Issue: Exploration expenditure and the claw-back rule
(Straterra, OceanaGold, Ernst & Young, Solid Energy New Zealand Limited/New Zealand Coal & Carbon Limited, PricewaterhouseCoopers, Newmont Waihi Gold Limited)
1. The proposal to claw-back exploration expenditure that produces an asset used in the extraction of minerals should not go ahead.
2. Such a claw-back rule is contrary to the tax treatment of research and development (R&D) expenditure and feasibility expenditure, and general taxation principles.
3. The distinction between the exploration and development phases is clear (or at least not substantially worse than any other boundary issues in taxation), so the claw-back rule is redundant.
4. Australia does not have any claw-back rule in its regime.
5. Any issues can be dealt with through the usual audit and anti-avoidance measures.
Officials do not accept the analogy between mining exploration expenditure and R&D. R&D expenditure is designed to create a novel product or process. By contrast, mining exploration expenditure is more likely to be using existing techniques to uncover a new mineral deposit. This is not to say that a mining company cannot incur R&D expenditure if it is developing a new product or process.
Officials do accept the analogy between exploration expenditure and feasibility expenditure, but do not consider that this is a reason for dispensing with the proposed claw-back rule.
Submitters have pointed out that, in the ordinary course of events, a taxpayer is required to make a judgement as to whether or not a deduction is available. Once that decision is made then the taxpayer is locked into that decision. This reasoning ignores the fact that self-assessments can be amended at later times, either through the disputes procedure or by the agreement of the Commissioner. However, more fundamental is the apparent assumption by some submitters that feasibility expenditure is always deductible.
Submitters have referred to the Commissioner’s interpretation statement on feasibility expenditure (IS 08/02: Deductibility of Feasibility Expenditure) to support the proposition that exploration expenditure should be subject to the normal tax rules that relate to feasibility. Officials note that the interpretation statement states, at paragraph 8:
…for feasibility expenditure to be deductible… there must be a sufficient relationship or nexus between the expenditure and the taxpayer’s business or income-earning activity. Any expenditure incurred before the establishment of a business or an income-earning process will not fulfil this statutory nexus because the expenditure will have been incurred too soon.
Officials therefore consider that, for a newly-established mining operator, prospecting and exploration expenditure may never be deductible because there is no income-earning activity for the expenditure to relate to. In this respect, the automatic deduction for prospecting and exploration expenditure provided for in the bill is concessionary to such miners, and creates certainty to all miners in that they do not have to determine how their expenditure would be treated if it were subject to the general feasibility rules.
When a line is drawn in tax legislation between expenditure that is immediately deductible and expenditure that is required to be capitalised, this will generally create an incentive for affected taxpayers to reclassify expenditure in favour of the category for which immediate deductions are available. Officials accept that, by allowing a category of expenditure to always have immediate deductions (exploration expenditure), the proposed rules create this incentive. The claw-back rule is designed to address this tension. If expenditure is incorrectly classified, deductions will be added back as income and depreciated.
It also addresses the situation that a miner may face in circumstances where they are genuinely unsure as to whether expenditure will create a lasting asset or simply be unsuccessful exploration expenditure. If no lasting asset is created, the deduction will remain in place. If it transpires that the expenditure has created an asset that will be used during the extraction process, it is the economically correct result that the expenditure be added back and depreciated over the useful life of the asset created (in this case, a mine).
Submitters have commented that, in almost all cases, the claw-back rule will have no practical application. The submissions note that mining operators take the decision to move from an exploration phase to a development phase very seriously because committing to development is committing significant financial resources. Decisions of this nature will invariably be taken at board level and detailed records will be available to identify when one phase ends and the other begin.
Officials accept that this may be the case. However, this is not sufficient justification for removing the claw-back rule. The rule is designed largely to remove the incentive to reclassify expenditure. In many respects, if it never gets used, it will be a mark of its success, rather than of its inherent failure. In any event, even when the decision to move to development is clearly marked in time, this does not mean that some expenditure has not been inadvertently misclassified in the prospecting phase.
Submissions have also pointed out the difficulty that a mineral miner may have in apportioning expenditure that is subject to the claw-back rule. An example raised in oral submissions was that a miner might build five roads into a site during the exploration phase and only use one of those roads in the extraction process. Officials accept that, in circumstances such as these, some sort of apportionment will be necessary. However, the requirement to apportion expenditure is a regular feature of tax legislation and it is generally achieved by fair and reasonable methods. Officials do not consider an apportionment exercise carried out to comply with the claw-back rule to be any different in this regard.
Officials note the situation in Australia but do not consider regimes operated in other jurisdictions to be determinative of what is appropriate for the New Zealand context.
