accrual amounts raised by the Operator to the Joint Account for which Suppliers’ and/or Contractors’ invoices have not been approved for payment. Unless otherwise agreed, such invoice shall be accompanied by the joint venture billing summarizing all charges and credits to the Joint Account, by appropriate classifications indicative of the nature thereof.
21 Sub-clause 1.8 of the Accounting Manual provided:
All costs both direct and indirect of producing, transporting, storing, processing and terminalling the Petroleum produced and saved from the field shall be allocated in the same manner as Production Entitlement from that field.
22 In November 1999, as a result of a global merger of Exxon with Mobil Group to form the ExxonMobil Group, the Mobil Group’s operations in Australia passed into the control of the merged entity.
23 Since then, the operations carried on by EAL for the ExxonMobil Group have been divided into “downstream operations” and “upstream operations”. The downstream operations include refineries at Altona and Adelaide, terminals for the loading or unloading of refined petroleum products, a fuel and lubricants business and retail distribution outlets, together with similar downstream businesses in New Zealand and the Pacific Islands.
24 The upstream operations involve producing and processing petroleum from greenfields sites, developing facilities for these production operations and exploration directed to identifying further reserves. These upstream operations include the Bass Strait project, which is currently EAR’s only production operation, and EAR’s exploration projects in the Scarborough Field and (part of) the Kipper Field. EAR operates Mobil’s upstream operations in relation to the development of the Wandoo Field in Western Australia.
25 EAL employed all the personnel engaged in EAR’s upstream and downstream operations. These employees worked at offshore platforms and plants at Longford and Long Island Point and in a large office building at Southbank near the Melbourne Central Business District. In that building a large number of specialist engineers and geoscientists were engaged in work which was, in part, related to the Bass Strait project.
26 Members of each EAL production and exploration department recorded their time spent on particular projects divided as between upstream and downstream operations. A monthly calculation was made of the proportion of each of these department’s labour costs spent on particular projects, including the Bass Strait project. This result was called the “labour ratio” and was used to effect a proportional allocation of the costs of EAL’s business support departments.
27 EAL’s business support departments did not record their time devoted to the Bass Strait project. They recorded their time spent on upstream and downstream activities and EAL then used these records to effect an allocation to the upstream portion by applying the labour ratio. The upstream portion of the overhead and associated cl 4(c) fee was thus allocated to particular projects by application of the labour ratio. EAL used its “Wizard” accounting system to record the costs attributable to the various operations conducted pursuant to the joint venture between EAR and BHP. Designated segments of the Wizard accounting system were referable to the Bass Strait project. Non-labour costs were allocated in the same way.
28 By way of example of this process of apportionment and allocation, EAL’s occupational health department maintained quarterly time allocation sheets which apportioned the time spent by the department’s personnel to the upstream and downstream activities of the ExxonMobil Group. Of the upstream work an estimate was then made of the proportion of the work attributable to the Bass Strait project, as opposed to the Wandoo project and a proposed venture in Papua New Guinea. A similar approach was taken in relation to EAL’s other business support departments, viz, the human resources department, law department, the global informations system organisation, the procurement department and the tax department.
29 The Commissioner accepted that the salaries of technical staff who were engaged in producing, development and exploration activities in relation to the Bass Strait project, but who were located at Southbank, were deductible under s 38 of the Act. On the other hand, a proportion of the cost of providing and maintaining the Southbank premises referable to the accommodation of these staff members was disallowed by the Commissioner. These costs were disallowed on the basis that, either it was not demonstrated that they were a liability incurred to procure the carrying on or providing the things comprised in the Bass Strait project, or in accordance with s 41 of the Act they were excluded expenditure under s 44(k) of the Act.
30 The Commissioner also rejected EAR’s claims that a proportion of rates and taxes, facilities charges and half the cost of annual audit of the accounting records of the Bass Strait joint venture, and facilities charges were deductible expenditure.
31 As to EAR’s obligation to pay a fee of 7½% of EAL’s overhead under cl 4(c) of the Service Agreement, the Commissioner disallowed amounts equal to 7½% of the amounts the Commissioner disallowed as allocated and attributed costs under cl 4(b). EAR accepted that only such proportion of the fee payable under subcl 4(c) of the Service Agreement that could be attributed to the amount properly deductible pursuant to subcl 4(b), could be deductible expenditure.
FACTUAL BACKGROUND
The MRC Issue
32 Affiliate companies within the ExxonMobil Group, such as EAR, may become “Members” of the Mutualised Research Program operated by the URC. From 1 January 2000 EAR entered into an Upstream Cost Sharing Agreement (UCSA) with the URC.
33 Under Art 2.2(b) of the UCSA each Member is required to pay the MRC, i.e. “a share of the Net Cost of Upstream Research, as described in Article 5 of [the] Agreement”. Each Member’s MRC is based upon things such as its exploration expenditure, relative proved and provable hydrocarbon reserves, discovery volumes, development capital expenditures, and hydrocarbon production volumes, as a proportion of the total of these things for the members as a whole.
34 In return for the MRC, EAR obtained the grant of royalty-free licences to the URC patent rights and technical information, whether available as a result of past research or arising from new or continuing research, for use in its upstream operations.
35 Under Art 7.2 of the UCSA EAR’s rights as a Member of the Mutualised Research Program could, with the written approval of the URC, also be made available to “extendees” including EAL. An “extendee” agreement between EAR and EAL, entered into on 28 December 2000, extended EAR’s rights under the UCSA to EAL, thus enabling EAL to take advantage of the research, development and expertise offered by the URC. EAL obtained a sub-licence of the research and intellectual property rights derived by EAR under the Mutualised Research Program. The evidence was that this research and technology was utilised by EAL in providing services to EAR under the Service Agreement for the benefit of the Bass Strait project.
36 Much of the work done by the URC was used by EAL on an ongoing basis in the Bass Strait Project and in adapting new computer software applications and other technology to EAL’s needs. Further, the URC provided training to enhance the skills of EAL’s employees.
37 EAR received monthly invoices from the URC which comprised two components: an exploration charge and a production charge. No part of these amounts was passed on by EAR to BHP under the Operating Agreement. The Commissioner argued that this circumstance is a significant indication that the payments were not made in carrying on or providing the operations and facilities of the Bass Strait project. EAR argued that this circumstance was of no significance in that it reflected EAR’s unwillingness to risk a demand from BHP for details of the information obtained from the URC.
THE RELEVANT PROVISIONS OF THE ACT
38 By s 19(1) of the Act a project exists “in relation to” a production licence issued under the Petroleum (Submerged Lands) Act 1967(Cth) (the PLSA). By s 19(1A) of the Act the Bass Strait project (which relates to several production licenses) is taken to be one project for the purposes of the Act.
39 The operations, facilities and other things relating to a petroleum project are described by s 19(4) of the Act:
(4) For the purposes of this Act, a reference to the operations, facilities and other things comprising a petroleum project is a reference to:
(a) operations and facilities for the recovery of petroleum from the production licence area or production licence areas in relation to the project; and
(b) such of the following as are carried on or provided:
(i) operations and facilities involved in moving petroleum so recovered between any storage or processing facilities prior to the production of any marketable petroleum commodity from the petroleum;
(ii) operations and facilities involved in the storage, processing or treatment of petroleum so recovered to produce any marketable petroleum commodity from the petroleum;
(iii) operations and facilities involved in the moving or storage of any such marketable petroleum commodity before it becomes an excluded commodity;
(iv) services, or facilities for the provision of services, in connection with the operations, facilities, amenities and services referred to in this section;
(v) employee amenities in connection with the operations, facilities and services referred to in this section.
40 Section 21 of the Act makes a person liable to pay the tax imposed by reference to the taxable profit of that person in relation to a petroleum project. It provides:
Subject to this Act, tax imposed in respect of the taxable profit of a person of a year of tax in relation to a petroleum project is payable by the person.
41 A person’s taxable profit is calculated under s 22 of the Act, which provides relevantly:
22 Taxable profit
Where, in relation to a petroleum project and a year of tax, the assessable receipts derived by a person exceed the sum of:
(a) the deductible expenditure incurred by the person;
…
the person is taken for the purposes of this Act to have a taxable profit in relation to the project and the year of tax of an amount equal to the excess.
42 The expression “assessable petroleum receipts” is explained by s 24 of the Act, relevantly as follows:
(1) For the purposes of this Act, a reference to assessable petroleum receipts derived by a person in relation to a petroleum project is a reference to:
(a) where any petroleum … recovered from the production licence area … is or was sold … before any marketable petroleum commodity is or was produced from it – the consideration receivable, less any expenses payable, by the person in relation to the sale; and
(b) where any marketable petroleum commodity (other than sales gas) produced from petroleum recovered from the area … becomes or became an excluded commodity by virtue of being sold – the consideration receivable, less any expenses payable, by the person in relation to the sale; and
(c) where any marketable petroleum commodity (other than sales gas) produced from petroleum recovered from the area … becomes or became an excluded commodity otherwise than by virtue of being:
(i) sold; or
(ii) treated or processed, or moved, for re-injection or destruction or for use in carrying on or providing operations, facilities or other things of a kind referred to in section 37, 38 or 39 in relation to the petroleum project;
so much of the market value of the commodity immediately before it becomes or became an excluded commodity …
43 Section 32 of the Act, as it was in force at the relevant times, described “deductible expenditure” relevantly for the purposes of this appeal as follows:
32 Deductible expenditure
For the purposes of this Act, a reference to the deductible expenditure incurred by a person in a financial year in relation to a petroleum project … is a reference to the total expenditure of the following kinds incurred by the person in the financial year in relation to the project:
…
(c) class 2 augmented bond rate general expenditure;
…
(e) class 2 augmented bond rate exploration expenditure.
44 Section 34A(2) of the Act relevantly described a reference in the Act to “class 2 augmented bond rate general expenditure” as a reference to the sum of:
(a) any amount of class 2 general project expenditure actually incurred by the person in relation to the project in the financial year …
45 Other terms are defined elsewhere in the Act, but of particular importance for present purposes is the phrase: “general project expenditure”. It is, as will be seen, defined in s 38 of the Act.
