Chapter 6 - More neutral tax rules
6.1 This chapter outlines the suggested new tax rules for specified mineral miners. It suggests that the existing specified mineral mining rules be replaced with rules that reflect the economic principles discussed in the previous chapter, while being broadly consistent with the taxation of other industries.
Overview of the suggested new rules
6.2 The following table summarises the suggested new rules for specified mineral miners:
|Suggested tax treatment|
|Prospecting expenditure||Allow a tax deduction in the year the expenditure is incurred.|
|Exploration expenditure||Allow a tax deduction in the year the expenditure is incurred. However, on the establishment of an operational mine, exploration expenditure on items used for the extraction of minerals is clawed back and is deductible over the life of the mine.|
|Development expenditure||Defer tax deductions and allow these over the life of the mine, on a unit-of-production basis.|
|Mining expenditure||Expenditure incurred in the extraction of minerals is subject to ordinary capital/revenue tax rules.|
|Rehabilitation expenditure||Allow a tax deduction in the year the expenditure is incurred. However, a tax deduction would be allowed earlier for payments made to Inland Revenue in advance for expected restoration costs.|
|Expenditure on land||Apply so-called “revenue account treatment” to land acquired in the prospecting, exploration and development phases. That is, sale proceeds would be taxable and the cost of acquiring and disposing of the land would be deductible.|
|Assets with a life tied to the life of the mine||Tax deductions for expenditure on assets whose economic life is tied to the life of the mine (excluding expenditure incurred in the prospecting and exploration phases) would be spread over the life of the mine, on a unit-of-production basis. When such assets are sold or disposed of, the consideration would be taxable in the year of disposal, less the balance of the miner’s costs associated with the asset.|
|Assets with a life independent of the mine||Apply general tax depreciation rules to expenditure on assets with a useful life independent of the life of the mine. Normal depreciation recovery rules would apply to the sale or disposal of such assets. During the development phase depreciation deductions would be capitalised and amortised over the life of the mine on a unit-of-production basis.|
6.3 Prospecting expenditure is generally incurred to identify and provide an initial view about the mining potential of mineral deposits within an area covered by a prospecting permit.
6.4 Under a strict framework, tax deductions for prospecting expenditure would be deferred and allowed as a deduction over the economic life of the mine. However, adopting this treatment would be inconsistent with the tax treatment of early-stage expenditure in other industries. For example, the existing petroleum mining rules allow immediate deductions for prospecting expenditure.
6.5 For this reason, the suggestion is to allow prospecting expenditure to remain deductible in the year it is incurred.
6.6 Prospecting expenditure would be limited to expenditure directly incurred on acquiring prospecting permits and information, labour, materials, services, administrative overheads and other expenses in prospecting for specified minerals. Prospecting expenditure would not include the costs of land.
6.7 Exploration expenditure is generally incurred to determine whether the minerals identified in the prospecting phase can be profitably recovered.
6.8 As discussed in the previous chapter, for tax to be neutral, expenditure incurred on acquiring something that will provide future economic benefits should be amortised over the expected period of future benefits. However, like prospecting expenditure, adopting this treatment for exploration expenditure would appear harsh when compared with the tax treatment of similar expenditure in other industries. For example, the existing petroleum mining tax rules allow immediate tax deductions for exploration expenditure.
6.9 Therefore, the suggestion is to allow exploration expenditure to remain deductible in the year that it is incurred.
6.10 Exploration expenditure would be limited to expenditure incurred on acquiring exploration permits and information, labour, materials, services, administrative overheads, and other expenses on exploration and feasibility studies. Exploration expenditure would not include the costs of land.
6.11 It is also suggested that on the establishment of an operational mine, exploration expenditure on items used for the extraction of minerals would be clawed back and allowed as a deduction over the life of the mine.
6.12 The suggested claw-back rule is consistent with the tax treatment of petroleum mining, where expenditure on an exploration well is clawed back if that well is then used to extract resources.
6.13 The claw-back rule is also intended to buttress the division between the “exploration” and “development” phases. That is, the claw-back rule will reduce the incentive to reclassify development expenditure as exploration expenditure in order to receive immediate deductions, as those deductions will be clawed back.
6.14 Similar to the claw-back rule in the petroleum tax regime, the claw-back of previous deductions would be achieved by treating an amount of income as arising in the first year of commercial production. The amount of income treated in this way would be equal to the amount of expenditure that has been previously claimed on items in the exploration phase that are subsequently used in the extraction process. A deduction would then be allowed for that amount over the life of the mine on a unit-of-production basis.