However, an accurate apportionment does however hinge off having appropriate records on which to base it on. On this subject, officials have also considered a point that was raised by the technical advisor to the Select Committee. The advisor has pointed out that it would be difficult for a taxpayer to comply with the claw-back rule in any period where they were no longer required to keep records for tax purposes. Officials have sympathy with this view and therefore consider that the application of the claw-back rule should be limited to expenditure incurred in a period for which the miner is required to keep records for the purposes of the Tax Administration Act 1994. Although this arguably creates an incentive for a miner to extend their development phase to avoid the application of the claw-back rule, officials do not consider this will be a substantial issue in practice. It is not the aim of these rules to impose record-keeping requirements on mineral miners over and above those that apply to other taxpayers.
That the submissions be declined, except that the claw-back rule be limited in its application to the period for which a miner would be required to keep records for tax purposes.
Issue: Timing of the claw-back rule is uncertain
(Newmont Waihi Gold Limited)
The claw-back rule applies to expenditure incurred after the 2012-13 income years under DU 1(1)(b), but that provision does not apply until the 2014-15 income year.
Officials agree that the claw-back rule should only apply to expenditure incurred after the new rules take effect. This will avoid unnecessary retrospective application.
That the submission be accepted.
Issue: “Life of Mine” concept for depreciation purposes
(Solid Energy New Zealand Limited/New Zealand Coal & Carbon, Ernst & Young, Straterra, PricewaterhouseCoopers, OceanaGold, Newmont Waihi Gold Limited)
The proposed use of the assumed life of the mine as the basis of spreading mining development expenditure should not go ahead (Oceana). The straight line and diminishing value methods of depreciation provided for in the bill do not adequately reflect the realities of the industry. Income is ‘lumpy’ and depreciation should be allowed to follow this income pattern. The most effective way of achieving this would be to allow depreciation on a “unit of production” or “extraction” basis, or at least an option to deduct on that basis. This would more closely align the treatment with that of the coal and petroleum mining industries. Alternatively, miners who use IFRS or other generally accepted accounting practice for financial reporting purposes should have the option of applying their financial reporting method for income tax purposes, without any adjustments being required (Ernst & Young, Oceana).
The rules should allow for deductions when mines are “mothballed” (i.e., abandoned projects).
Officials accept that a unit of production basis for determining the life of a mine is an appropriate measure. However, it is important to establish an appropriate denominator for any depreciation calculation using this basis. Officials understand that some miners base their units of production used in their accounts on the units extracted over the “economically recoverable amount”. We consider this would be an inappropriate measure for tax purposes because it would be subject to fluctuation in accordance with things like the prevailing commodity prices. It is for this reason that we also disagree with the proposition of final deductions being available if a mine is “mothballed”.
For example, if a mineral price dropped significantly, a miner might determine that it was no longer economical to recover any more minerals. The mine would be ‘mothballed’ and all further development expenditure taken as a deduction. If, the following year, the commodity price rose again, the miner might make the decision that more minerals could be extracted at a profit. The miner would be utilising the original development expenditure to restart the mine but would have already claimed all deductions in respect of those assets. Such an outcome would fail to recognise that the development assets have a useful life that at least partly depends on the minerals still being in situ rather than simply the commodity price on any given day.
Officials therefore consider that any depreciation on a unit of production basis should take place as a function of the “proven and probable” mineral reserves. Such an outcome is consistent with the proposals in the original officials’ issues paper that suggested these revised rules and would also be consistent with a depreciation method available to petroleum miners under the Income Tax Act 2007.
Officials accept that a unit of production method is probably only of value to miners that produce IFRS accounts. Requiring all miners to produce equivalent accounts just to determine their depreciation calculations may impose significant compliance costs on smaller operators. Therefore, officials consider that the following rules should apply to determine which method is used:
- Miners can use the unit of production method, as set out above, if they produce IFRS accounts or otherwise keep appropriate records for this method to be verified; otherwise
- Miners can use the methods currently provided for in the bill, meaning they depreciate their costs over a period not shorter than the life of mine estimated in their accounts (or over the period they reasonably estimate the mine to operate if they are not required to perform any such calculations for the purposes of their accounts).
Officials consider this combination of methods can provide the maximum flexibility to miners without imposing significant compliance costs – while also providing appropriate outcomes from a policy perspective. However, to avoid additional complexity, officials recommend that, once a person has made their choice of deduction method (when commercial production commences), that method should be retained for the entire life of the mine.
Officials accept that any depreciation method has potential to create ‘trapped’ development expenditure at the end of a mine’s life. This issue is covered in the “refundable credit” section, below.
That the submissions be accepted and unit of production method, based on proven and probable reserves, be included as a depreciation method in the bill.
Issue: Drafting issues for “Life of mine”
(Ernst & Young)
The use of the terms “income year” and “spreading period” in proposed sections DU 6 and DU 7 that may cause uncertainty and potentially lead to disputes.