46 Section 37 of the Act, as amended, defines “exploration expenditure”. It is in the following terms:
37 Exploration expenditure
(1) For the purposes of this Act, a reference to exploration expenditure incurred by a person in relation to a petroleum project is a reference to payments (not being excluded expenditure), whether of a capital or revenue nature, liable to be made by the person:
(a) in carrying on or providing operations and facilities involved in or in connection with exploration for petroleum in the eligible exploration or recovery area in relation to the project; and
(b) in carrying on or providing such of the following as are or have been carried on or provided:
(i) operations and facilities involved in the recovery of any petroleum from the eligible exploration or recovery area (other than any production licence area) in relation to the project;
(ii) operations and facilities involved in moving any petroleum so recovered to or between any storage or processing facilities prior to the production of any marketable petroleum commodity from the petroleum;
(iii) operations and facilities involved in the storage, processing or treating of any petroleum so recovered to produce any marketable petroleum commodity from the petroleum;
(iv) operations and facilities involved in the moving or storage of any such marketable petroleum commodity before it becomes an excluded commodity;
(v) services, or facilities for the provision of services, in connection with the operations, facilities, amenities and services referred to in this section;
(vi) employee amenities in connection with the operations, facilities and services referred to in this section; and
(c) in procuring another person to stabilise, transport, store, recover or process petroleum recovered from the eligible exploration or recovery area (other than any production licence area) in relation to the project, if that stabilisation, transportation, storage, recovery or processing constitutes the processing of external petroleum in relation to another petroleum project;
and includes any exploration permit, retention lease or other fee (not being an excluded fee) liable to be paid by the person in relation to the carrying on or providing of any operations, facilities or other things referred to in this section.
(2) Where, by reason of the application of subsection 5(3), exploration for petroleum during a period is taken to occur in a retention lease area or areas in relation to a retention lease or leases related to an exploration permit, any liability incurred during that period to pay an exploration permit fee shall, for the purposes of subsection (1), be taken to relate proportionally to the carrying on of operations involved in exploration for petroleum in the retention lease area or areas and in the remainder of the exploration permit area in relation to the exploration permit, according to the respective sizes of those areas.
47 Section 38 of the Act defines “general project expenditure”. From 1 April 2002 up until 20 October 2003, s 38 read as follows:
38 General project expenditure
For the purposes of this Act, a reference to general project expenditure incurred by a person in relation to a petroleum project is a reference to payments (not being excluded expenditure, exploration expenditure or closing-down expenditure), whether of a capital or revenue nature, liable to be made by the person:
(a) in carrying on or providing operations and facilities preparatory to the activities referred to in paragraph (b), including in carrying out any feasibility or environmental study; and
(b) in carrying on or providing the operations, facilities and other things comprising the project;
and includes any production licence or other fee (not being an excluded fee) liable to be paid by the person in relation to the carrying on or providing of any operations, facilities or other things referred to in this section.
48 Section 38 was amended by Schedule 5 of the Taxation Laws Amendment Act (No. 3) 2002 (Cth) with effect from the 14 October 2003. Nothing turns on the amendments and so it is not necessary to set out the text of the amended s 38.
49 Section 39 provided relevantly:
39 Closing down expenditure
For the purposes of this Act, a reference to closing-down expenditure incurred by a person in relation to a petroleum project is a reference to payments (not being excluded expenditure), whether of a capital or revenue nature, liable to be made by the person in carrying on operations involved in closing down the project, including in any environmental restoration as a consequence of closing down the project.
50 At all material times, s 41 provided:
41 Effect of procuring the carrying on of operations etc by others
Where a person (in this section referred to as the eligible person) incurs or incurred a liability to make a payment to procure the carrying on or providing of operations, facilities or other things of a kind referred to in section 37, 38 or 39 by another person, then, for the purposes of this Act:
(a) the operations, facilities or other things shall be taken to have been carried on or provided by the eligible person and not by the other person; and
(b) the liability shall be taken to have been incurred by the eligible person in carrying on or providing the operations, facilities or things.
51 Section 42 provided:
42 Expenditure on property for partial project use
Where:
(a) a person incurs or incurred eligible real expenditure in relation to a petroleum project; and
(b) the eligible real expenditure is or was capital expenditure in respect of property for use only proportionally (the proportion of use of which is in this section referred to as the eligible proportion) in carrying on or providing the operations, facilities or other things by reason of which the capital expenditure is eligible real expenditure of the person in relation to the project;
the eligible proportion only of the eligible real expenditure shall be taken for the purposes of this Act to be the eligible real expenditure.
52 Section 44 defines the expression “excluded expenditure” for the purposes of ss 37 and 38 of the Act. Section 44(j) and (k) are of particular relevance in the present case. Section 44 is in the following terms:
44 Excluded expenditure
For the purposes of this Act, a reference to excluded expenditure is a reference to:
(a) payments of principal or interest on a loan or other borrowing costs; or
(b) interest components of hire-purchase payments;
(c) payments of dividends or the cost of issuing shares; or
(d) the repayment of equity capital; or
(e) payments of a kind known as private override royalty payments; or
(f) payments to acquire, or to acquire an interest in, an exploration permit, retention lease, production licence, pipeline licence or access authority, otherwise than in respect of the grant of the permit, lease, licence or authority; or
(g) payments to acquire interests in petroleum project profits, receipts or expenditures; or
(h) payments of tax under the Income Tax Assessment Act 1936, the Income Tax Assessment Act 1997; or the Fringe Benefits Tax Assessment Act 1986; or
(i) payments of GST under the GST Act; or
(j) payments of administrative or accounting costs, or of wages, salary or other work costs, incurred indirectly in carrying on or providing operations, facilities or other things of a kind referred to in sections 37, 38 and 39; or
(k) payments in respect of land or buildings for use in connection with administrative or accounting activities in respect of the carrying on or provision of other operations, facilities or things of a kind referred to in sections 37, 38 and 39, not being land or buildings located at or adjacent to the site or sites at which those other operations, facilities or things are carried on or provided.
THE REASONS OF THE PRIMARY JUDGE
The Service Agreement Issue
53 Before the primary judge, EAR’s principal contention was that EAR’s liability to EAL under cl 4 of the Service Agreement was one indivisible liability marked by the Service Agreement with the character of a service fee deductible under ss 32, 37 and 38 of the Act. EAR argued that, while there was only one liability to EAL, the evidence of apportionment, allocation and attribution which EAR adduced served to establish that EAR was truly liable to make these payments (which included EAL’s overheads and the 7½% charge thereon) as “reasonable and just charges” by EAL under cll 4 and 5 of the Service Agreement.
54 The Commissioner argued that cl 4 of the Service Agreement did not give rise to a single liability for a service fee, but to separate liabilities under each of subcll (a), (b) and (c). Whether, and the extent to which, each of these liabilities was incurred in carrying on the activities comprised in the Bass Strait project could be determined, so it was said, only by a dissection of EAL’s activities. Dissected and viewed through the prism of s 41 of the Act, many payments under subcl 4(b) of the Service Agreement could be seen to be excluded expenditure under s 44(j) or 44(k) of the Act, and so outside ss 37 and 38 of the Act.
55 The primary judge upheld EAR’s contention and rejected the Commissioner’s approach. His Honour explained his approach at Reasons [119]-[123]:
119 … [Section] 38 is predicated on “expenditure” incurred by a person by reference to “payments” liable to be made by that person in, amongst other things, carrying on or providing the operations, facilities and other things comprising the project (emphasis added).
120 That structure of the relevant sections of the Act requires them to be applied by asking what payments have been made by the person (in this case, [EAR]) in carrying on or providing the operations, facilities and other things comprising the project (emphasis added). I accept that the use of the word “in” at the forefront of each of paragraphs (a) and (b) of s 38 signifies that a close connection is required between the “payments” which the relevant person has made or was liable to make and the carrying on or provision of the project; see Robe River v Commissioner of Taxation, at first instance and on appeal quoted at [95] above.
121 However, the immediate close connection that is required is between the payments which the relevant person is liable to make, not the goods or services which constitute the consideration for those payments. That is not to say that the goods or services which constitute the consideration for a payment should not be examined in order to assess whether the payment has been made in carrying on or providing the operations, facilities or other things comprising the project. Frequently, such an examination will be determinative of the question as where the contract imposing the liability to make the payment discloses that it is in consideration of the supply of a single piece of equipment like a piece of casing forming part of an oil rig or the performance of work by a single employee such as a drilling engineer.
122 A more complex examination is required where, as here, the contract discloses that the consideration for the “payments” is the provision by a contractor (in this case EAL) of an aggregation of goods and services to a principal [EAR] … [T]hat aggregation was described in cl 1 of the Service Agreement as “all technical, operational, financial, accounting, advisory and related services which are required from time to time by [EAR] for its exploration, producing and marketing operations in Australia and its Continental Shelf.” Likewise, the Accounting Manual noted at [13]-[19] above contemplated that BHP should be invoiced for “its share of the total net charges incurred by [EAR] on behalf of the Joint Undertaking during [the preceding] calendar month.”
123 Where a payment which a relevant person is liable to make is, as a matter of contract, of an indivisible amount for an aggregation of goods and services, there is no warrant in the language of the Act for dissecting the goods and services in order to conclude that part only of the payment is liable to be made by the person in carrying on or providing operations, facilities or other things comprising the project and that another part is liable to be made as excluded expenditure within one of the categories enumerated in s 44. Had the drafters of the Act intended to require an apportionment of all expenditure in that way they could easily have achieved that result by appropriately expanding s 42 which was limited to “capital expenditure in respect of property for use only proportionally … in carrying on or providing the operations, facilities or other things by reason of which the capital expenditure is eligible real expenditure of the person in relation to the project.” “Eligible real expenditure” was defined in s 2 of the Act to mean “exploration expenditure, general project expenditure or closing-down expenditure.”
(Emphasis added).
56 The first sentence in [121] of his Honour’s Reasons seems to be incomplete, in that it does not identify the things with which the payments referred to in s 38 must be connected; but it is tolerably clear that his Honour considered that the connection must be with the carrying on of the project. The primary judge accepted EAR’S argument that the payments made under cl 4 of the Service Agreement were to be viewed as a single indivisible payment and that s 38 of the Act (and presumably s 37 as well) does not accommodate a dissection of the goods and services provided under the Service Agreements to enable them to be scrutinised against the exclusionary provisions in s 44(j) and (k) of the Act. It is also important to note that in [121] of his Reasons his Honour frames the issue for determination as being whether “the payment has been made in carrying on or providing the operations, facilities or other things comprising the project”. To frame the issue in this way tends to elide the requirement of the section that a payment be one which the person is liable to make in carrying on the operations comprising the project. To elide this requirement is to allow a deduction for a payment which can be shown to have been made in carrying on operations which may happen to include the project, even though the liability to make the payment did not arise specifically in relation to the project.