An immediate deduction would be allowed for the costs associated with establishing an access road initially used in the exploration phase. However, if that road is later used in the mineral extraction phase, the cost associated with establishing the road would be treated as income in the first year of commercial production. That same amount would be an allowable deduction and allocated over the life of the mine.
6.15 Once a profitable mineral resource is found, development of a mine begins. Expenditure on developing a site for mining operations includes the costs of acquiring the mining permits, resource consents, and establishing mine infrastructure, including processing and transportation infrastructure.
6.16 Under general tax principles, expenditure that is incurred to produce a capital asset should not be immediately deductible. Rather, the costs should be capitalised and written off over the economic life of the asset. Similarly, when a miner spends money developing a mineral resource, that expenditure should be seen as part of the cost of producing a productive mine.
6.17 Therefore, it is suggested that these costs should be deducted over the life of the mine, on a unit-of-production basis.
Life of the mine
6.18 The “life of the mine” is based on the estimated reserves of minerals in the permit area at the beginning of the year. The deductions for the development expenditure would be then aligned with the amount of minerals extracted during the year.
6.19 The suggested method of allocating deductions over the estimated reserves is heavily influenced by the International Reporting Template (IRT) work of the Committee for Mineral Reserves International Reporting Standards (CRIRCSO). The IRT is a document that draws on the best of the CRIRSCO-style reporting standards, the JORC Code (Australasia), SAMREC Code (South Africa), Reporting Code (UK / Western Europe), CIM Guidelines (Canada), SME Guide (USA) and Certification Code (Chile). These reporting standards are recognised and adopted world-wide for market-related reporting and financial investment.
6.20 The IRT sets out a framework for classifying tonnage and grade estimates of mineral deposits according to levels of geological confidence and degree of technical and economic evaluation. Having reviewed this work, we consider that the most appropriate estimate for amortising the development costs of a mining permit is on the basis of “proven” plus “probable” mineral reserves.
6.21 A proven mineral reserve represents the highest confidence category of reserve estimates. A probable mineral reserve has a lower level of confidence, but is of sufficient quality for the deposit to be developed. Together, these estimates represent the economically recoverable part of the mine.
6.22 This estimate also provides allowances for diluting materials, and the losses which may occur when the material is mined. This includes the consideration of, and modification by, realistically assumed mining, metallurgical, economic, marketing, legal, environmental, social and governmental factors.
6.23 Deductions for development expenditure under the depletion method would be computed according to the following basic formula:
Allowable deduction = expenditure x proportion of extracted minerals
- expenditure: The amount of development expenditure, less the expected residual value, reduced by the total deductions allowed in previous tax years; and
- proportion of extracted minerals: The proportion that the current production in that year bears to the estimated total recoverable reserves remaining at the beginning of the year.
6.24 From time to time, over the life of a field, additional development expenditure may be required to maintain production or bring new reserves into production. It is suggested that miners account for additional development expenditure in the income year directly following the year in which the expenditure was incurred.
6.25 A similar approach is suggested to deal with changes in reserves. That is, changes in reserves will be counted in the year directly following the year the reserve’s estimate is adjusted. Estimates of reserves may change over the life of the mine. This may be due to external reasons, like a natural disaster, or to changes in the expected price of the mineral. It may also occur because of matters relating to the specific field, such as original reserve estimates being less than previously estimated.
6.26 While there is an element of approximation in both these suggested treatments, they have the benefit of being relatively straightforward.
6.27 It is suggested that expenditure incurred in the extraction of the minerals be subject to ordinary capital/revenue tax rules.
6.28 This means that expenditure on revenue items will be immediately deductible, and expenditure on capital assets will either be deductible over the life of the asset or over the life of the mine.
6.29 Whether the cost of the asset is deductible over the life of the asset or the life of the mine depends on whether the asset’s life is independent or tied to the life of the mine. This concept is discussed in paragraphs 6.36 to 6.44.
6.30 This suggested rule is intended to align the specified mineral mining tax rules with ordinary tax principles.
Cost of land
6.31 Under the suggested new rules, land acquired directly for prospecting, exploration or mining development would be treated as “revenue account property”. This means the sale proceeds would be taxable and the cost of acquiring and disposing of the land would be deductible in the year of sale.