Officials agree that confusion in this regard is undesirable.
That the submission be accepted.
Issue: Unit of measure: “mine” or “permit area”
(OceanaGold, Newmont Waihi Gold Limited, Straterra)
Some miners have multiple mines in one permit area, whereas others have a single mine that covers multiple permit areas. Given some mines have shorter life-spans than others in the same permit area, it is penal to enforce depreciation of development expenditure on a permit area basis because some of this expenditure may relate to a relatively short-lived mine.
Officials accept that depreciation should generally be based on the estimated useful life of the actual income-producing asset. There are therefore good policy reasons for allowing depreciation deductions over the life of a particular mine if the expenditure is properly attributable to that mine. The concern would be if the rules allowed a miner to inappropriately allocate expenditure to a shorter-life mine in order to accelerate depreciation deductions.
Officials have contacted colleagues in the Resource Markets Policy Team of the Ministry of Business, Innovation and Employment (MBIE) to see if the differentiation between “permit area” and “mine” is likely to be significant in practice. MBIE is of the view that almost all mineral miners will only have one mine per permit area, and that the two terms will effectively be interchangeable in those cases. Those miners that do have a mine that covers several permit areas are likely to be large operators that are required to produce audited IFRS accounts. Officials have confidence in the fact that there is a high degree of rigour that goes into these accounts that should prevent costs being misallocated to shorter-life projects.
Officials therefore consider that a mineral miner should be able to use an individual mine as the measure for depreciation purposes. However, this option should only be available to miners that produce audited IFRS accounts and the allocation of expenses to individual mines should only be allowed if they are permitted for the purposes of those accounts. If expenses cannot be so allocated, the default position should be that the life of the permit area is the relevant depreciation measure. This approach would appear to provide a full market capture (on the understanding that only large mining operators will have more than one mine), while still preventing inappropriate allocation of expenses in such cases.
That the submission be accepted, subject to the “mine” option only being available to miners that produce audited IFRS accounts and the allocation of expenses to individual mines should only be allowed if they are permitted for the purposes of those accounts.
Issue: Refundable credit for development expenditure
OceanaGold agree that there should be a tax credit for mineral miners, but are concerned about how it will work in practice and submit that it should have wider application. Depreciating development expenditure over the life of the mine creates the potential for “black-hole” expenditure to arise. This may occur if the depreciation deductions available in the final year of the mine’s operation exceed any income derived from the mine in that year. The refundable credit mechanism should be extended to cater for this eventuality.
Officials accept that this is an issue. It is not the intention of these rules to create black-hole expenditure for miners in the circumstances described. However, officials would be reluctant to recommend a system whereby a mineral miner could obtain a refundable credit in advance of when it was appropriate. The refundable credit mechanism is designed to prevent a miner having deductions at the end of the life of the mine when there is no corresponding income to offset the expenditure.
In order to be consistent with this principle, a refundable credit for development expenditure should only be available after mining operations have ceased. To have otherwise may allow a miner to write development expenditure down to zero on the basis that their accounts show the mine has no residual life and, if they had insufficient income in that final year, claim a refundable credit. However, the mine may just be ‘mothballed’. If the miner then started using the mine again (because the commodity price rose), they would still be using the same assets created by the original development expenditure, but would have claimed all that expenditure as a deduction.
To prevent this result, while still producing an appropriate policy outcome, officials consider that the refundable credit should be available for residual development expenditure, but only when it is certain that mining operations have ceased. The most effective way of achieving that result would be to provide that the credit was only available in the year that the miner relinquishes its rights under the relevant permit. “Relinquish” is a term that is already used for the purposes of the petroleum mining rules and there are legislative markers in the Crown Minerals Act that set out when a miner finally surrenders rights to mine an area. Tying the credit to these dates already provided for in relevant statutes will provide certainty to both miners and Inland Revenue in determining when the refundable credit is available in respect of development expenditure.
That the submission be accepted, subject to officials’ comments.
Issue: Extend the refundable credit to petroleum miners
(Corporate Taxpayers Group)
The proposed refundable credit rule should be extended to other regimes within the Income Tax Acts such as the petroleum mining sector. There is currently uncertainty as to whether the existing loss carry back rule that applies to petroleum miners can operate beyond the four-year statutory time-bar for amending assessments.
Alternatively, the loss offset and refund rules should be revised to ensure that their operation is consistent with the operative provisions in the Income Tax Acts, including the petroleum mining rules.
The refundable credit proposed for mineral miners is an economic equivalent to the loss carry back rule available to petroleum miners – in this respect, we consider there is an inherent consistency between the two. This is further demonstrated in the proposed changes to quantum of the tax credit for non-company miners (see “amount of tax credit” submission, below).