57 His Honour proceeded on the footing that the services for which a claim is made may be analysed, but only in order to determine whether the disputed amounts are payments which EAR was truly liable to make to EAL under the Service Agreement, not in order to determine whether costs incurred by EAL could be attributed to EAR as liabilities incurred by it for the purposes of s 44 of the Act. The primary judge said at Reasons [124]:
The conclusion reached at [123] above does not entail that the goods and services for which a payment is made cannot be analysed into their constituent elements for the purpose of determining whether a payment, for which those goods and services were the consideration, was one which the relevant person was liable to make in carrying on the operations, facilities and other things comprising the project. However, such an analysis is only to be undertaken for the purpose of characterising the contractual liability of the eligible person to make the payment. The legislation did not authorise an analysis of the goods and services from the point of view of the contractor who provided them and who, ex hypothesi, did not have the connection with the petroleum project which required the incurring of expenditure in relation to it.
(Emphasis added).
58 His Honour rejected the argument that s 44 of the Act applied to exclude any part of the payments from deductible expenditure. His Honour declined the Commissioner’s invitation to treat EAL’s expenses as if they had been incurred by EAR. In his view, EAR’s only liability was to pay the service fee to EAL. In this regard, his Honour said at Reasons [126]-[127]:
126 Payments made by [EAR] to EAL were not, even partly, of administrative or accounting costs or of wages, salary or other work costs incurred by [EAR] “indirectly” within the meaning of s 44(j) in carrying on or providing operations, facilities or other things comprising the Bass Strait project. [EAR], because it occupied no land or buildings and had no employees, incurred no liability to make payments in respect of land or buildings or wages or salaries directly or indirectly in carrying on or providing operations, facilities or other things in respect of the petroleum project. The liability which it incurred was to make a single, undifferentiated, payment, or series of payments, to EAL. Whether EAL apportioned the activities of its employees and accommodation costs between the Bass Strait and other upstream activities on the basis of time spent or some other criterion was relevant only to whether each payment which it sought in respect of the Bass Strait project was a “reasonable and just” charge for the services rendered by EAL under the Service Agreement and was part of the “total net charges incurred by [EAR] on behalf of the Joint Undertaking” as stipulated in the Accounting Manual for which Art 8 of the Operating Agreement provided.
127 Similarly, s 44(k) of the Act created an exclusion from deductibility of payments in respect of land or buildings for use in connection with administrative or accounting activities in respect of the carrying on or provision of other operations, facilities and other things comprising a petroleum project. However, an exception to that exclusion was created by the concluding words of s 44(k) in respect of land or buildings housing administrative or accounting staff which land or building were adjacent to the site at which the operations, facilities and other things comprising the project were carried on or provided. Curiously … the Commissioner has conceded that payments made to [EAR] in respect of the accommodation at Southbank of engineers and geoscientists engaged on the joint venture project were deductible. Presumably that concession implied an acceptance that Southbank, although geographically remote from Bass Strait, was a “site” at which operations, facilities or other things comprising the Bass Strait project were carried on or provided by the engineers and geoscientists. It would follow logically from that implied acceptance that other parts of the Southbank building housing administrative or accounting staff were located at or adjacent to the “site” where the engineers and geoscientists carried on their operations comprising the petroleum project. However, it is unnecessary to attempt to resolve these difficulties because I have come to the clear view, outlined at [125] above, that [EAR] did not make any identifiable payment which was excluded expenditure within s 44(k).
59 His Honour’s conclusion that the payments made by EAR to EAL were stamped with the character of deductible expenditure within s 38 of the Act by the terms of the Service Agreement may have been aided by his finding as to EAR’s purpose in making the payments. He said at Reasons [131]-[132]:
131 The fact that some of the costs for which [EAR] made payments to EAL were in respect of overheads or “indirect costs” incurred by EAL otherwise than in the direct carrying on or providing of the operations, facilities and other things comprising the project does not mean that the payments liable to be made by [EAR] were not in the carrying on or providing by it of the same operations, facilities and other things. In my view, the payments by [EAR] to EAL and by BHP to [EAR] under the Operating Agreement had the direct or close connection with the operations, facilities and other things which was postulated by Gummow J and the Full Court in Robe River. As far as purpose is relevant in the sense indicated in Commissioner of Taxation v Mount Isa Mines [supra], the substantial, if not the sole, purpose of each of [EAR] and BHP in making the payments was to carry on or provide the operations, facilities or other things comprising the joint venture project.
132 I do not attach significance to the fact that some upstream costs payable by [EAR] to EAL were allocated between the Bass Strait project on the one hand, and other activities such as those undertaken at the Kipper and Scarborough fields and the Wandoo project in Western Australia. That allocation was done to ensure that only costs referable to the Bass Strait project were charged to the joint venture. Whether the allocation was by application of the “labour ratio” or some other means, it did not detract from the conclusion that the liability thereby incurred by [EAR] was to make payments in carrying on or providing the operations, facilities and other things comprising the joint venture project. That conclusion would only have been unavailable if the method of allocation had been inaccurate or inappropriate. I am not persuaded that the allocation to Bass Strait of the costs of EAL’s Law Department was in that category. Similar considerations support, prima facie, the deductibility of costs of the GIS organisation and the Procurement Department which were allocated by EAL to the joint venture project. Likewise, I regard it as appropriate for part of the Fringe Benefits Tax paid by EAL in respect of its employees to have been allocated to the Bass Strait project in accordance with cl 2.1(c) of the Accounting Manual. It would be otherwise if the allocation of the cost of Fringe Benefit Tax were not proportionate to the extent to which EAL’s employees had been engaged on the Bass Strait project.
60 It may be noted that the primary judge did not accept that audit costs in relation to the joint venture were deductible. His Honour said at Reasons [133]:
I agree with the Commissioner’s contention that audit costs incurred in relation to the joint venture did not constitute expenditure deductible by [EAR] in either of the relevant years. Those costs were incurred pursuant to cl 10.2 of the Operating Agreement set out at [12] above. They were, therefore, an incident of the joint venture itself but were not incurred in carrying on or providing the operations, facilities or other things comprising the joint venture project. For the reasons explained by French J in Woodside Energy Ltd v Federal Commissioner of Taxation (supra), the expenditure on the annual audit of the joint venture’s accounts did not have the requisite close connection with the “physical activities involved in the petroleum project.”
61 The primary judge went on to conclude his consideration of the Service Agreement issue at Reasons [134]-[135]:
134 I have already explained my reasons for concluding that costs incurred by EAL and allocated to [EAR] and BHP using the “time ratio” or otherwise were not “indirect costs” from [EAR’s] standpoint so as to fall within s 44(j) of the Act. It was only if those costs were inappropriately or inaccurately allocated to the Bass Strait project that they could be said not to have been incurred by [EAR] or BHP in carrying out or providing the operations, facilities or other things comprising that project. For example, if the [EAR] workplace manual prepared by the Occupational Health Department was for use on the Bass Strait project as well as at other places, it was open to EAL to charge a proportionate part of the cost of its preparation to [EAR], and through it, to BHP.
135 Even if payments for the payroll administration for the Gippsland locations had been made directly by [EAR] to ADP [Pty Ltd] and not through EAL, liability to make those payments would have been incurred by [EAR] in carrying out or providing the operations at those locations.
THE REASONS OF THE PRIMARY JUDGE
The MRC
62 As to the MRC, the primary judge noted the limited assistance of decisions given under different legislation in the interpretation of the Act. He said at Reasons [136]:
136 The outgoing in the form of [EAR]’s contribution to MRC was, in the phrase used in Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (supra) “reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of [EAR’s] business”. However, that was a test derived from s 51(1) of the Income Tax Assessment Act 1936 (Cth). The test to be applied in the context of the present Act involves asking whether the liability to make the payment was incurred in carrying out or providing operations or facilities involved in or in connection with exploration for petroleum or comprising a petroleum project.
63 His Honour accepted the evidence adduced on behalf of EAR that EAR’s Bass Strait operation benefitted substantially from the MRC. His Honour said at Reasons [137]:
137 I accept that research and development carried out by URC has been useful or beneficial in the operations of the Bass Strait project. In the respects explained by Mr Griffith, it has increased significantly the recovery of available hydrocarbons from the Bass Strait oil field. However, it does not follow from the fact that a payment has led to a benefit being conferred which has assisted the entity making the payment to carry out an operation or provide a facility that the payment has been made in carrying out the operation or providing the facility.
64 His Honour explained why that view of the facts did not lead to a conclusion in EAR’s favour, saying at Reasons [138] – [140]:
138 As a Full Court of this Court acknowledged in Federal Commissioner of Taxation v Phillips [supra], the question of the purpose of a taxpayer in making a payment is ultimately one of fact. Because the test erected by the Act is narrower than that embodied in s 51(1) of the Income Tax Assessment Act 1936 (Cth), I have not been persuaded to resolve that question in [EAR’s] favour as far as it relates to MRC payments made to URC in the years in question.
139 Counsel for [EAR] sought to draw an analogy between the contribution to URC for Mutualised Research and the cost to a barrister of a subscription for a textbook in the form of a loose leaf service. However, if, at the time when the subscription is paid, the barrister has not been retained in any matter in which the service could be of use, the subscription could not be assigned as a business expense incurred in conducting a particular case or cases. Nevertheless, it is likely that the cost of the subscription would be deductible for income tax purposes as an ordinary business expense of the barrister’s practise [sic].
140 I regard as a more appropriate analogy a subscription paid by a large employer to an employers’ industrial organisation. Such a subscription usually entitles the member to information and industrial advice disseminated or provided by the organisation and to representation, as and when required, before industrial tribunals and courts. However, the extent (if any) to which the employer will need or require assistance of that kind cannot be known at the beginning of the year when the subscription is paid. Although the cost of the subscription may well be a revenue expense for income tax purposes, it cannot be said to have been incurred by the employer in carrying on a particular operation or providing a facility comprising a specific part of its business. As already pointed out, deductibility under the Act is confined to a narrower range of payments incurred in carrying on or providing operations or facilities involved in or in connection with exploration for petroleum or comprising a petroleum project. Each MRC contribution, when made, was for the right to receive the product of general research and development which could be exploited at [EAR]’s discretion anywhere within the ExxonMobil Group. The fact that the right was exercised in several locations consistently with that discretion and for general staff training attenuated the connection between the payment and the exploration and production activities in Bass Strait.
