Deductions for a mineral miner

(Clause 27 and 35)

Summary of proposed amendments

The bill proposes that most expenditure of a mineral miner be divided into the following categories, dependent on the phase of the mine in question:

• mining prospecting expenditure – immediately deductible;
• mining exploration expenditure – immediately deductible, subject to the claw-back rule discussed above;
• mining development expenditure – deductible over the life of the mine created;
• mining rehabilitation expenditure – deductible in the year it is spent.

Other types of expenditure are:

• expenditure on land – deductible in the year the land is disposed of;
• expenditure on the acquisition of mineral mining assets – timing of deduction dependent on the stage of the operations; and
• all other expenditure – subject to general tax rules, including capital/revenue distinction when appropriate.

Application date

The amendments will apply from the beginning of the 2014–15 income year.

Key features

Under the proposed new rules, all of the main types of expenditure will be treated as mutually exclusive. This means that prospecting, exploration, development and rehabilitation expenditure will each have specific exclusions for any amounts that fall into one of the other categories. Equally, “residual expenditure” is excluded from all of the main classes of expenditure. To accommodate this, “residual expenditure” in section YA 1 will be extended to include appropriate types of mining expenditure.

Proposed section DU 9(2) also clarifies that no expenditure covered by the definitions of exploration, development or rehabilitation expenditure can be reclassified as prospecting expenditure. This is necessary because prospecting expenditure is immediately deductible and not subject to any claw-back rule.

As expenditure will generally relate to a “permit area”, the definition of that term has been expanded to include mineral mining activities.

Mining prospecting expenditure (sections DU 1(1)(a) and DU 10)

A mineral miner will be allowed an immediate deduction for mining prospecting expenditure. This term is defined in proposed section DU 10 to mean expenditure incurred directly in relation to a prospecting right or “mining prospecting information”, which is defined consistently with the corresponding term in existing legislation.

Specifically excluded from “mining prospecting expenditure” are the costs of land, plant, machinery, expenditure that falls into on the other main classes of expenditure and “residual expenditure”. Plant and machinery acquired will be subject to the general capital/revenue distinction. To the extent they are capital and depreciable, they will be subject to the normal depreciation rules at the appropriate rate.

Mining exploration expenditure (sections DU 1(1)(b), DU 6 and DU 11)

“Mining exploration expenditure” will also be immediately deductible, except when the claw-back rule described previously applies. In that case, the exploration expenditure will be effectively reclassified as “mining development expenditure” and is subject to the spreading rule in proposed section DU 6. The spreading rule is explained in more detail below.

The definition of “mining exploration expenditure” is largely taken from existing legislation. However, it also specifically excludes land, plant and machinery (as well as the other classes of expenditure and residual expenditure).

Mining development expenditure (sections DU 6, DU 7, DU 8 and DU 12)

“Mining development expenditure” will be capitalised and deducted over the life of the mine. It is defined to mean expenditure:

• incurred in preparing a permit area of mining operations or associated mining operations; or
• on operations carried out on a permit area for deriving income, including mining, work directly related to mining and earthworks.

It is important to note that, in either case, the expenditure must relate to a permit area.

Proposed section DU 12(2) contains a number of specific inclusions, such as acquiring mining permits, obtaining resource consents, establishing mine infrastructure (including, plant, machinery, vehicles, production equipment and storage facilities) and costs of providing utility services to the permit area.

Specifically excluded from the definition is the cost of land and any expenditure incurred after commercial production has begun on property that has an estimated useful life independent of the mine. This is designed to capture ongoing expenditure of the mining operations, including plant and machinery purchased after commercial production has begun, which should be deducted according to the estimated useful life of that asset.

The rationale for these rules is in accordance with general tax principles: amounts spent on the creation of an asset should be capitalised and deducted over the course of that asset’s useful life. So, for example, expenditure on earthworks undertaken to increase the production capacity of a mine should be spread over the life of the mine created. By contrast, expenditure on a vehicle that has not contributed to the creation of the mine asset (because it was purchased after the mine was operational) should be deducted over its own estimated useful life.

Spreading rule

Proposed sections DU 6 to 8 set out the spreading rule that applies to development expenditure.

The starting premise is that a deduction for the relevant expenditure is denied except in accordance with the spreading rule. Deductions are denied until the mineral miner starts to use the permit area to derive income. The formula for spreading is:

rate x value

“Value” is the adjusted tax value or the diminished value of the expenditure, as appropriate.