As the submitter notes, the petroleum loss carry back rule contains a provision that explicitly overrides the statutory time-bar. However, officials consider the policy intent of these provisions is clear. Further, officials are not aware of the argument used by submitters ever being adopted by Inland Revenue to disadvantage a petroleum miner in practice.
Officials also consider making the changes proposed in the submission would be inappropriate for the following reasons:
- The changes in the current bill are focussed on mineral mining, not petroleum. The petroleum rules are relatively complex and officials would be concerned that amending one part of them without adequate consideration of the rules in general may result in unintended consequences.
- Making changes to the petroleum mining rules at this stage in the bill’s progress would preclude consultation with the wider industry. Officials are reluctant to recommend changes to such a significant sector without providing that industry with an opportunity to comment.
That the submission be declined.
Issue: Refundable credit should be based on tax paid by the mining company, not the particular permit area
(Newmont Waihi Gold Limited)
The refundable credit should be limited to tax paid by the mining company, not ring-fenced to the particular permit area.
The refundable credit is designed to ensure that the appropriate amount of tax is paid on a project by project basis. Allowing the refundable credit to operate on a company may allow a company to effectively cash-out a loss on any given mine. Cashing out losses is not a general feature of the New Zealand tax system.
That the submission be declined.
Issue: Rehabilitation expenditure
(PricewaterhouseCoopers, Ernst & Young, Solid Energy New Zealand Limited/New Zealand Coal & Carbon Limited, OceanaGold, Straterra, New Zealand Law Society, Newmont Waihi Gold Limited)
Allowing a deduction for rehabilitation expenditure only when it is paid is penal when compared to the general rules. A deduction should be available when:
- The expenditure is incurred;
- A provision is able to be made in the miner’s audited accounts for rehabilitation costs.
The provision that allows a deduction for rehabilitation expenditure should be stated to supplement the general permission because such deductions may only be available after income-earning activity has ceased. (Ernst & Young)
Mining companies will have agreements with agencies such as the Department of Conservation and local authorities to undertake the rehabilitation work. This provides assurance that the work will be carried out. The quantum of the provision is capable of reasonable estimation (PricewaterhouseCoopers).
The definition of rehabilitation expenditure is too narrow as it does not refer to all legislation that may require rehabilitation work to be carried out. (OceanaGold)
Some submitters noted their support for the proposal to allow a tax credit for rehabilitation expenditure where there is insufficient current year income to offset the expenditure (OceanaGold), given the restrictions on the ability to group losses, and the existence of a similar rule for petroleum miners (New Zealand Law Society).
The bill provides that a deduction for rehabilitation expenditure is available when the amount is paid. Officials considered this approach provided certainty to the parties concerned and also aligned the deduction to what is understood to be the practice in the petroleum mining sector.
Allowing a deduction on the basis of amounts paid is also not unprecedented in the Income Tax Act. However, officials accept that the general rule for deductibility for tax purposes is to allow the deduction when it is incurred.
In saying that, officials are concerned that submitters are collapsing the two possible alternative positions into one. Officials consider there are fundamental differences between the legal test of when expenditure is “incurred” and the tests used for accounting purposes to determine whether a provision should be made. This is rightfully so given the two sets of rules ultimately serve slightly different purposes. Accounting rules can be incorporated into tax rules when they produce appropriate policy outcomes. However, there will be circumstances where accounting tests are inappropriate for tax purposes, and officials consider this is such a case.
Officials consider that allowing a deduction based on the provisioning in accounts would allow inappropriately large deductions to be taken upfront, when there is insufficient certainty that such expenditure will be incurred for tax purposes. Although it is accepted that provisions in audited accounts are valued and estimated to the best of the person’s ability, there is considerable uncertainty as to whether the expenditure is accurate, whether the timing of the expenditure is accurate or even if the relevant person will ever incur the expenditure. For example, the legal obligation to carry out rehabilitation expenditure rests with the permit holder. However, a permit is transferable personal property – it is possible for a miner to sell their permit and with it the obligation to perform the rehabilitation work. A provision in the miner’s accounts is justified because this future obligation will impair the value of the company (and presumably result in a lower purchase price for the permit as the purchaser will also inherit the rehabilitation obligations), but it is not considered to be a reasonable basis on which to allow a tax deduction.
Equally, other Government agencies will require undertakings from miners to ensure that the land cannot simply be abandoned after mining has concluded. These arrangements are appropriate to achieve those policy objectives. However, they also are not considered as a suitable measure to quantify tax deductions. Officials have previously mooted the idea of a special account that a miner could contribute to in order to access tax deductions for rehabilitation expenditure but, in responses to the officials’ issues paper, industry were firmly opposed to this approach.