65 The primary judge’s conclusion that the MRC was not a liability incurred by EAR in carrying on the operations of exploration or production comprising the Bass Strait project was based on his view of the scope of s 37 of the Act. His Honour said at Reasons [141]:
141 In the present case, the relevant part of the production component of the MRC was allocated entirely to the Bass Strait project because, in the years in question, that was the only producing project which [EAR] operated. The exploration component of the MRC was allocated between the Bass Strait, Kipper and Scarborough fields in accordance with the exploration “labour ratio.” However, by contrast with EAL’s indirect or overhead costs, that allocation was not appropriate on any basis because the payment by [EAR] was not liable to be made in carrying on or providing operations and facilities involved in or in connection with exploration for petroleum within the meaning of s 37 of the Act.
66 The controversy as to the relevance of EAR’s failure to claim 50% of the MRC from BHP was also resolved by his Honour in favour of the Commissioner. His Honour said at Reasons [142]:
142 It is also significant that no part of the MRC contributions paid by [EAR] to URC has been charged to BHP pursuant to the Operating Agreement. That may partly reflect the fact that the contributions were paid directly by [EAR] and not by EAL which acceded to the benefits of URC’s research and development only as an “extendee.” It has also been suggested that no part of the contribution was passed on to BHP because of the need to keep the information derived from URC confidential within the ExxonMobil Group. The evidence does not permit a finding that a charge could not have been made to BHP without disclosing to it confidential information derived from URC. Whatever be the explanation for them, I consider that these features in combination militate against a conclusion that the contributions were, to any extent, payments which [EAR] incurred a liability to make as required by either s 37 or s 38 of the Act.
THE PARTIES’ ARGUMENTS ON APPEAL
The Service Agreement Issue
67 The Commissioner submits that EAR did not incur liability to make “a single, undifferentiated payment, or series of payments,” to EAL in relation to the carrying on of the Bass Strait Project. That is said to be evident from the terms of cl 4 of the Service Agreement itself. The Commissioner submits that the book entries which were the result of the process of apportionment and allocation described above should have been examined and dissected, in order to determine whether or not the requisite connection with the Bass Strait project was established. The Commissioner argues that the apportionments and allocations recorded in the Wizard accounting system were not payments of liabilities incurred in carrying on the operations comprised in the Bass Strait project or were not shown not to be excluded expenditure under s 44 of the Act. The Commissioner argues that, because EAL’s business support departments did not record, but rather estimated, their time and costs spent on project activities, EAR is unable to establish that the disputed expenditure constituted the discharge of a liability directly referable to the Bass Strait project. The Commissioner argues that, if such an exercise in dissection is neither permitted by the Act, nor possible on the evidence, then the disputed expenditure is not deductible under ss 37 or 38 of the Act because it cannot be seen to have been incurred in carrying on the activities comprising the Bass Strait project.
68 The Commissioner also argues that EAR procured EAL to carry on or provide the operations, facilities and other things comprising the Bass Strait project, and that, accordingly, s 41 of the Act was engaged. The effect of s 41 is to allow EAR a deduction for the liability incurred by it, but only to the extent that it would have been entitled to the deduction if it had itself carried on the activities comprising the project. A payment by EAR to EAL would be deductible only if that payment is not excluded by s 44(j) or (k) of the Act.
69 On this basis, payments made by EAR to EAL in respect of administrative or accounting costs or of wages, salary or other work costs are said to have been incurred by EAR “indirectly” within the meaning of s 44(j), because they were estimates, and because they were in the nature of overheads. All business support department’s administrative or accounting costs, salaries, wages, other work costs, payments of tax under the Fringe Benefits Tax Assessment Act 1986 (Cth), and payments in respect of land or buildings used in connection with the project’s administrative or accounting activities are said to be non-deductible by virtue of s 44(j) or (k) of the Act.
70 As to the argument that, unless the payments reflected in EAL’s book entries are dissected, they cannot be seen to have the requisite nexus with the carrying on of the Bass Strait project, Counsel for the Commissioner acknowledged the absence of textual support in the Act for the dissection and apportionment of a liability incurred by a person. Counsel for the Commissioner argues that if, as EAR insists, the liabilities arising under cl 4 of the Service Agreement are regarded as one indivisible liability (as the primary judge held) then they do not fall within s 37 or s 38 of the Act. That is said to be so because an indivisible liability under cl 4 of the Service Agreement is, by virtue of the terms of the Service Agreement, incurred in carrying on the totality of the business operations of EAR in Australia, not, as is required by the Act, in carrying on the Bass Strait project.
71 EAR submits that the primary judge was correct in holding at [132] that “the liability thereby incurred by [EAR] was to make payments in carrying on or providing the operations, facilities and other things comprising the joint venture project”. The primary judge was right, it is said, to conclude that EAR is entitled to a deduction for a liability to make a single, undifferentiated payment or series of payments by way of a service fee for the aggregation of goods and services provided under cl 4 of the Service Agreement. EAR, as a separate legal entity, incurred the liability in order to operate the project through entering into the Service Agreement with EAL.
72 That the disputed amounts may be dissected by reference to the services apportioned by EAL to the Bass Strait project, does not mean, so EAR argues, that one can “look through” EAR’s engagement of EAL under the Service Agreement to conclude that EAR incurred liabilities for the expenses separately incurred by EAL relating to carrying on the project. That EAR chose to enter into a contract with a service company, being one means of carrying on the activities comprised in the project, does not affect the conclusion that the liability it incurred in doing so under the Service Agreement is deductible. Accordingly, it is said, there is no basis to conclude that the service fee payable by EAR to EAL was excluded from deductibility in whole or in part by the terms under s 44. In particular, s 44(j) of the Act does not apply because, as held by the primary judge, the service fee amounts disallowed by the Commissioner cannot be viewed as administrative or accounting costs incurred by EAR.
73 Counsel for EAR dispute the proposition that s 41 of the Act assists the Commissioner’s argument. EAR argues that s 41(b) provides only that the liability of EAR to EAL under the Service Agreement shall be taken to have been incurred by EAR in carrying on the Bass Strait project, not that the components of that liability shall have the same character as if the payments actually made by EAL had been made by EAR.
74 What is involved in these arguments may be better appreciated when one considers the example of payments of fringe benefits tax. EAR makes the point that it does not employ anyone on the Bass Strait project: it is EAL which employs the labour necessary for the project and makes payments of fringe benefits tax. And so, when s 44(h) excludes from deductible expenditure “payments made under the … Fringe Benefits Tax Assessment Act” it is not speaking of the payment made by EAR to EAL because that is not a payment made by EAR under the Fringe Benefits Tax Assessment Act 1986 (Cth); it is a payment made under the Service Agreement.
75 The Commissioner makes the point in response that the consequence of accepting EAR’s argument is that EAR, by procuring EAL to carry on the project, is enabled to claim an amount by way of deduction from its assessable receipts relating to the project that it could not have claimed had it carried on the project itself. The Commissioner argues that this outcome is odd. One cannot reasonably attribute to the Parliament the intention that s 44 of the Act could be defeated by an operator of a project by the simple expedient of contracting with another person for the carrying on of the operations of the project. Counsel for EAR responds that this outcome is simply a consequence of the language in which the Act is cast, there being no suggestion that the Service Agreement is not a genuine arm’s length arrangement.
76 It may be noted that EAR initially contended that s 41 does not apply to the service fee because, at all times, and notwithstanding the Service Agreement, it was EAR which carried on or provided the relevant operations, facilities or other things, and so EAR did not procure EAL to carry them on. Under the pressure of argument, Counsel for EAR did not press this contention, acknowledging that the language in which s 41 is cast is too general to be limited to arrangements such as that which obtains under the Operating Agreement between BHP and EAR.
77 The primary judge at Reasons [21] spoke of EAL as EAR’s agent for the purpose of carrying on the Bass Strait project. Counsel for EAR disputed this characterisation of the relationship between EAR and EAL as one of principal and agent. And for good reason: if EAL were regarded as EAR’s agent for the purpose of carrying on the Bass Strait project, there would be nothing to prevent s 44(j) and (k) of the Act operating upon what would stand revealed as EAR’s own liabilities.
78 In these circumstances, EAR was content to accept that s 41 applies to the relationship created by the Service Agreement and to rely upon its argument that under s 41 of the Act EAR’s liability under the Service Agreement was not deemed to include liabilities referred to in s 44 of the Act.
79 At this point we record our reservations as to the utility of the effort devoted by the parties to the issue of whether the liability of EAR to EAL under cl 4 of the Service Agreement was an indivisible liability or as many liabilities as there were costs incurred by EAL under cll 4(a) and (b) of the Service Agreement. EAR seemed to regard the inseverability of that liability as an essential element of its argument that it is not possible to use s 41 of the Act to look through the Service Agreement (and the liability for an indivisible service fee created by cl 4) to see the particular costs incurred by EAL and associated overheads and mark-up as particular liabilities of EAR to which s 44 might apply. But if s 41 of the Act does operate to allow EAR the same deductions in respect of its liability to EAL as it would have obtained had EAR itself carried on the activities performed by EAL in carrying on the project, then EAR’s insistence on the inseverable nature of its liability to EAL is unnecessary.
80 On the other hand, the Commissioner’s proposition that subcll 4(a) and (b) of the Service Agreement create separate liabilities in EAR to reimburse each separate cost incurred by EAL in carrying on the Bass Strait project would not, of itself, defeat EAR’s argument that its liabilities to EAL were of the character of a service fee and not of the same character as the liabilities incurred by EAL. Whether or not one describes EAR’s liabilities under cl 4 as inseverable, they would still bear the character of a liability to pay a fee to EAL for the performance of services by it: the distinct corporate personalities of EAR and EAL and the legal relationship created by the Service Agreement between them cannot be disregarded. That having been said, as we will explain in our additional observations after addressing the arguments agitated by the parties, the premise on which the Commissioner’s assessments and his principal argument before the primary judge proceeded is misconceived for the reason that EAR’s liability to EAL under the Service Agreement is not a liability incurred by EAR in the carrying on of the activities comprised in the Bass Strait project. It is a liability incurred in the course of EAR’s exploration, production and marketing operations in Australia and the continental shelf. On the proper construction of ss 32, 37 and 38 of the Act, a liability incurred in carrying on these operations is not a liability incurred in carrying on the operations comprising the Bass Strait project.