The relevant “rate” is the nearest rate to those set out in the schedule 12, column 1 (for the diminishing value rate) and column 2 (for the straight line rate). To arrive at the rate, it is necessary to perform the calculation in proposed section DU 8:

100%
Assumed life

“Assumed life” is a self-assessed determination of the life of the mine. For a mineral miner that uses an amortisation period for the mine for accounting purposes, the assumed life cannot be less than the accounting amortisation period. If a mineral miner is not required to use an amortisation period for their accounts, they must reasonably estimate the period they expect the permit area to accommodate commercial production. The assumed life is capped at 25 years from the later of the date commercial production begins in the permit area or the date in which the expenditure is incurred.

As a mine develops, a miner will continually reassess the assumed life of that mine. It may be that an additional mineral deposit is discovered, which increases the assumed life, or that some factor results in that assumed life reducing. Because the estimated assumed life is not a static concept, proposed section DU 8(3) requires a miner to re-estimate this figure for each year. The figure arrived at applies from the start of the next income year.

Proposed section DU 7 clarifies that the spreading calculations have to be performed in respect of particular expenditure over the spreading period. The spreading period starts from the later of the income year in which commercial production starts in a permit area or the income year in which the expenditure is incurred – and ends at the expiry of the assumed life of the mine.

Mining rehabilitation expenditure (sections DU 2 and DU 13)

Under the proposed rules mining rehabilitation expenditure will be deductible in the income year in which the amount of expenditure is actually paid (as opposed to “incurred”). To recognise the fact that this payment may occur after the conclusion of a miner’s income-earning activity, a tax credit may be generated under proposed section LU 1 for the corresponding year (this tax credit is explained in more detail below).

“Mining rehabilitation expenditure” is defined to mean rehabilitation expenditure incurred on mining permit land carried out in order to comply with the miner’s obligations under their permit or the Resource Management Act 1991. It covers amounts paid during or after the miner’s operations have ceased, but excludes the cost of the land itself.

Land (section DU 3)

As mentioned above, consideration derived from the disposal of land will be treated as income of the miner. Proposed section DU 3 sets out the deductions available for land purchases. A miner will be allowed a deduction for land or interests in land that it acquires. However, the rule is limited to land that is part of the mineral miner’s permit area, the site of mining operations or associated mining operations. Any expenditure for which the miner has a deduction before disposing of the land or interest in land will be excluded.

The deduction will be allowed in the year the land or interest in land is disposed of. This means that the timing of this deduction will match any income derived under proposed section CU 2 and so a net income amount or deduction will be available in that year, depending on whether the land is sold for a profit or loss. Although land generally does not decline in value, a miner may have paid a premium for the land based on its perceived mineral deposits. If those deposits are then removed, it is possible that the land will be sold for less than its purchase price.

Again, it is recognised that this disposal may be the final act of a miner’s operations, so could occur in a period when no income-earning activity takes place. So, like rehabilitation expenditure, any loss attributable to land sales may be eligible for a tax credit under proposed section LU 1.

Mining assets and farm-out arrangements (sections DU 4 and DU 5)

The bill proposes that expenditure on the acquisition of a mineral mining asset will either be immediately deductible or deductible over the life of the relevant mine, depending on the timing. If the asset is acquired before the date a mining permit for the permit area to which the asset relates, then it will be deductible. This is because, if a mining permit has not been obtained, the area will still be in the prospecting/exploration stage. Once a mining permit has been obtained, the holder of that permit is intent on developing the area for commercial production. The purchaser is therefore buying a functioning asset, which should be depreciated over its useful life. The way this is achieved (through proposed section DU 4(2)), is to treat the purchase of a mining asset after the mining permit is granted as “development expenditure”, so it will be spread over the life of the mine.

Proposed section DU 4(3) clarifies that “expenditure” for these purposes does not include the actual application costs for a mining right or permit.

As a result of sections CU 3 and DU 4, the purchaser of a mineral mining asset will be eligible for a deduction for that expenditure (either immediately or over time) and the person disposing of that asset will treat the consideration received as income.

On the other hand if a person, instead of acquiring the mineral mining asset outright, agrees to incur farm-in expenditure, proposed section DU 5 clarifies that this expenditure is to be treated as if it were the applicable class of mining expenditure. If, for example, the expenditure was classified as development expenditure, the farm-in party would be allowed a deduction for that amount over the life of the relevant mine. As the existing rights holder is not getting any money from the farm-out arrangement, the expenditure of the farm-in party is excluded income to the farm-out party (as discussed above in proposed section CX 43).

Other types of expenditure

Other types of expenditure not covered by the specific rules in subpart DU will be covered by the appropriate general rules set out in the Act. This includes the application of the capital/revenue distinction in determining whether expenditure is immediately deductible, deductible over time or not deductible.