In summary, officials accept that, for the purpose of consistency, there are good reasons for rehabilitation expenditure to be deductible when it is “incurred”. In saying this, it is not anticipated that the change will result in a significant difference in practice from the “paid” test currently in the bill – the legal test for “incurred” (as set out in case law) will still need to be satisfied before a deduction can be taken.
For the submissions regarding:
- the general permission, officials agree that this change is justified, given expenditure may be incurred after the miner’s income earning activities have ceased;
- definition of rehabilitation expenditure being too narrow, officials accept that the definition should cover other legislation to the extent necessary.
Finally, officials consider the changes proposed here will also address an Ernst & Young submission regarding the use of the word “incurred” in proposed section LU 1.
That the submission that rehabilitation expenditure be deductible when it is incurred be accepted.
That the submissions that rehabilitation expenditure be deductible based on provisions in the person’s accounts be declined.
That the submission suggesting that the rehabilitation deduction provision should supplement the general permission be accepted.
The submission suggesting that the rehabilitation expenditure definition cover other applicable legislation that may require rehabilitation work to be carried out be accepted.
Issue: Definition of “development expenditure”
(Straterra, OceanaGold, Solid Energy New Zealand Limited/New Zealand Coal & Carbon Limited, Ernst & Young, PricewaterhouseCoopers, Newmont Waihi Gold Limited)
The definition of development expenditure in the bill:
- is too broad and may capture expenditure that is better described as “operational”;
- is incomplete and may result in black-hole expenditure being incurred;
- should draw a distinction between immovable and movable property;
- should distinguish between depreciable property and other property (the latter being depreciated over the life of the mine)
- should be expanded to include vessels to accommodate the fact that mining can take place offshore (PricewaterhouseCoopers);
- operational mining expenditure should be deductible in the year incurred rather than spread over the life of the mine (Ernst & Young, Straterra).
The definition of “development expenditure” is essentially designed to capture the costs of developing the mine to the point when commercial extraction can begin and any expenditure after that point that has an enduring benefit to the mining operations. In this respect, the rules attempt to mimic the general tax rules – in that expenditure on creating a capital asset is capitalised into the cost of that asset and any ‘capital improvements’ that are made after the asset is in operation is similarly capitalised into the cost-base and depreciated over the remaining life of the asset.
It is not the intention of the rules to capitalise expenditure that is only related to the day-to-day operation of the mine after commercial production has commenced. Officials consider this can best be addressed by creating a new definition of “operational expenditure” and specifically carving that type of expenditure out of “development expenditure”. If this is done, the expenditure that is left will be capital in nature and appropriate to deduct over the life of the mine.
With regard to the completeness of the definition, officials consider that the creation of a defined “operational expenditure” term should address this concern. Expenditure incurred after commercial extraction begins will be either “operational” or not. Under officials’ suggestion, operational expenditure would be subject to the normal tax rules. So if, for example, a miner purchased a piece of plant that was only going to be used for operational expenditure, it would be deductible in accordance with its estimated useful life as a stand-alone piece of plant. Similarly, revenue expenditure for operation matters would be immediately deductible. Assets that are used for multiple purposes should be apportioned in an appropriate manner.
Officials do not agree that a distinction should be drawn between movable and immovable property, or that there should be types of property that is always depreciable according to set rules. Immovable property will generally have an estimated useful life that is contingent on the life of the mine, so it is appropriate that it is depreciated over that timeframe. However, that does not mean that movable property cannot be used to create assets of enduring benefit. Take, for example, a digger that is exhausted in the development phase of the mine. From a tax policy perspective, the ‘right’ outcome is that the cost of that digger is depreciated over the life of the asset it has created; in this case the mine itself. The benefit from the expenditure on that digger lasts for the length of the mine. This can be compared with a similar digger that is only used for extracting minerals – the benefit from its work is only derived while it is still operational so it should be depreciated over its useful life as a stand-alone asset.
Officials agree that the addition of “vessels” would add clarity to the definition.
That a new definition of “operational expenditure” be added to the bill and that operational expenditure should be carved out of the development expenditure definition. The definition of “development expenditure” should include vessels.
That the submissions that assets be distinguished by whether they are movable or immovable, or always be classified in a particular way, be declined.
Issue: Land expenditure
Clause 13 and 35
(Ernst & Young)
It is not clear why all land should be treated as revenue account property simply because it may have been acquired in connection with mining operations but are not directly part of those activities.
The legislation should clarify how the proposed land rules are intended to interact with the general tax rules for revenue account property.
The submission is of the view that because proposed section CU 2 treats land as being on revenue account when it is “acquired for the purposes of... mining activities...” this will capture an inappropriately large amount of land, such as land acquired in other locations for office or administrative purposes.