81 As we will explain, the statutory context in which ss 32, 37 and 38 of the Act operate confirms that the liability postulated in these sections must be to meet the exigencies of the project and not operations other than the project. One difficulty with EAR’s principal submission is that, while EAR takes its stand on the terms of the Service Agreement as stamping its inseverable liability to EAL with the character of a service fee, EAR also seeks to go behind the Service Agreement to show that the expenses apportioned and allocated by EAL are in economic terms referable to the Bass Strait project. EAR is driven to argue in this way because the necessary connection between liability and the project is not established by the Service Agreement. The liability created by cl 4(a) of the Service Agreement, if it is regarded as indivisible, is a liability to pay all direct costs incurred by EAL in performing the full range of services for all of EAR’s operations in Australia and the continental shelf, including the marketing of products. And the liability for a proportionate share of EAL’s overheads created by cl 4(b) of the Service Agreement is concerned with that part of EAL’s operations devoted to the totality of EAR’s operations in Australia and the continental shelf; it is not concerned with that portion of EAL’s operations relating to that part of EAR’s operations devoted to the Bass Strait project.
THE PARTIES’ ARGUMENTS ON APPEAL
The MRC Issue
82 EAR argues that the primary judge failed to recognise that EAR would not have been able to carry on or provide the operations, facilities and other things comprising the Bass Strait petroleum project as it did without the payments made by it under the UCSA to obtain knowledge of improved technology and know-how, and the rights to use that technology and know-how including the software used in the Bass Strait operations. Further, through participating in the Mutualised Research Program, EAR acquired the opportunity to commission particular research from the URC, which it would not have been economically viable to otherwise commission. This argument may be rejected without further discussion: ss 37 and 38 of the Act do not erect a “but for” test of deductibility.
83 EAR also points out that a number of technologies were in development during the dispute period which had potential application in the Bass Strait. That the length of the agreement is for nine years is said to indicate that EAR’s payments during the dispute period were not only for the use and enjoyment of the benefits of past and present research but to contribute to long-term research developments, which would reasonably be expected to benefit the Bass Strait Project in subsequent years. This argument may also be rejected without further discussion. It is actually destructive of EAR’s case in that it shows that the expenditure is not a payment in carrying on the Bass Strait operations because it is apt to enure in respect of the many operations in which EAR is engaged.
84 The thrust of EAR’s submission is that the primary judge took an unduly narrow approach in considering whether or not an expense was incurred “in” carrying on providing the project. Expenditure need not be directly “on” the operations, facilities, and other things comprising the project, and the circumstance that it benefits other aspects of EAR’s business does not mean that it was not incurred in carrying on the activities of the project.
85 EAR points to a number of specific instances in which benefits obtained from the Mutualised Research Program were used in carrying on the Bass Strait Project during the relevant years. As part of its “extendee” subscription to the Mutualised Research Program EAL is said to have derived a number of benefits in terms of the right to use, and to receive upgrades of, software tools. In particular, EAR argues that EAL’s Bass Strait reservoir engineers were, and are, “reliant upon a combination of software tools for the purposes of carrying on reservoir management” developed by the URC. Further, software programs including a reservoir simulation software tool, a thermodynamic modelling tool and a corrosion modelling software application assisted the Bass Strait project during the dispute period. The software programs are ExxonMobil’s proprietary tools, so that without subscription to the Mutualised Research Program access to the software programs would only have been achievable by paying a licence fee.
86 EAR argues that it acquired, by reason of its subscription to the Mutualised Research Program, research results in a number of key areas such as the Gas and Facilities Divisions, as well as geoscience research and ‘spectral shaping inversion’ techniques utilised in its operations. The Bass Strait Project operations were also improved by the acquisition of the URC’s corrosion related research resources and research concerning EAR’s Wells and Material Division. Further, due to participation in the Mutualised Research Program, EAR acquired Technical Manuals and Guidelines created and updated by the URC, which, for example Bass Strait corrosion engineers heavily relied upon.
87 Similar arguments are advanced to support the deductibility under s 37 of the Act of the exploration component of amounts paid by EAR under the UCSA in respect of exploration.
88 The Commissioner argues that the MRC payments were not liable to be made in carrying on or providing the operations and facilities or other things comprising the project within s 38 or in carrying on or providing the operations and facilities involved in or in connection with exploration for petroleum within the relevant area in relation to the project within s 37. They were not payments substantially or solely incurred in carrying on or in connection with the project. The lack of connection between the URC’s research and the project is apparent in the broad scope of the operations to which the information generated by the URC may be applied. The URC’s research covers a diverse range of areas such as offshore division research on Arctic and Environ Tech, developing new technologies to improve the operation of assets being developed by ExxonMobil Development Company, and engineering on recovery technology. Importantly, the evidence does not permit a finding that the URC conducted research specifically for the project in return for EAR’s payment of the MRC.
89 The Commissioner supports the conclusion of the primary judge that while the MRC was valuable in relation to EAR’s broader business interests, the occasional or incidental benefit derived by EAR specifically in relation to the Bass Strait project is not a sufficiently close connection to qualify it as deductible. It is not as though EAR, as it might have done, commissioned the URC to provide specific information or assistance in relation to the particular exigencies of the Bass Strait project.
90 The Commissioner also argues that, as held by the primary judge, the liability to pay the MRC cannot be apportioned. In the event that this Court holds that apportionment is possible, the Commissioner submits that it is nevertheless necessary to dismiss the appeal because of the impossibility of identifying any specific component of the MRC which possesses the requisite connection with the Bass Strait project.
91 In this Court, the Commissioner continues to rely on the argument that neither EAR nor BHP considered the MRC to be project expenditure. Article 8 of the Operating Agreement provided that the joint venturers would equally bear all expenses. EAR did not seek any contribution from BHP. The Commissioner argues that EAR’s failure to seek a contribution from BHP is a significant indication that neither entity considered the MRC payment to be part of the project or project expenditure.
CONSIDERATION ON APPEAL
The operation of the Act
92 Before addressing directly the arguments relating to the Service Agreement and the MRC, we propose to make some general observations in relation to the operation of the Act.
93 As the primary judge acknowledged at Reasons [120], the text of s 38(1)(a), (b) and (c), with the word “in” at the forefront of each of these paragraphs, signifies that the connection required between the liability to make the payments and the carrying on of the project must be close and direct. It is important, however, to note that the section speaks of “general project expenditure incurred” as “payments … liable to be made”, not simply of “payments made”. The text of the section directs attention to the liability to make payments, not to whether costs can be discerned to have been met in a general economic sense in carrying on the operations of the project. To elide the reference to liability, as the primary judge seems to have done at [121] of his Reasons, is to liberalise unduly the scope of the section. The test erected by the section is a legal, not an economic, test. The vital question is whether there is a liability to make payments in the carrying on of the operations of the project, not whether payments can notionally be attributed to the carrying on of the operations of the project by a consideration of the economic effects of the payments made in discharge of a liability incurred in carrying on the entirety of the taxpayer’s business operations. Further, the nature and extent of the closeness and directness required by ss 32, 37, 38 and 39 is not left at large as a matter of impression and degree. The text of ss 32, 37, 38 and 39, and the context in which they appear, serve to indicate that expenditure which discharges a liability – incurred in the conduct of the generality of the business – of a person who happens to carry on a petroleum project, is not sufficiently connected with the activities of the project.
94 To speak of a liability incurred in carrying on a specific operation of a taxpayer is apt to exclude reference to the taxpayer’s other operations. In Commissioner of Taxation v Mount Isa Mines Ltd (1991) 28 FCR 269 at 279, Pincus and Ryan JJ said:
No doubt in many contexts it is necessary to decide whether a right depending upon the existence of a stipulated purpose can be claimed, where what is done has a number of purposes. A familiar example in the income tax field is the line of authority dealing with the purpose of profit making by sale, mentioned in s 25A(1) of the Act and its predecessor, s 26(a). It has been held that under those provisions it is not enough if the purpose of profit making by sale is one of the purposes; that must be the dominant purpose: see, for example Annalong Pty Ltd v Commissioner of Taxation (Cth) (1972) 127 CLR 174 at 181.
There is no general rule that such a condition – that is, one expressly or implicitly requiring the existence of a purpose – is satisfied, if it is shown that a stipulated purpose was one of the proponent’s purposes, nor is it so that ordinarily the purpose must be a dominant one; each provision must be considered in its own context. Here, there is no express mention of “purpose” and the words used are simply “in providing … water … for use on … the site …”. In an ordinary use of language, expenditure is not spoken of as having been incurred “in” a certain way unless that is the way in which it has been at least substantially, if not solely, incurred. For example, a person who is told by another that the latter has spent a certain sum in providing for his family would not take it that the expenditure was also directed to other, quite separate, ends.
95 The statutory context in which ss 32, 37, 38 and 39 of the Act appear confirms that these sections are concerned with the liability of a person to pay for the operations of a particular petroleum project. The statutory context includes ss 22 and 24 of the Act. If one reads s 22 of the Act exegetically with the description of “deductible expenditure” in ss 32, 37, 38 and 39 of the Act, one sees that the annual taxable profit of a person in relation to a petroleum project consists of the excess of assessable receipts derived by that person over the total of the payments liable to be made by that person in carrying on or providing the operations, facilities and other things which together comprise the project. Subject to s 41 of the Act, it is only where a person incurs a liability to make a payment to procure the carrying on of the project that the liability qualifies as deductible expenditure in relation to the project.
96 The taxation regime established by the Act is significantly different from that established under the Income Tax Assessment Act 1936 (Cth) and the Income Tax Assessment Act 1997 (Cth). The Act is not concerned to impose tax on the net income of a resident taxpayer ascertained by deducting from the entirety of the taxpayer’s assessable income, derived from all sources, the entirety of the taxpayer’s allowable deductions. The Act is concerned to impose tax on the taxable profit derived by a person in relation to a particular petroleum project. Just as that person’s income derived from sources other than the project is immaterial to the ascertainment of assessable receipts in relation to the project, so that person’s expenditures in the course of gaining assessable income other than specifically from the project are immaterial to the exercise contemplated by s 22 of the Act.
97 The ascertainment of taxable profit and deductible expenditures under the Act takes place in a context in which taxable profit and deductible expenditure are in a relationship to the project which is exclusive of other businesses or enterprises in which the person may be engaged and which its also exclusive of income derived and expenditure incurred by other persons who do not derive assessable receipts in relation to the project. The evident intent of s 38, understood in its context, is to ensure that the person who derives the profit from carrying on a petroleum project should be entitled to deduct the expenses which reduce the taxable profit derived by that person from carrying on the project, but only those expenses. It would be a curiously asymmetrical outcome if expenditure which was incurred generally in activities for the generation of income from all the business operations of the person might be deductible from those receipts.
