Tax Benefits To Be Introduced For Australian Geothermal Explorers

Exposure draft legislation released in May 2012 will allow Australian geothermal explorers to access immediate tax write offs and deductions for exploration expenses in certain circumstances.  The new rules will apply to assets first used after 1 July 2012, and will give geothermal exploration entities the same ability to claim immediate tax deductions and depreciation on certain assets as miners and other exploration companies in Australia. 
 
The current wording of the applicable legislation (which has not kept up with the technological advances made in mining over the past few decades) allowing immediate tax deductions and depreciation does not encompass geothermal exploration activity.  The introduction of the draft legislation follows the Australian Federal Government’s announcement in March 2011 that it would adopt the Policy Transition Group’s recommendations in relation to Australia’s new resource taxation arrangements.
 
Key Points

 - If the legislation is passed, geothermal exploration rights will now be included as depreciating assets for tax purposes, and will be immediately deductible provided certain criteria are met.

 - Geothermal exploration information will also be included as a depreciating asset and will also be immediately deductible provided certain criteria are met.

 - The cost of a depreciating asset first used in geothermal energy exploration may be immediately deductible.  However, an immediate deduction is not available if the asset, when first used, is used for development drilling for geothermal energy resources or for the design or development of geothermal energy extraction.
 
How The New Rules Will Work

Based on examples outlined in the Explanatory Memorandum to the draft legislation, here are two examples of how the new rules will work in practice:
 
Example One

Greensteam Pty Ltd is a geothermal energy exploration company searching for geothermal energy resources in the Great Sandy Desert in northwestern Australia.  Greensteam carries on a business that includes exploration or prospecting for geothermal energy resources from which energy can be extracted by geothermal energy extraction.
 
Greensteam estimates that it will need to drill over 500 exploration wells as part of its exploration program.  Rather than lease drilling machinery to conduct the exploration work, the company determines that it would be cheaper to purchase its own drilling equipment.  Greensteam purchases drilling equipment on 15 May 2013 for AUD $500,000 and uses it to explore for geothermal energy resources.  The first exploratory drill hole undertaken as part of Greensteam’s exploration program is drilled in search of hot underground water.  The drilling of this first hole constitutes a use of the drilling equipment for exploration or prospecting for geothermal energy resources.
 
At that time, Greensteam does not know that the required conditions will be found in the drill hole and so it does not use the drilling equipment for development drilling for geothermal energy resources or for the design or development of geothermal energy extraction.  Greensteam is able to immediately deduct the cost of the drilling equipment.
 
Example Two
 
Percolating Power Co holds a geothermal exploration right and conducts exploration activities on the tenement, the results of which indicate a geothermal energy resource that is technically feasible to extract.  The company undertakes further work to determine if development of the resource is economically viable.  Based on these findings, the company determines that geothermal energy extraction is economically feasible, and that a power plant should be established to utilise the geothermal energy extracted to produce electricity to be fed into the transmission lines of the local grid.
 
The company applies to the relevant Australian state government authority for the grant of a geothermal production licence with the expectation that it will be approved within six months.

In the meantime, Percolating Power Co continues to use its exploration right to drill further holes to determine where the best energy flows are located and where the power plant should be built.  It spends AUD $1 million on this additional work.
 
The expenditure incurred on additional drilling is not incurred on exploration or prospecting for geothermal energy resources from which energy can be extracted by geothermal energy extraction.  Rather, the expenditure is directed towards the design or development of geothermal energy extraction.  As a result, the cost of the additional drilling work is not immediately deductible.
 
Generally, the expenditure incurred on design work that leads to the development of depreciating assets forms part of the cost of those assets and is generally subject to ordinary decline in value deductions (i.e. depreciation), as is the case for the costs of any other electricity producer’s energy generation assets.
 
Progress of the Draft Legislation

The exposure draft calls for submissions to be made on or before 22 June 2012.  Given that the draft legislation provides tax benefits based on assets acquired, expenditure incurred or assets first used on or after 1 July 2012, it is irrelevant whether the legislation is passed before or after that date.  However, we anticipate that final legislation will be passed through the Australian Parliament close to or just after 30 June 2012.
 
With a myriad of taxes now applying to Australia’s mining sector (including the new Minerals Resource Rent Tax and carbon pricing regimes), this legislative change will, for geothermal explorers, provide a welcome tax break that will put them on an equal tax footing with other resources explorers.
 
* The contents of this paper are not intended to be a complete statement of the law on any subject and should not be used as a substitute for legal advice in specific fact situations.  HopgoodGanim cannot accept any liability or responsibility for loss occurring as a result of anyone acting or refraining from acting in reliance on any material contained in this paper.


HopgoodGanim offers commercially-focused legal advice, coupled with reliable and responsive service, to clients throughout Australia and across international borders.  With industry-leading expertise in key sectors driving local and international growth, including resources, mining and energy, the firm advises a variety of prestigious corporate and multinational companies, as well as government and regulatory organisations.

Justin Byrne is a special counsel of taxation and revenue at HopgoodGanim.  He advises on a wide range of complex taxation issues including capital gains tax, GST, stamp duty, and the tax aspects of capital raisings, business acquisitions and disposals, corporate restructuring, and resources and energy transactions.  His clients range from individuals and small business owners to large corporations and government departments.

Justin is a Fellow of the Taxation Institute of Australia and sits on a number of its committees.  He speaks at Institute functions and regularly assists with submissions to the Australian Taxation Office and Treasury on tax-related matters.
Justin can be contacted by phone on +61 7 3024 0467 or via email at j.byrne@hopgoodganim.com.au