Officials agree that there is no good policy reason for capturing such land within the mining land rules. The policy intent behind the land provisions was only to capture land that includes, or is intended to include, all or part of a permit area. Officials had considered that the use of the term “mining operations”, which is itself a defined term in proposed section CU 7, limited the scope of the land rules to such land. However, we accept that the wording in this regard is not as clear as it could be.
Officials also agree that it would be useful to clarify the inter-relationship between the proposed rules and the general revenue account property rules so that the specific land rules applied in preference to the general rules.
That the submission be accepted so that:
- proposed section CU 2 be clarified to only applying to land that contains all or part of a permit area; and
- the specific land rules override the general revenue account property rules.
Issue: Premium on land
Any premium paid by a mineral miner for land should be included as “development expenditure” and depreciated over the life of the mine.
Officials accept that mineral miners can pay a premium for land, on the basis that the existing landowner will inflate their sale price once they are aware their land may contain mineral deposits. In theory, any overpayment will be for the minerals within that land, so that portion of the expenditure will devalue as those minerals are extracted.
However, there are genuine valuation issues associated with attempting to calculate any premium paid. Valuations for land can differ significantly even before mineral deposits are added to the equation. Although officials are aware that there are tax rules for forestry that allow the cost of the trees to be separated from the cost of the land. However, forestry assets are inherently easier to value because they are above land and readily quantifiable. Although a mineral miner will not buy land unless they are relatively certain it will contain commercially viable deposits, officials do not consider that valuing those deposits with sufficient certainty to allow a tax deduction (even over time) is possible.
There are also compliance costs issues associated with obtaining such valuations. Officials consider that motivating miners to obtain valuations may result in dead-weight costs being incurred. In officials’’ view, the only time that any premium can effectively be valued is at the time the land is disposed of (when the difference between the cost price and the resulting land value is crystallised). The refundable credit for losses made on land sales is designed to address this premium issue. If a mineral miner has actually paid a premium for land and is forced to take a loss when the land is ultimately sold, the credit may be available to ensure that no capital loss is suffered.
That the submission be declined.
Mining companies should be allowed to group with non-mining companies. Allowing grouping with any company is consistent with the tax rules that apply to other taxpayers. (KPMG, Straterra, OceanaGold)
Grouping should at least be available until a continuity breach (PricewaterhouseCoopers).
The general loss rules that apply to all taxpayers should apply to mineral mining. (Solid Energy New Zealand Limited/New Zealand Coal & Carbon Limited, Straterra)
Under existing tax rules, which the bill does not propose to significantly alter, a mineral mining company can only form a tax group with other mineral mining companies. This restriction on grouping for miners is seen by officials as inter-related with the existing concession that allows mineral miners’ losses to survive a continuity breach (in other words, a change in majority shareholding). Under this continuity rule, if a mineral mining company suffers a breach in continuity, any losses in existence at the time of that breach are able to be carried forward to future years. This differs from the general tax rules, under which losses that exist at the time of a continuity breach are permanently forfeited.
Officials are concerned that if these losses are allowed to survive a continuity breach, but mining companies were also allowed to group with any other company, opportunities for inappropriate loss trading may arise. The concession around continuity breaches is designed to recognise that mineral mining is a risky, but capital intensive industry. It may be that equity finance is the only way that a start-up miner can raise sufficient funds to make a viable operation. The flip-side of retaining this concession is that losses should only be used to offset mining income. Officials consider the best way to ensure this result is to limit the ability for mining companies to group with non-mining companies that may derive income from other sources.
Allowing grouping only up until the point of continuity breach, would solve some of these issues, but would be complicated to administer as it would involve a mining company having different treatment to another mining company. Officials consider it is preferable to treat the industry as a whole and have one set of rules applying to it.
That the submission be declined.
Issue: Loss continuity rules
The proposal not to change the rule that allows losses to survive a continuity breach are welcomed. (Straterra, OceanaGold, PricewaterhouseCoopers)
The loss continuity rule should be clarified so that it covers all of the new types of expenditure covered in clause 35. (Straterra, OceanaGold)
The existing loss continuity rules do not work as intended. (OceanaGold)
Officials agree that the loss continuity rules should apply to all types of expenditure. This would align them with the current treatment, which is intended to be retained.
With regard to possible flaws in the existing rules, officials consider the solution proposed would effective require each mining permit to be treated as a silo so that loss-offset could be maximised. The logical extension of this would be that, in the converse situation when a particular permit area was in profit, a company could not use losses in another permit area to shelter those losses. We do not consider this would be an acceptable solution for the industry.
Ultimately, officials consider the loss continuity rules work for the situation they are designed for – when a company is required to breach continuity to raise funds to carry on its operations.
The submission regarding the types of expenditure that can survive a continuity breach be accepted.
The submission regarding possible existing flaws in the continuity rules be declined.