98 It is also to be noted that ss 32, 37 and 38 of the Act, unlike s 51AAA of the Income Tax Assessment Act 1936 (Cth), are not concerned with the taxpayer’s purpose in incurring expenditure; they are concerned with whether a liability is incurred in carrying on specified activities. In this regard, the primary judge observed at Reasons [131] that “as far as purpose is relevant”, the “substantial, if not the sole purpose of each of [EAR] and BHP in making the payments was to carry on or provide the operations, facilities or other things comprising the joint venture project”. Each of ss 37, 38 and 39 requires that the character of the expenditure to which it refers be determined according to whether the payments in question are liable to be made in carrying on the activities comprising the project. Whether a given liability to make payments is of the desired character depends on the arrangements which have been made; and one should be able to ascertain the character of expenditure at the time when the liability is incurred by reference to the arrangements under which it is incurred. In our respectful opinion, it is not necessary to consider the purposes of the payer in the operation of ss 37, 38 or 39 as something distinct from the effect of the commercial arrangements under which the liability is or was incurred.
99 When one comes to construe s 41 of the Act, two aspects of the statutory context need to be borne in mind: first, s 41 affords a person which derives income in relation to a petroleum project but which does not itself carry on the operations comprising the project (whether by itself or by an agent) the only basis for obtaining deductions under ss 32, 37, 38 and 39. Secondly, there is nothing in the statutory context to suggest that a person who engages a contractor to carry on the activities which comprise the project should be better off, in terms of deductible expenditure, than if that person had carried on those activities itself.
100 Section 41 is engaged by the incurring of a liability by a person (the eligible person) to procure the carrying on by another person of activities relating to a project. Section 41 has no relevant operation unless the eligible person has incurred a liability to procure another person to carry on or provide operations or things of a kind which would give rise to deductible expenditure if paid for directly by the eligible person. As we have indicated, that requirement will not be satisfied by a payment which enures for the benefit of the project only incidentally as part of a larger liability connected to other business operations of the eligible person. Whether an eligible person “incurs or incurred a liability to make a payment to procure the carrying on … of operations … of a kind” specified for the purposes of s 41 of the Act is to be resolved by asking whether the liability is or was incurred in return for the carrying on of the specified operations. That question falls to be resolved by reference to the contractual arrangements made by the eligible person to procure the carrying on of the specified operations. It is not sufficient for the purposes of s 41 that payments in discharge of a liability incurred for a broad range of operations may subsequently be dissected so as to be attributed in an economic sense to operations comprising the project.
101 Some awkwardness in the interpretation of s 41 may be said to arise because it is engaged by an eligible person incurring a liability to procure the carrying on or providing of operations, facilities or other things of a kind referred to in ss 37, 38 or 39 by another person, and s 41 then goes on to deem that liability “to have been incurred by the eligible person in carrying on or providing the operations, facilities or things”. Section 38 defines general project expenditure by excluding from its scope “excluded expenditure” which is in turn defined by s 44 in terms of payments for what appear to be “operations facilities or things”. It is this shifting of focus between “liability” and “activities” on which EAR’s argument fastens. There may be a question whether the words in s 41 “of a kind referred to in section 37, 38 or 39” should be regarded as describing “the liability” or “operations, facilities or things” referred to in each of those sections. However this question may be resolved, EAR’s position cannot be sustained.
102 As to the extent of the deeming worked by s 41, EAR would have it that it does no more than deem the liability incurred by the eligible person to have been incurred in “carrying on or providing the operations, facilities or things”. EAR says that the limited deeming by s 41(b) does not go so far as to pierce the corporate veil to erase the character of EAR’s liability as a fee under the Service Agreement and leave revealed payments for activities which happen to be excluded expenditure deemed to have been made by EAR. But that is expressly what s 41(a) does. It is difficult to see what operation s 41(a) might have which would accommodate EAR’s argument. Where s 41 is engaged, its effect is to deem the liability incurred by the eligible person to the contractor, to have been incurred by the eligible person “in carrying on or providing the operations, facilities or other things”. These are the same “operations, facilities or other things” that s 41(a) deems to have been carried on, not by the contractor, but by the eligible person.
103 It is sufficient to dispose of EAR’s arguments as to the operation of s 41 to say that s 41 achieves the unsurprising result that the eligible person is in the same position to claim deductions from assessable receipts in relation to a project as it would have been if it had carried on the activities comprising the project itself. Where an eligible person incurs a liability to make a payment to procure the carrying on or providing of operations, facilities or things of a kind referred to in s 37, 38 or 39 by another person, the deeming worked by paras (a) and (b) of s 41 makes the liability of the eligible person a liability to pay for those operations, facilities and things including liabilities for operations, facilities or things which are “excluded expenditure” as designated by s 44. The construction of s 41 for which EAR contends is contrary to the scheme and evident intent of the Act.
CONSIDERATION ON APPEAL
The Service Agreement Issue
104 Where a payment is liable to be made under an agreement, the question of what the payment was for is to be answered “by having regard to the legal agreements entered into”: City Link Melbourne Ltd v Commissioner of Taxation (2004) 141 FCR 69 at [44]. The liability incurred by EAR under cl 4 of the Service Agreement was incurred to obtain the promise of EAL’s assistance in the broad range of EAR’s business activities referred to in cl 1 of the Service Agreement. If one looks at the terms of the Service Agreement to fix the character of the payments under cl 4, one cannot say the payments were made to discharge a liability in carrying on the activities comprising the Bass Strait project. An indivisible liability under cl 4 of the Service Agreement is not within the scope of ss 37 or 38 of the Act. But it is not necessary to found our conclusion that the cross-appeal must be allowed on this ground. It is sufficient to note that because of the operation of s 41, it is not possible to say of the liability created by the Service Agreement that it does not include excluded expenditure.
105 Somewhat ironically, given its principal submission, EAR argues that an apportionment of the liability created by the Service Agreement is permitted by the Act so that items of excluded expenditure may be separated from items of exploration and expenditure and items of general project expenditure. In support of the argument that apportionment is possible, EAR relies upon Ronpibon Tin N.L. v Federal Commissioner of Taxation (1949) 78 CLR 47 at 59 (Ronpibon) where the High Court, in a unanimous judgment, said:
The charges for management and the directors' fees are entire sums which probably cannot be dissected. But the provision contained in s. 51 (1), as has been already said, contemplates apportionment. The question what expenditure is incurred in gaining or producing assessable income is reduced to a question of fact when once the legal standard or criterion is ascertained and understood. This is particularly true when the problem is to apportion outgoings which have a double aspect, outgoings that are in part attributable to the gaining of assessable income and in part to some other end or activity. It is perhaps desirable to remark that there are at least two kinds of items of expenditure that require apportionment. One kind consists in undivided items of expenditure in respect of things or services of which distinct and severable parts are devoted to gaining or producing assessable income and distinct and severable parts to some other cause. In such cases it may be possible to divide the expenditure in accordance with the applications which have been made of the things or services. The other kind of apportionable items consists in those involving a single outlay or charge which serves both objects indifferently. Of this directors' fees may be an example. With the latter kind there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income. It is an indiscriminate sum apportionable, but hardly capable of arithmetical or ratable division because it is common to both objects.
In such a case the result must depend in an even greater degree upon a finding by the tribunal of fact.
106 As the High Court explained in Ronpibon at 58 the question posed by s 51 of the Income Tax Assessment Act 1936 (Cth) was “to what extent the expenditure … was incurred in gaining or producing the assessable income”. The question in that case, as the High Court went on to explain, “is how far was it incurred in the course of, how far was it incidental and relevant to, gaining or producing the assessable income”. In contrast, ss 32, 37 and 38 of the Act do not invite an inquiry as to whether the expenditure was incurred in the course of, or was incidental and relevant to, gaining or producing assessable income. Further, ss 32, 37 and 38 do not invite an inquiry as to the extent of the relation of the postulated liability to the derivation of assessable receipts. Rather, they invite attention to the more narrowly focussed questions of whether the liability to make payments is “in carrying on or providing operations and facilities involved in or in connection with exploration for petroleum … in relation to the project” (s 37(a)) or “comprising the project” (s 38(b)). Under these provisions no occasion arises to consider a notional apportionment of liabilities or payments to assessable receipts.
107 On the other hand, if one cannot regard the payments under cl 4 of the Service Agreement as payment of an indivisible liability rather than payments of liabilities separately created under subcll 4(a), (b) and (c) then, by virtue of the operation of s 41 of the Act, the claims under subcll 4(b) and (c) are, as the Commissioner argues, even more readily to be seen to comprise excluded expenditure under s 44(j) and (k) of the Act.
108 In this regard, the “portion of the cost of maintaining [EAL’s] office facilities, and staff or personnel” referred to in cl 4(b) of the Service Agreement, falls within the description of “administrative or accounting costs, or wages, salary or other work costs, incurred indirectly in carrying on… things of a kind referred to in ss 37, 38 and 39 of the Act” in s 44(j) of the Act. Similarly, the costs of maintaining EAL’s office facilities falls within the description of “payments in respect of land or buildings for use in connection with administrative or accounting activities in respect of the carrying on or provision of other operations, facilities or things of a kind referred to in sections 37, 38 and 39, not being land or buildings located at or adjacent to the site” of those activities.
109 As has been noted, EAR argues that the liability for these expenses was incurred by EAL rather than EAR. But that argument does not accommodate the operation of s 41 of the Act which we have explained above. The conclusion that the Service Agreement does not accommodate EAR’s preferred view of the operation of the Act is hardly surprising, given that the Service Agreement was made several decades before the Act came into force.
110 In summary, under this heading, whether or not the service fee payable under cl 4 of the Service Agreement is regarded as one indivisible payment, or as payments of separate liabilities under each of sub-cll 4(a), (b) and (c), s 41 of the Act does not permit a deduction for excluded expenditure or for payments which include excluded expenditure in respect of activities deemed to have been carried on by EAR. There is no other basis on which EAR can claim to deduct the disputed amounts. Accordingly, the Commissioner’s cross-appeal must be allowed.
CONSIDERATION ON APPEAL
The MRC Issue
111 It follows from the view which we take of the correct approach to the construction of ss 37, 38 and 41 of the Act that we consider that the primary judge was correct in resolving the MRC issue against EAR and its appeal should be dismissed.
112 The work being conducted by the URC for which EAR makes a contribution by the MRC is not conducted in carrying on the activities comprised in the Bass Strait project. The URC’s work may well, and apparently has, enured for the benefit of that project, but to say that falls distinctly short of saying that the URC has carried on or provided the operations, facilities or things comprising the project.
