By Kenneth Wee and Janelle O’Hare

IT GOES without saying that exploration is vital to the petroleum industry.

Significant effort is required to continually discover and extract resources from existing and new reserves, which in turn is a high risk activity requiring large upfront capital commitment. Fiscal settings impact the net cost of exploration and must be competitive and efficient to continue to attract investment.

The ever-evolving Australian tax landscape has given particular attention to the fiscal treatment of costs incurred on exploration activities in recent years.

While developments have attempted to shed light on the interpretation of “exploration expenditure”, the narrow views adopted have raised more questions than answers, creating unnecessary fiscal uncertainty.

Recent developments and impacts associated with both the Petroleum Resources Rent Tax (PRRT) and income tax as they relate to exploration are examined below.


The 40 per cent economic rent tax on upstream petroleum profits calculated by project has long recognised the need to adequately compensate for the risk and capital investment associated with exploration.

As such, exploration expenditure is the only category of cost which is not ring-fenced to a project but is transferable amongst a taxpayer’s commonly-owned projects. Additionally, exploration expenditure is augmented (or uplifted) at a higher rate compared to other expenditures.

Historically, industry has applied a well-understood view that exploration encompasses all the activities relating to the discovery and determination of a commercially recoverable accumulation of petroleum which support a decision to produce.

However, recent developments (an Administrative Appeals Tribunal decision in the ZZGN case and a still-to-be-finalised Commissioner of Taxation Draft Taxation Ruling on the scope of PRRT deductible exploration expenditure) seek to limit exploration to the technical analytical work undertaken to evaluate/appraise the resource.

This view is based on the ordinary, lay-person understanding of the term “exploration”, which is confined to the discovery and identification of the existence, extent and nature of petroleum reserves.

Further, this school of thought suggests “exploration” does not include feasibility studies of the field for future development and production. This, however, ignores the industry or commercial parlance of the term, and the context in which the term is used, having regard to the nature of the PRRT regime as a specific petroleum tax.

Besides affecting future exploration commitments, these developments result in significant and potentially far-reaching practical implications for businesses, particularly from a commercial and contractual perspective, if applied to past undeducted expenditures.

The ATO’s view also potentially creates an unintended black hole for expenditure incurred on evaluating the economic and commercial viability of developing a petroleum resource (e.g. front-end engineering and design), if the development does not ultimately proceed and a “petroleum project” does not come into existence or if a project does come into existence, where such expenditure falls outside the scope of “general project expenditure”.


Industry has historically also had a well understood view of what represents exploration for income tax purposes. An immediate income tax deduction is currently available for exploration expenditure, including the cost of acquiring mining rights and information first used for exploration purposes. There is no ring-fencing of exploration costs for income tax purposes.

A number of current developments relate to exploration expenditure. These include an ATO review of Taxation Ruling 98/23, which addresses the meaning of “exploration” for income tax purposes in an attempt to provide greater clarity as to its scope and to reflect contemporary industry trends and practices, and the Federal Government confirming in November 2013 that it will proceed with reforms to the first use deduction originally announced as part of the 2014-2015 Budget.

If not implemented appropriately, these reforms could potentially have a negative impact on the petroleum, industry, including reduced merger and acquisition activity or reduced transaction values, a tax-induced bias against brownfield exploration, an inability for investors to obtain a tax shield from exploration for a number of years, and practical uncertainty regarding when exploration is deemed to be unsuccessful.

These PPRT and income developments present various tax technical, commercial and practical issues which underpin a new approach to the tax treatment of exploration expenditure for the petroleum industry.

The Government should capitalise on the opportunity to adopt a holistic review of the resource tax landscape from exploration through to project maturity as part of its promised White Paper on tax reform. The industry requires certainty and stability in fiscal policy, which can only be developed with a long-term approach which focuses on promoting exploration as a starting point.