Introduction

A reliable and competitively priced supply of petroleum products is essential to the effective functioning of the Australian economy and to maintain living standards. Petroleum is the energy source for over 50 per cent of Australia's primary energy consumption, and supplies nearly all of Australia's transport energy requirements.¹

The oil and gas industry² is an important contributor to the Australian economy. In 2006–07, the industry accounted for 2.1 per cent of nominal Gross Domestic Product and generated estimated revenue of $28 billion.³ Industry revenue expanded strongly between 2003–04 and 2007–08, reflecting large increases in oil and gas prices. However, oil prices fell substantially in late 2008, reversing the trend. Geoscience Australia has forecast that crude oil production will fall in coming years, while Australia's natural gas production levels will almost double in the five years to 2012.

The Petroleum Resource Rent Tax (PRRT) is imposed by the Petroleum Resource Rent Tax Assessment Act 1987 (PRRTA Act), which came into force from 15 January 1988. The PRRT is a profit-based tax levied on most offshore petroleum projects.⁴ PRRT is applied to the recovery of all marketable petroleum commodities (MPCs),⁵ including crude oil, condensate, liquefied petroleum gas, natural gas and ethane, from Australian Government waters.⁶ The PRRT is not applied to value added products such as liquefied natural gas or petroleum products extracted from the North West Shelf project and the Joint Petroleum Development Area.⁷

The PRRT aims to encourage the exploration and production of petroleum while ensuring an adequate return to the community for the development of its petroleum deposits. The PRRT is levied at a rate of 40 per cent of a project's taxable profit. Taxable profit is the project's income after all project and ‘other' exploration expenditures⁸ have been deducted from all assessable receipts. Other key features of the PRRT include:

• it is assessed on a project basis;
• liability to pay PRRT is on a producer/company basis;
• PRRT is levied before company tax, and PRRT payments are deductible for company tax purposes;
• any excess of expenditure over receipts can be compounded forward for deduction against future receipts from the project;
•  the rates at which undeducted expenditures are compounded forward depends on the nature of those expenditures and when they were incurred before the granting of a production licence; and
• deductions include capital and operating costs that directly relate to the petroleum project, and are deductible in the year they are incurred.

The PRRT is a significant secondary tax, which has generated over $22 billion for the Commonwealth Government since it was first collected in 1989. PRRT annual gross revenue averaged slightly over $1.5 billion between 2001–02 and 2007–08, which was nearly 30 per cent of the $5.4 billion tax paid each year by the oil and gas exploration and production industry.⁹

In October 2008, there were 65 separate PRRT registrations across 24 projects. Only 10 projects, and 9 company groups, were making profits and therefore paying the tax. There was a high degree of concentration in PRRT payments, with one project providing a significant majority of all PRRT revenue in 2007–08, and the top five projects providing over 95 per cent of all revenue.

The Australian Taxation Office (Tax Office), as Australia's principal revenue agency, has responsibility for administering Australia's revenue system under the law. The Energy and Resources Segment within the Tax Office's Large Business and International Business Line, has responsibility for administering the PRRT for the Tax Office. In 2007, primary responsibility for administering the PRRT was transferred from the Moonee Ponds Office in Melbourne to a PRRT unit in Northbridge, Perth.¹⁰

Audit objective and scope

The objective of the audit was to assess the effectiveness of the Tax Office's administration of the PRRT. The Australian National Audit Office (ANAO) identified four key areas for review: general administration; compliance; promoting certainty in administering the PRRT; and governance arrangements.

As with other taxes, risk management is the key to the effective administration of the PRRT. The ANAO examination therefore focused on how the Tax Office assesses and manages risks associated with the PRRT and what assurance is provided on those risks resulting from its approaches to encouraging taxpayer compliance.

The ANAO conducted fieldwork in the Tax Office's Northbridge and Moonee Ponds offices between August and December 2008. The ANAO also consulted a range of stakeholders including: the Australian Petroleum Production and Exploration Association (APPEA); major Australian oil and gas companies;¹¹ the Department of the Treasury; and the Department of Resources, Energy and Tourism.

Conclusion

 Overall, the Tax Office has administered the PRRT in a generally effective manner, which has supported voluntary compliance by taxpayers. The vast majority of PRRT taxes are paid promptly in accordance with administrative arrangements that underpin the self-assessment system. Compliance activities are being undertaken according to the Tax Office's risk-based strategy following the recent increase in coverage, general administration of the PRRT is sound, and governance arrangements are suitable. Most petroleum industry stakeholders are satisfied with those elements of administration but expressed major concerns about the time taken by the Tax Office deliberating on a number of PRRT technical issues, which are yet to be resolved.¹² To provide taxpayers with greater certainty in applying the PRRTA Act, it is important that the Tax Office continues to build on recent increases in the provision of guidance and advice, and allocates adequate technical support resources to PRRT.