113 In addition, in this regard it may be noted that the expense of obtaining a production licence in relation to which a petroleum project can be identified for the purposes of the Act is expressly taken to be deductible expenditure by s 38 of the Act. Without this express provision the expense of obtaining a production licence would not be within s 38 because it is not incurred in carrying on the operations of the project for the obvious reason that it is a pre-cursor to the carrying on of those operations. It would be surprising if the expense of obtaining the production licence would be seen as being too remote from the carrying on of the project to qualify as deductible expenditure, but an even more remote preliminary expenditure, such as the MRC, would qualify.
114 It is also to be noted that s 38(a) of the Act expressly includes within general project expenditure payments liable to be made by the person “in carrying on or providing operations and facilities preparatory to the activities referred to in sub-paragraph (b), including in carrying out any feasibility or environmental study”. These preparatory activities are expressly included in general project expenditure on the evident basis that they would be too remote from the “carrying on or providing the operations, facilities and other things comprising the project” to be comprehended by sub-paragraph (b) of s 38. And yet these preparatory activities are more closely and specifically connected to the project than the work of the URC.
115 In reaching this conclusion it is not necessary to rely upon the fact that EAR did not claim 50% of the MRC from BHP under the Operating Agreement. Whether or not it is right to say, as EAR urged, that it refrained from seeking the payment to avoid a claim by BHP for access to the information obtained by EAR from the URC, and even if EAR’s failure to seek payment from BHP could be regarded as an admission of law by EAR, we would not regard that admission as having any weight in resolving the issue of whether the MRC was a liability incurred in carrying on the operations comprising the Bass Strait project for the purposes of s 38 of the Act.
ADDITIONAL OBSERVATIONS
116 The Commissioner’s amended assessments for the years of tax proceed on the premise that, apart from that part of the consideration paid by EAR to EAL pursuant to the Service Agreement which he has disallowed, the balance qualifies as deductible expenditure. It will be apparent that we are far from satisfied that the Commissioner’s premise is correct. Indeed, if pressed, we would conclude that it is not correct. On the other hand, having regard to the history of this controversy including the basis of the amended assessments, the grounds of the objections, the decisions on the objections, the issues as agitated before the primary judge and the parties’ respective contentions on appeal, we do not think it is open to this Court to embark upon some de novo re-assessment. The task of this Court is confined to determining whether the learned primary judge was correct in concluding, the MRC issue aside, that the amended assessments were excessive. The Court can do this without recourse to a de novo re-assessment, even if it is of the view that the amended assessments are not only not excessive, but understate the correct taxable profit in the years in question.
117 We have addressed the arguments agitated by the parties in relation to the Commissioner’s cross-appeal, and for the reasons we have given, we have concluded that the cross-appeal should succeed. It would not be appropriate to decide the case on a basis which departs from the assumption on which the assessment proceeded; and we do not do so. Nevertheless, we should shortly state the reasons for our view that the premise upon which the Commissioner’s amended assessments are predicated is wrong.
118 First, having regard to the terms of the Service Agreement, in particular cl 1, which sets out the services to be provided by EAL to EAR in return for the consideration to be paid by EAR to EAL under cl 4, that consideration does not qualify as exploration expenditure incurred by EAR in relation to the Bass Strait Project under s 37 of the Act, nor as general project expenditure incurred by EAR in relation to that project under s 38. In the end, there was no serious contention that EAL did what it did as agent for EAR, so that it was EAR, not EAL, that was carrying on or providing operations, facilities or other things comprising the project and EAR, not EAL, that was incurring the expenditure. Besides, as noted earlier, if such a contention were to be accepted, that would be fatal to EAR’s contention that the character of the liability it incurred to EAL under the Service Agreement was not to be determined by reference to the characteristics of the components of EAL’s expenditure.
119 Secondly, s 41 of the Act does not assist EAR. The deeming worked by that section only occurs where the eligible person (EAR) incurs a liability to make a payment to another person to procure the carrying on or providing of operations, facilities or other things of a kind referred to in ss 37, 38 and 39 of the Act; in other words, in relation to a particular petroleum project. The consideration that EAR is required to pay to EAL under cl 4 of the Services Agreement is not, by reason of the services to be provided by EAL to EAR under cl 1, so confined. In this regard, it is to be contrasted with the provisions of the Operating Agreement between EAR and BHP, in particular Arts 4.01, 4.02, 4.04 and 4.05 and the liability undertaken by BHP under Art 8 to procure the carrying on or providing of those operations, facilities or other things by EAR, all of which are confined to the Bass Strait Project.
120 Putting this fundamental difficulty to one side and accepting, for the purposes of further analysis, that s 41 applies to the Service Agreement between EAR and EAL, EAR says that the deeming worked by that section does not enable the Commissioner to attribute to the consideration paid by EAR to EAL under the Service Agreement the same characteristics as attend the various components of expenditure incurred by EAL. In other words, the fact that items of expenditure incurred by EAL may be “excluded expenditure” for the purposes of s 44 of the Act, does not enable the Commissioner to treat an equivalent proportion of the consideration paid by EAR to EAL under the Service Agreement as excluded expenditure.
121 As we have explained, if s 41 applies to the Service Agreement relationship between EAR and EAL contrary to the view expressed in [119] above, then its application may be described shortly as working a statutory agency as between EAL and EAR for the purposes of ss 32, 37, 38 and 39 of the Act. By para (a) of s 41, the operations, facilities or other things comprising the project are taken to have been carried on or provided by EAR and not EAL; and by para (b), EAR’s liability under the Service Agreement is taken to have been incurred in carrying on or providing the same operations, facilities or other things. On this basis, there is no difficulty in attributing to the consideration paid by EAR under the Service Agreement the same characteristics as attend the various components of EAL’s expenditure; if a component of EAL’s expenditure is excluded expenditure within s 44, then the equivalent proportion of the consideration paid by EAR to EAL will be excluded expenditure and denied deductibility.
ORDERS
122 We would make the following orders:
1. The appeal by EAR be dismissed.
2. The cross-appeal by the Commissioner be allowed and the judgment below set aside.
3. EAR pay the Commissioner’s costs of the appeal and cross-appeal, with such costs to be taxed in default of agreement.
| I certify that the preceding one hundred and twenty-two (122) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Chief Justice Keane and Justice Edmonds. |
Associate:
|
IN THE FEDERAL COURT OF AUSTRALIA | |
| VICTORIA DISTRICT REGISTRY | |
| GENERAL DIVISION | VID 630 of 2011 |
| ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA |
| BETWEEN: | ESSO AUSTRALIA RESOURCES PTY LTD (ACN 091 829 819) Appellant |
| AND: | COMMISSIONER OF TAXATION Respondent |
| JUDGES: | KEANE CJ, EDMONDS & PERRAM JJ |
| DATE: | 20 FEBRUARY 2012 |
| PLACE: | BRISBANE |
REASONS FOR JUDGMENT
PERRAM J
123 I have had the advantage of reading in draft the reasons prepared by the Chief Justice and Edmonds J. I respectfully agree with the Chief Justice and Edmonds J that the appeal must be dismissed and the cross-appeal allowed and I do so, save in relation to one matter, for the reasons given by their Honours. The one matter relates to the proper construction of s 41 of the Petroleum Resource Rent Tax Assessment Act 1987 (Cth) (‘the Act’) in respect of which I have arrived at the same conclusion albeit by a slightly different route.
124 That question of the proper construction of s 41 involves the operation of the Act as it applies to the Bass Strait Project. The tax itself is imposed at the rate of 40% on the ‘taxable profit’ of a person in relation to a ‘petroleum project’ by ss 4 and 5 of the Petroleum Resource Rent Tax Act 1987 (Cth). Subject to presently immaterial exceptions, the taxable profit in relation to a petroleum project is the difference between the taxpayer’s ‘assessable receipts’ and its ‘deductible expenditure’ (s 22 of the Act). Perhaps unlike many other taxes, therefore, this tax is assessed by reference to profits generated in respect of particular petroleum projects rather than by the income derived by a taxpayer. It is a profits tax, not an income tax, and it is a profits tax in which the locus of the tax rests in distinct petroleum projects. A profits tax of that kind supplants a royalty arrangement but, in effect, fulfils a similar economic role: the capture of some of the economic advantage obtained by the taxpayer from the exploitation of a State regulated resource.
125 The identification of the profits derived from a petroleum project is, therefore, the central purpose of the Act. Much of its machinery is devoted to the ascertainment of the difference between a taxpayer’s ‘assessable receipts’ and its ‘deductible expenditure’. As might naturally be expected, in a straightforward case the taxpayer’s ‘assessable receipts’ will consist of the money it receives on the sale of the petroleum products derived from the project. Section 24 refers to these as ‘assessable petroleum receipts’. At times there can be questions of some subtlety generated by the machinery of s 24; this Court’s recent decision in Esso Australia Resources Pty Ltd v Commissioner of Taxation [2011] FCAFC 154 is an illustration of some of the problems which may arise. In essence, the conceptual difficulties are driven by the need to identify some point or threshold by which the project may be seen as delimited. Point of sale is a convenient and straightforward one but the Act contemplates others too, such as the point at which there is a transportation away from the production site (see s 24(1)(c) and the definition of ‘excluded commodity’ in s 2).
126 At the other end of the process the Act concentrates on ‘deductible expenditure’. Because the tax is assessed by reference to projects, the conceptual task the Parliament has pursued is to winnow those of the taxpayer’s expenditures which relate to the project from those which do not. Because the business of extracting petroleum from the earth’s crust is almost always a significant undertaking very often taxpayers will be involved in multiple projects and, in almost all cases, will have business units – marketing, head office, accounting, legal and so on – which are not directly involved in the actual process of petroleum extraction. The Act seeks to ensure that expenses of that kind do not intrude into the assessment of the profits generated by any particular project. As with the quantification of ‘assessable petroleum receipts’ the conceptual task underpinning the notion of ‘deductible expenditure’ is the identification, for expenditure purposes, of some point or threshold by which the project may be seen as being circumscribed.
127 It will be noted that there is a symmetry about this and that the driving force in that symmetry is the concept of a project. Both assessable receipts (s 23(1)) and deductible expenditure (s 32) are calculated ‘in relation to a petroleum project’. If a receipt or expenditure cannot be seen as being ‘in relation to a petroleum project’ it is not assessable. It is the particular process by which these matters are implemented in the case of expenditure which gives rise to the present issue. The Act recognises three central forms of expenditure. These are:
1. exploration expenditure (s 37);
4. general project expenditure (s 38); and
5. closing-down expenditure (s 39).