6.32 Where land is disposed of for consideration below the costs of the asset, a loss on disposal would be allowed.
6.33 This treatment reflects the fact that mining generally decreases the value of land. This is because land values may reflect the unexploited minerals contained in the land. As minerals are extracted, the value of the land decreases, representing a cost of the mine. Therefore, miners should be able to claim a deduction for the decline in value.
6.34 Conversely, any realised gains should also be taxable. Otherwise, the tax base would be subsidising the mining industry by allowing deductions for realised losses while not taxing realised gains.
6.35 Furthermore, if mining land were not taxable on sale or disposal, a specified mineral miner may in certain situations be able to extract the value of economically recoverable resources without tax, by selling the land rather than mining and selling the resources.
Assets with a life independent of the mine
6.36 Under the suggested new rules, the cost of assets with useful lives independent of the life of the mine would be amortised over the assets estimated useful life, in accordance with the current depreciation rules. This includes the costs of assets attained during the prospecting, exploration, development, mining phases and rehabilitation phases.
6.37 This would include assets that have a different lifespan to that of the mine. Examples include assets that could be reasonably expected to be moved to other operations, such as motor vehicles or on-site office equipment. These assets are likely to have a useful life less than the mine. Other assets – for example, a tailings dam, may have a useful life beyond the life of the mine.
6.38 Depreciation deductions on these assets incurred during the development phase, and before the mine becomes operational, should be capitalised and deductible over the life of the mine. This treatment is appropriate for these expenses as they represent the cost of producing a capital asset (the operational mine). Once the mine becomes operational, the capitalised depreciation deductions have a nexus with the income-earning process and are allowable over the life of the mine.
6.39 Furthermore, it is suggested that normal depreciation recovery rules would apply to the disposal of assets that have a life independent of the mine. For example, disposal of an asset for more than its adjusted tax value creates depreciation recovery income. Conversely, if the calculation of depreciation recovery income reveals a loss, a further deduction for that loss will be allowed.
Assets tied to the life of the mine
6.40 It is suggested that the cost of assets that is commercially inseparable from the mineral deposits be amortised over the life of the mine (excluding expenditure that creates assets with a life tied to the mine in the prospecting and exploration phase, as it is suggested an immediate deduction would be allowed). Such assets might include items that are not readily movable (for example roads, buildings and utilities) or assets that are so specialised that there is no other economic use for them other than to extract minerals from a particular mine.
6.41 There are a number of ways of allocating the costs of assets that are commercially inseparable from the mineral deposits within the mining permit area. Such costs could be allocated over the life of the mining permit, including renewals, or over the geological mineral resource estimates for the mining permit area. Our preference is for the latter, because this method is most likely to better reflect the pattern of consumption of the assets’ future economic benefits.
6.42 Further, it is suggested that the proceeds from the sale or disposal of such assets be taxable, less the balance of the miner’s costs associated with the asset in the year of disposal. If assets are disposed of for consideration below the costs of the asset, a loss on disposal would be allowed.
6.43 The rationale for the suggested change is similar to the rationale behind the suggested treatment of mining land on revenue account. That is, the value of the asset (similar to land) will generally be tied to the value of the mine and, as minerals are extracted, the value of the asset will generally decrease. Therefore, miners should be able to claim a deduction as the asset declines in value.
6.44 The suggested new rule also reduces the incentive to extract the value of economically recoverable resources without tax by selling the asset rather than mining and selling the resources.
Mine reclamation and monitoring expenditure
6.45 Typically, mining companies are required to restore, or at least make safe, land and land improvements once mining activities have ceased. These obligations often extend to requirements to monitor and remedy any post-mining environmental risks and hazards.
6.46 It is suggested that deductions be allowed for mining reclamation and monitoring expenditure in the year this expenditure is incurred. These costs are incurred in producing taxable income from the mining activities and therefore should be deductible in the year that they are incurred.
6.47 However, given these costs are often incurred after the mining activity ceases to earn income, it is suggested to allow deductions for payments made to Inland Revenue for expected mining reclamation and monitoring expenditure. The payments would be based on amounts that the miner has made a provision for in their financial accounts.
6.48 These payments will be held on account for the mining company and will be able to be drawn down on when these liabilities fall due. The rules would broadly follow the current environmental restoration account rules in subpart EK of the Income Tax Act 2007.