Chapter 7 - Other matters
Income from mining
7.1 A mining company is currently required to separate its mining income from other income. Expenditures and losses also have to be categorised into amounts relating to mining exploration or development (or income from mining) and amounts that relate to other income.
7.2 A mining company may deduct a net loss from one class of income from the other class of income. This is subject to the qualification that any mining income deducted from the non-mining income should be reduced by one-third (for example, every $100 of mining loss is worth only $66.66 when making the deduction from non-mining income).
7.3 Repealing the rules is suggested for classes of income and the deduction reduction rule for future expenditure incurred by mining companies.
7.4 Currently, a New Zealand company that holds shares in a mining company may claim a deduction for amounts written off in respect of loans, excluding interest, made to the mining company to fund its exploring, searching or mining activities. Should this amount be recovered, the Commissioner of Inland Revenue has the power, at any time, to reopen the assessments on the holding company and disallow the deductions.
7.5 Repeal of these rules is suggested for future loans and allow the general provisions for bad debt and bad debt recoveries to apply.
Appropriation of income
7.6 A specified mining company is currently allowed a deduction for an amount of income appropriated towards mining exploration or development expenditure. The deduction is allowed in the year that the appropriation is made. This rule is concessionary compared with the general deduction rules.
7.7 It is suggested that the current appropriation rule be repealed.
Insurance proceeds for mining assets
7.8 The current rules treat compensation received for the loss, damage or destruction of mining assets as income to the miner.
7.9 It is suggested this rule be repealed and that the normal tax treatment of insurance receipts apply. Therefore, if the compensation is for the loss of trading profits the payment is generally taxable. If the compensation relates to the damage to an asset, the compensation is generally a non-assessable capital receipt.
7.10 A farm-out arrangement is a contractual agreement where a mineral rights owner or lessee (the vendor) assigns a working interest to another party (the purchaser) who will become responsible for specific exploration, development or production activities.
7.11 It is suggested that the consideration received by the vendor, less any costs that the vendor has not already claimed and losses carried forward, would be taxable in the year of sale.
7.12 Further, the purchaser would capitalise the purchase price and deduct it over the life of the mine on a unit-of-production basis. However, if the purchase was made during the prospecting and exploration phase, it is suggested that the purchaser would be able to claim an immediate deduction for the purchase cost.
7.13 Any expenditure subsequently incurred by the parties to the farm-out arrangement would be treated according to the suggestions outlined in this paper (ensuring that the vendor and the purchaser do not both claim for the same expenditure). For example, development expenditure incurred by the purchaser would be capitalised and allocated over the life of the mine.
Grouping and losses
7.14 Mining companies seek ore deposits with characteristics that enable its profitable extraction and processing. Often the subsequent analysis of mineral deposits identified during the prospecting phase determines that the identified ore deposit is not worth recovering. In theory, the costs of unsuccessful projects should be offset against the next successful project. After all, mining businesses expect to be compensated for costs incurred in the unsuccessful prospects by the successful mines.
7.15 Currently, special rules apply to the consolidation of mineral mining operations to ensure that a mineral mining company may only form a consolidated group with other wholly owned mineral mining companies. These rules are likely to have been put in place because of the concessions that applied to specified mineral mining.
7.16 Provided most of the current concessions for specified mineral mining are repealed, we see no policy reason why normal grouping rules should not apply to entities involved with specified mineral mining.
7.17 In addition, under the current rules, losses incurred by a mineral mining company are ring-fenced to the mining company and to the relevant mining permit area when shareholder continuity has been breached. That is, losses can only be used to offset income derived from the permit area.
7.18 With the suggested changes to the specified mining rules, it seems unnecessary to keep the current loss ring-fencing rules for losses incurred under the new rules. Instead, the normal shareholder continuity rules should apply.
Resident and non-resident mining operators
7.19 The current rules apply differently depending on the way the business activity is structured and whether the business is a resident or a non-resident taxpayer.
7.20 It is suggested that most of these distinctions be removed (resident and non-resident mining operators). However, the rule that deals with mining assets transferred under a relationship property agreement should be retained. In these cases, the asset will be deemed to transfer at book value and the transferee is assessed on any profit made on the subsequent disposal of the mining asset. This occurs as if the mining asset was sold by the transferor.
Timing of changes
7.21 Reforms improving efficiency should be implemented as quickly as possible, since their deferral would also defer the economic benefits of the reform. Transitional measures may be justified on efficiency grounds to effect a smooth reallocation of resources. Such measures can also be justified on equity grounds when the loss suffered would otherwise be substantial, or when individuals cannot readily adjust their circumstances to minimise the impacts of the policy change. Any transitional measures must, however, achieve a significant reduction in inequities at an acceptable cost in terms of deferral or reduction of the efficiency gains.
7.22 There appears to be no strong efficiency or equity arguments for a gradual phase-out of the concessions or for other transitional measures. Further, it would not be appropriate to grandparent mining operations that exist at the time the new rules are introduced. Expenditure incurred before the new rules would have received the benefits of immediate deductions and, in this sense, there is nothing to grandparent. Expenditure on new assets associated with existing mines should be subject to the suggested new rules as this promotes more efficient investment decisions.
7.23 Royalties, on the other hand, can be regarded as a contract between the Government and miners. Therefore, grandparenting current royalty treatment for mining investment can be justified.
7.24 Accordingly, it is suggested that the changes suggested in this paper apply from the beginning of the 2014–15 income year. This provides a short period of time for mining companies to gear-up for the new rules.
7.25 However, tax losses created under the current concessionary regime should continue to be subject to the current (more restricted) grouping and loss rules. The loss rules are intended to balance the more concessionary specified mineral mining rules. Therefore, for consistency, and to avoid revenue risks, losses created under the current rules should be subject to the more restrictive grouping and loss rules.
7.26 New losses created under the new rules would be subject to ordinary tax grouping and loss rules.