Issue: International competiveness
The proposed changes demonstrate a lack of understanding of the nature of investment in minerals in New Zealand. It is not about whether or not to allocate a New Zealand investment dollar in minerals or other sectors; it is about being competitive for attracting global minerals investment into New Zealand, as opposed to elsewhere in the world
Officials continue to hold the view set out in the Regulatory Impact Statement outlining the proposed changes (http://taxpolicy.ird.govt.nz/sites/default/files/2013-ris-arfsrm-bill-2.pdf). Of particular relevance to addressing the submitter’s concerns are paragraphs 15-17 of that statement:
15) Tax concessions that favour one particular industry distort investment decisions and the productivity of capital. Distortions arise in this context if a tax concession induces people to invest in a particular sector that, in the absence of the tax, they would not invest in. If businesses are effectively subsidised through the tax system, it also has the potential to distort the domestic labour market through that industry being in a position to offer remuneration that a non-subsidised business could not match.
16) New Zealand’s framework for taxing inbound capital is based around applying broadly the same tax rules no matter which area of the economy the capital is invested. This is consistent with our broad-base, low rate tax framework. This is why, for example, the same company tax rate applies to companies across the New Zealand economy. The logical extension of option 1 [maintaining the existing concessionary regime] would be to abandon this framework and apply lower effective tax rates on foreign investment into certain areas of the economy. Not only would such an approach put the company tax base at extreme risk, it would likely result in unfair and inefficient outcomes. In addition, it would strongly encourage industries to lobby Government for industry-specific tax concessions.
17) Further, we consider that, even if tax settings are a consideration when investing into a certain jurisdiction, they will - provided the rules are not actively discriminatory - be relatively insignificant compared to other factors, such as a country’s infrastructure, the skill of its labour force and the market price of the mineral in question.
That the submission be noted.
Issue: Offsetting losses
(New Zealand Institute of Chartered Accountants)
Miners should be able to offset losses from one permit area against income derived in respect of another permit.
Apart from the restriction on grouping and ring-fencing of losses that survive a continuity breach, mentioned above, officials consider that losses from one permit area will be able to be used to offset income from another.
That the submission be noted.
Issue: Changing structures
(New Zealand Institute of Chartered Accountants)
Mining companies should be allowed to change business structures (to, for example, a partnership). A mechanism should be in place to allow this to happen without tax impost.
Officials do not consider a mechanism that allows a mineral miner to change business structures is appropriate in this instance. Very often there are sound tax policy reasons for crystallising gains and losses at the time a business structure is changed.
The only recent precedent for allowing such a tax free transfer was when loss-attributing qualifying companies (LAQCs) were removed from tax legislation. That was a special case because the LAQC structure was being disbanded. In this instance, there is no impediment to a miner carrying on business in a company structure – in fact officials consider that the vast majority of miners would wish to carry on in that way. Introducing extremely complex rules (the LAQC rules cover approximately 4 pages of legislation) to address a theoretical problem would appear to be unnecessarily complex.
That the submission be declined.
Issue: Amount of tax credit
(New Zealand Institute of Chartered Accountants)
That the rate of tax that applies to refundable credits for specified mineral miners who are neither companies nor trustees should be clarified.
Officials agree that the amount of the tax credit should be clarified in cases where the credit is available to non-companies. Officials suggest that the credit should be based on the previous year’s income of the person, subject to the proposed cap on the credit. This would mean that, for an individual, the credit would be limited to the tax paid in the previous year from their mining activities. If that income is insufficient to absorb all of the losses, it would be carried back to the previous year (where the same treatment should apply) and so on. Mining income should be treated as the first income such a person derives.
Reimbursing trustees at the trustee rate may overcompensate the trust – particularly if the income from previous years has been distributed to low-income beneficiaries. Officials therefore consider that, in the hands of a trustee, the credit should be limited to the total tax paid by the trustee and its beneficiaries in the previous year. This should be limited to income derived from mining activities in the previous year and based on an assumption that all of the trust’s income was mining income and was the first to be distributed to beneficiaries.
Such rules would be consistent with the policy that the tax credit is the economic equivalent of the loss-carry back rule that applies to petroleum miners.
Sam is a “mineral miner” who also has a part-time job. In each of years 1 and 2, Sam earned taxable income of $80,000 in total from is mining activities and $20,000 from his job. At the end of year 2, Sam’s mining activity ceases and in year 3 Sam incurs $150,000 of rehabilitation expenditure and derives no other income.
Sam is entitled to a tax credit. The amount of the credit is calculated by looking back at the total tax paid in the previous years. The first year to consider is year 2. Sam derived $80,000 in taxable income from mining that year. Sam’s tax liability on that $80,000 was $17,320.
