Did You Know…

“exploring” petrol can be tax deductible?

As petrol prices climb (a consequence of the current political climate), it seems timely we turn our attention to the recent Full Federal Court decision concerning the “exploration” of petroleum.

Commissioner of Taxation v Shell Energy Holdings Australia Ltd (Shell Case)[1]

Before delving into an analysis of the Shell Case decision, we set out the below relevant facts:

• Shell Energy Australia Limited (Shell) and Chevron Australia Pty Ltd (Chevron) (amongst others) were in a petroleum venture and together were holders of an “exploration permit and six retention leases” (Statutory Titles);
• Shell bought out Chevron’s interest in the venture and claimed a deduction of $2.3 billion under section 40-80 of the Income Tax Assessment Act 1997 (Cth) (the Act) for the cost incurred in acquiring an “additional proportional interest” (Acquired Statutory Titles); and
• The Commissioner of Taxation (Commissioner) disallowed the deduction; and
• Shell brought proceedings challenging the Commissioner’s decision, and the matter was heard before the Federal Court of Australia, where Shell was partially successful (see Shell Energy Holdings Australia Limited v Commissioner of Taxation (Commonwealth)[2]).

Since then, the Commissioner appealed part of the primary judge’s decision – originating the Shell Case – arguing that:

• none of Shell’s activities authorised by the additional acquired rights were for exploration purposes, and therefore the total cost was not deductible under section 40-80 of the Act; and
• section 40-77 of the Income Tax (Transitional Provisions) Act 2001 (Cth) does not apply.

Throughout the matter, Shell countered that the additional proportional interest in the Statutory Titles was “first used” for exploration when the asset was held and ready for use, pending regulatory approval and registration. Shell further argued that the primary judge should have allowed the whole of the cost to be deducted.

It should be noted that the additional proportional interest, being the Acquired Statutory Titles, were not a contentious issue in the Shell Case.  Rather (and at the crux of the Commissioner’s argument) was whether the Acquired Statutory Titles are an asset capable of being used by a taxpayer for exploration.

Court’s decision

In handing down its judgment, the Full Federal Court considered the following:

• taxation legislation should be construed in the same way as other laws;
• statutory constructions begin by looking at the text itself;
• dictionary definitions are not always practically helpful, especially where there is more than one meaning;
• it is necessary to consider the context of the legislation (surrounding words, sections and divisions);
• legislative history and extrinsic material should be considered; and
• avoid constructions where anomalies, lacunas or absurd results will ensue.[3]

Turning its attention to each of the above principles, the Court found in favour of Shell.  Notably, the Court’s decision in the Shell Case is contrary to the Administrative Appeals Tribunal’s view in ZZGN v Commissioner of Taxation [2013] AATA 351, where it considered that exploration “…should not extend to include feasibility studies of the field for future development and production”.  

Key takeaways

Typically, depreciation is calculated from the start time (when the asset is first used or installed ready for use).  Section 40-80 of the Act permits a party to record the depreciation of an asset, as the assets cost.  In this case, the Court accepted Shell’s argument that passive use can be constituted as “use” in the context of section 40-80 of the Act and that intangible assets are deemed to have been “first used” once held for use.  That is, the “first use” of the Acquired Statutory Titles – synonymous with the “start time” applied for depreciation – was the approval and registration of Shell’s acquisition of Chevron’s interest.

Further, the case provided clarity on what exploration means in the context of the law.  Whilst the Commissioner pursued a narrow interpretation of the Act – suggesting that section 40-80 is limited to the discovery of mineral or petroleum – Shell adopted a more liberal approach and put forward the argument that exploration includes assessing the extent, worth and commercial feasibility of recovering petroleum.

Ultimately, it appears that the Court was persuaded by Shell’s holistic approach and detailed and thorough legal analysis – serving as a reminder that whilst cases may succeed on evidence, quality submissions and experts in the industry are vital to victorious outcomes.

Nonetheless, the difficulty with the Court’s decision in the Shell Case is whether (for example) its adoption and acceptance of a broad interpretation of the term exploration will extend to claims concerning the evaluation, appraisal and assessment of prospective projects after a discovery is made to gauge whether there is commercial merit.  Therefore, we anticipate that the Australian Taxation Office may see a surge in similar claims, relying on the Shell Case to obtain a disallowed cost deduction.  In fact, following Shell’s success, we can similarly expect to see increased pressure on the judicial system, as the Commissioner and taxpayers litigate on deductions made pursuant section 40-80 of the Act and that have been disallowed in a similar vein as the Shell Case.

[1] [2022] FCAFC 2.

[2] [2021] FCA 496.

[3] Philip Bisset, Luke Furness and Declan Carr, Statutory interpretation and tax law: examples from Shell’s Court win in deducting its exploration assets (Web Page, 3 March 2022) <https://www.claytonutz.com/knowledge/2022/march/statutory-interpretation-and-tax-law-examples-from-shells-court-win-in-deducting-its-exploration-assets>.