128 These sections operate through the vectors contained in ss 32-36 which mediate carried forward capital expenditure by reference to two different discount rates. Nothing in this case turns on those provisions which, although important in the assessment process, may be safely put to one side for present purposes. The expenditure in this case was, if it was anything, general expenditure to which s 38 applied. It provides:
38 General project expenditure
(1) For the purposes of this Act, a reference to general project expenditure incurred by a person in relation to a petroleum project is a reference to payments (not being excluded expenditure, exploration expenditure or closing-down expenditure), whether of a capital or revenue nature, liable to be made by the person:
(a) in carrying on or providing operations and facilities preparatory to the activities referred to in paragraph (b), including in carrying out any feasibility or environmental study; and
(b) in carrying on or providing the operations, facilities and other things comprising the project; and
(c) in purchasing, as part of the project, external petroleum, or internal petroleum, in relation to the project; and
(d) in procuring another person to stabilise, transport, store, recover or process petroleum recovered from the production licence area or areas in relation to the project, if that stabilisation, transportation, storage, recovery or processing constitutes:
(i) the processing of internal petroleum in relation to the project; or
(ii) the processing of external petroleum in relation to another petroleum project;
and includes any production licence or other fee (not being an excluded fee) liable to be paid by the person in relation to the carrying on or providing of any operations, facilities or other things referred to in this section.
(2) To avoid doubt, carrying on or providing the operations, facilities and other things comprising the project referred to in paragraph (1)(b) includes carrying on or providing the operations, facilities and other things in relation to the processing of external petroleum, or internal petroleum, in relation to the project.
129 Two aspects of this deserve emphasis. First, s 38 allows the deduction of expenditure incurred ‘in carrying on’ various activities which might loosely be described as project operation. That expression has been held to require a reasonably close nexus between the project and the expenditure: Commissioner of Taxation v Mount Isa Mines Ltd (1991) 28 FCR 269 at 279. Of course, if that nexus were loosened the focus on the profits generated by the project might well be disturbed. Secondly, the expenditure contemplated does not include, as the parenthesis shows, ‘excluded expenditure’. That exemption from the operation of s 38 is, as will be seen, critical for the outcome of the present issue. ‘Excluded expenditure’, in turn, is defined in s 44 thus:
44 Excluded expenditure
For the purposes of this Act, a reference to excluded expenditure is a reference to:
(a) payments of principal or interest on a loan or other borrowing costs; or
(b) interest components of hire-purchase payments; or
(c) payments of dividends or the cost of issuing shares; or
(d) the repayment of equity capital; or
(e) payments of a kind known as private override royalty payments; or
(f) payments to acquire, or to acquire an interest in, an exploration permit, retention lease, production licence, pipeline licence or access authority, otherwise than in respect of the grant of the permit, lease, licence or authority; or
(g) payments to acquire interests in petroleum project profits, receipts or expenditures; or
(h) payments of tax under the Income Tax Assessment Act 1936, or the Income Tax Assessment Act 1997; or
(i) payments of GST under the GST Act; or
(j) payments of administrative or accounting costs, or of wages, salary or other work costs, incurred indirectly in carrying on or providing operations, facilities or other things of a kind referred to in sections 37, 38 and 39; or
(k) payments in respect of land or buildings for use in connection with administrative or accounting activities in respect of the carrying on or provision of other operations, facilities or things of a kind referred to in sections 37, 38 and 39, not being land or buildings located at or adjacent to the site or sites at which those other operations, facilities or things are carried on or provided.
130 But for the exclusion of these matters by the parenthetical excision in s 38, many of these items of expenditure would otherwise constitute general expenditure under its terms. For example, the interest on a loan used to acquire a capital asset to be deployed in the extraction process would be an expense incurred ‘in carrying on’ the project. The effect of the parenthesis is, therefore, not descriptive of what then follows but instead operates directly as an excision from what would otherwise have been the ambit of s 38.
131 It is against that backdrop that the present question arises. The taxpayer in this case is Esso Australia Resources Pty Ltd (‘EAR’). In the years ending on 30 June 2003 and 30 June 2004 it included in its returns under the Act its share of the profits derived from the operation of the Bass Strait Project. It is not disputed that this project is a petroleum project to which the provisions of the Act apply (s 19(1A)).
132 The project is conducted by EAR as a joint venture with BHP Billiton Petroleum (Bass Strait) Pty Ltd (‘BHP’). Under the arrangements between the two companies the burden of operating the project was to be borne by EAR. In fact, however, EAR owns little more than interests in the relevant statutory licences authorising exploration and exploitation of the petroleum resources in Bass Strait. In particular, it has neither the physical nor human capital by which the very significant processes of finding and extracting petroleum might be carried into effect.
133 The answer to this apparent inability on EAR’s part to carry out its side of the bargain with BHP has resided in alternate arrangements which EAR has made. From the very inception of the Bass Strait Project, which was in the early 1960s, EAR has employed the services of another company, Esso Australia Ltd (‘EAL’), to put in place the facilities comprising the project and thereafter to conduct it.
134 This was done under the auspices of a broader agreement between EAR and EAL known as the Services Agreement which was entered into on 22 December 1966. As at 2003 and 2004 (the tax years in dispute in this case) the Services Agreement had three notable features. First, it recited the inability, on the one hand, of EAR to exploit the interests it held in Australia and on the continental shelf and, on the other hand, EAL’s willingness to provide such services. Secondly, EAL bound itself to provide services of that kind in return for the payment of fees by EAR. Thirdly, the Services Agreement was not in terms limited in its operations to Bass Strait.
135 At the heart of the matter therefore lies this fact: EAR did not in fact conduct petroleum exploration or petroleum production activities in Bass Strait but such activities, as were carried on, were conducted instead by EAL. At the threshold, therefore, something of a difficulty arises for although s 38 permits deductions of general project expenditure this must be expenditure actually incurred in the operation of a project.
136 One possible solution to this problem would have been for EAR to constitute EAL as its agent for the purpose of carrying on the Bass Strait Project. But it does not appear that the Services Agreement had that consequence and no contention to that effect was advanced during the appeal.
137 Another solution lies in s 41 of the Act. It provides:
41 Effect of procuring the carrying on of operations etc. by others
(1) Where a person (in this section referred to as the eligible person) incurs or incurred a liability to make a payment to procure the carrying on or providing of operations, facilities or other things of a kind referred to in section 37, 38 or 39 by another person, then, for the purposes of this Act:
(a) the operations, facilities or other things shall be taken to have been carried on or provided by the eligible person and not by the other person; and
(b) the liability shall be taken to have been incurred by the eligible person in carrying on or providing the operations, facilities or other things.
138 Indeed, it is only through s 41(b) that EAR is permitted to claim the liabilities it has incurred to EAL as general project expenditure under s 38. But for the operation of s 41 the liabilities incurred by it under the Services Agreement would not have been incurred in carrying on the Bass Strait Project and, therefore, would have resided beyond the reach of any assistance that s 38 might have proffered. There was no dispute that s 41 resolves at least that issue on this appeal.
139 The drafting of s 41 carries with it, however, a problem. Whilst it is plain that the machinery of s 38 ensures (through the parenthetical excision to which reference has already been made) that excluded expenditure under s 44 cannot be claimed by a project operator it does not appear that this result is expressly transposed into the operation of s 41.
140 This matters because of the terms of cl 4 of the Services Agreement. It provides:
[EAR] agrees to pay [EAL] for the services provided hereunder the following:
(a) All direct costs incurred by [EAL] on behalf of [EAR] in the performance of services hereunder; and
(b) That portion of the cost of maintaining [EAL’s] office facilities and staff of personnel which is properly allocable to the performance of services hereunder; and
(c) A fee of seven and a half (7½%) per cent of net charges under (b) of this Clause.
141 It will be seen that expenditure of the kind referred to in cl 4(b), if incurred by a person actually conducting a petroleum project, would be excluded expenditure under s 44(j) and (k) and hence not claimable under s 38. One potentially has, therefore, the situation where expenditure, if incurred by a petroleum project operator, would be excluded under s 44 but where passed on through a service company becomes not excluded.
142 This is an interpretation of s 41 which, if it can legitimately be avoided, should be. As was remarked during argument on the appeal, if the exclusions demanded by s 44 can be evaded by the simple expedient of interposing a service company then the Act is afflicted by a very significant loophole. Effectively such an interpretation will mean that the concept of excluded expenditure in s 44 is practically redundant. Given that the Act pays such careful attention to the boundaries of a petroleum project as a taxing concept, such a reading of s 41 is, at heart, antithetical to significant architectural features of legislation.
143 In my opinion, s 41 can comfortably be read to avoid this implausible, and undesirable, outcome. The provision takes the familiar form of an ‘if….then’ statement. The antecedent is the incurring of a particular kind of liability; the consequent consists of two elements both of which are deemings – the operations are taken to have been carried on by the eligible person (even though they were not in fact so carried on) and the liability is taken to have been incurred by the eligible person in the conduct of that operation (even though it was not so incurred).
144 The critical question is the ascertainment of the nature of the liability in the antecedent. It is expressed to be a ‘liability to make a payment to procure the carrying on or providing of operations, facilities or other things of a kind referred to in section 37, 38 or 39 by another person’. The italicised words are used repeatedly in the Act and indeed are defined in s 19(4). It is not necessary to set that definition out. It is sufficient instead to observe that the words immediately following those words in s 41 (‘of a kind referred to in section 37, 38 or 39’) do not there appear. It is possible then that these words in s 41 qualify:
(a) the ‘liability’ referred to earlier on; or
(b) ‘the operations, facilities or other things’ referred to just after the word ‘liability’ and otherwise defined in s 19(4).
145 As to (a), the taxpayer’s argument fails if the expression qualifies the liability. This is because s 38 has cleaved from it any liabilities which are excluded by s 44. If read that way then s 41 is not capable of applying to liabilities excluded by s 44. As to (b), the other reading of s 41 will not have that effect: ‘liability’ will not be qualified by the expression ‘of a kind referred to in section 37, 38 or 39’ and it will be possible for an excluded liability under s 44 to become non-excluded simply by passing its imposition through a service company and transmuting it into an intermediary fee.
146 As a matter of grammar both constructions are equally open. In the choice between two competing, but equally grammatically plausible constructions, I prefer the one which does not entirely undermine the operation of the Act: ‘of a kind’ therefore qualifies ‘liability’. It follows that a fee may not be claimed under s 41 which reflects excluded expenditure under s 44.
147 I agree with the orders proposed by the Chief Justice and Edmonds J.
| I certify that the preceding twenty-five (25) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Perram. |
Associate:
Dated: 20 February 2012