Sam still has $70,000 of rehabilitation expenditure that has not been offset, so that is carried back to year 1. Sam’s $80,000 of taxable mining income from that year exceeds the $70,000 still to be offset, so Sam is required to calculate the credit based on the first $70,000 of income. The tax on $70,0000 is $14,020.
Sam’s total tax credit on his $150,000 rehabilitation expenditure is $17,320 + $14,020 = $31,340.
The trustee of the Mining Trust is a “mineral miner”. The trust has three beneficiaries: Amy, Ben and Charlie. In year 1, the trust earned $100,000 taxable income. It distributed $20,000 to each of the beneficiaries as beneficiary income and retained $40,000 as trustee income. The beneficiaries are in the following situations for the year:
- Amy has carried forward losses of $50,000;
- Ben has no income other than that received from the trust;
- Charlie is employed on an annual salary of $100,000.
At the end of year 1, the trust’s mining activity ceases and in year 2 it incurs $80,000 of rehabilitation expenditure and derives no other income.
The trust is entitled to a tax credit. The beneficiary income from year 1 is required to be counted first. For each $20,000 distribution, the tax liability was as follows:
- Amy paid no tax because the distribution simply absorbed some of her losses;
- Ben paid tax on $20,000 at $2,520;
- Charlie earned a total of $120,000 but his distribution is treated as his first income, meaning his tax liability on the $20,000 is also treated as being $2,520.
This makes a total credit from the $60,000 distributed of $5,040. There is still $20,000 of rehabilitation expenditure required to be offset at the trustee tax rate, making an additional credit of $6,600.
The trustee’s total tax credit is therefore $5,040 + 6,600 = $11,640.
That the submission be accepted, subject to officials’ comments.
Issue: Application date for changes
Clauses 10−12, 13, 19−24, 27, 28, 34, 35, 37, 39, 56−60, 64 76−85, 88 and 103(2), (3), (5) – (7), (12), (14), (15), (17) – (36), (40) –(43), (47−(51)
(Newmont Waihi Gold Limited, Ernst & Young)
The proposed timing of the changes will give miners with an early balance date insufficient time to change systems to accommodate them. Information needs to be recorded in real-time in order to achieve compliance.
The proposed changes are currently expressed as coming into force on 1 April 2014. This should be amended so that they apply from the 2014-15 income years an later.
Officials agree that legislation with retrospective effect is not ideal, even if it is only for a very small number of taxpayers. However, although any new rules would alter the tax treatment of various types of expenditure, it does not mean that it will impose increased information-capture responsibilities on miners. Expenditure would need to be recorded whether a deduction was being claimed under the existing rules or the new rules – the difference is how that expenditure is accounted for in tax returns. There is not expected to be filing obligations before these rules take effect.
The legislation already provides that the revised rules would apply from the 2014-15 income years, so officials do not consider any changes are required in this regard.
That the submissions be declined.
Issue: Review of existing depreciation rules
(PricewaterhouseCoopers, OceanaGold, Newmont Waihi Gold Limited)
The depreciation rates for mining should be reviewed with a view to adding additional assets to the relevant depreciation determination and consulting with the industry to determine appropriate useful lives.
From a policy perspective, plant and machinery used in mineral mining should be able to be depreciated over its estimated useful life (or, in the case of plant and machinery used to develop the mine, over the life of that mine).
Policy officials understand that Inland Revenue’s depreciation rates have been recently audited by a third party (including those rates applicable to the mining sector). That audit found the current rates to be appropriate. However, officials encourage submitters to contact Inland Revenue if there are items that should be on these tables of rates but are not currently listed. Equally, if there are genuine concerns over the rates that are listed, submitters are welcome to contact the Department to discuss those concerns.
That the submission be noted.
Issue: Depreciation of low-value items
(Waihi Gold Limited)
The current thresholds under which low-value items can be immediately deducted should be reviewed, and – in the mining context – should be lifted to $5,000 for individual items and $10,000 for a pool of items.
Officials note the concerns, but consider this is an issue of application to more than simply mining. There are many capital intensive industries where higher-value items are used more frequently. Any review of these thresholds should be carried out as part of a broader initiative and not be industry specific.
That the submission be declined.
Issue: Farm-out rules
Clauses 19 and 35
Uncertainty in those rules can currently be mitigated by agreeing an approach with Inland Revenue. (PricewaterhouseCoopers, Straterra)
It is appropriate to align the farm-out rules with those of petroleum miners. This is an area that could be reviewed at a later date if Inland Revenue agrees there are issues with the application of the rules. (PricewaterhouseCoopers)
That the submission be noted.
1 Officials do note the recent issues paper related to the cashing-out of certain types of R&D expenditure, but consider this to be a carefully defined initiative to assist start-up companies, and not something that has application in the context suggested here.