More specifically, taxpayer uncertainty in applying the PRRTA Act arises when the Tax Office's position is not understood, or because of differences in interpretation of the PRRTA Act. In this regard, most industry representatives contacted as part of the audit informed the ANAO that they were seeking a clear articulation of the Tax Office's position on many technical PRRT issues, which would include practical examples, such as those categories of expenditure that could (and could not) be included as eligible indirect expenditure. On this basis, many industry representatives considered that after 20 years of operation the current level of uncertainty in applying the PRRT was unacceptable. These representatives noted that the level of uncertainty has lead to many different interpretations of key aspects of the tax. The Tax Office has recognised the importance of increasing the extent of guidance on PRRT laws, and issued three public rulings on key aspects of the PRRT between September 2008 and February 2009. The Tax Office is also in the process of identifying high priority technical PRRT issues to form a program of work to provide further guidance to taxpayers.

Recognising a lack of coverage in previous years, there was a significant increase in the number of PRRT risk reviews and audits in 2008–09, which, if maintained at these levels, would satisfy the requirements of the Tax Office's risk-based compliance strategy. These compliance activities have covered relevant risks and issues, collected sufficient information, which was analysed thoroughly, and had successful outcomes. Taxpayers advised that these activities have created a fairly large administrative burden, particularly on those companies that are not the operators of a petroleum project. The time taken to complete risk reviews was typically close to relevant benchmark targets, but much longer than the benchmark for the major PRRT audit underway at the time of ANAO fieldwork. There is scope to increase the extent to which apparent inconsistencies in information provided by taxpayers on instalment statements and annual returns are addressed in a timely way. This has potential benefits to both the Tax Office and taxpayers in minimising the impact of taxpayer errors.

The Tax Office effectively undertakes the core administrative elements of the PRRT—identifying and registering taxpayers, processing PRRT payments, and providing refunds. PRRT debt recovery is rarely an issue.

The Tax Office's governance arrangements for PRRT adequately support key processes and practices, including those relating to the provision of interpretative assistance and advice, compliance activities and general administration. Line management responsibilities are clearly established and there are appropriate mechanisms to liaise with industry stakeholders. Scope exists, however, to usefully extend the PRRT planning framework by enhancing key performance indicators to better monitor and report on the achievement of strategic goals.

Key findings by chapter

General administration (Chapter 2)

As reflected in the findings of this audit, petroleum industry stakeholders considered that Tax Office general administration processes and practices were sound, with very few problems encountered with registration processes, submitting PRRT payments and receiving refunds.

PRRT registration processes were streamlined and straightforward, collecting sufficient information to allow the Tax Office to effectively process annual returns and quarterly instalments. The Tax Office was aware of petroleum projects that should be subject to PRRT and were taking adequate steps to ensure all relevant companies were registered.

Audit testing found that all PRRT quarterly instalment and annual PRRT payments had been correctly accounted for in 2007–08. Amounts on instalment notices or annual statements in all 49 cases in 2007–08 matched amounts actually paid to the Tax Office, posted to the Tax Office computerised financial system and recorded in PRRT operational spreadsheets. There was evidence that the PRRT Unit had undertaken substantial checking to assure the accuracy of processing PRRT payments. The Tax Office had refunded all PRRT over-payments accurately and promptly in 2006–07 and 2007–08.
 
Largely reflecting the volatility of oil prices, exchange rates and resource costs, actual PRRT revenue varied from official forecasts by over 30 per cent in three of the five years from 2003–04 to 2007–08, and the average error in forecasts over this period was 27 per cent. While communication arrangements between the PRRT Unit and Revenue Analysis Branch in place at the time of audit fieldwork adequately supported Tax Office forecasts of PRRT revenue, it is important that the Tax Office reviews the appropriateness of these arrangements on a periodic basis, given the extent of volatility in actual PRRT revenues and the difficulties involved in providing accurate forecasts.

Compliance (Chapter 3)

PRRT compliance plans form part of a cohesive line management approach, involving the Energy and Resources Segment, Large Business and International Business Line and Tax Office wide compliance planning documents and approaches. Compliance planning approaches for PRRT are consistent with, and integrated into, broader compliance approaches in the Tax Office. The Petroleum Industry Compliance Strategy 2007 was a useful means of updating petroleum industry tax risks and determining compliance and related strategies for PRRT and income tax in following years. One aspect for the Tax Office to consider in any future updates of this strategy would be increasing the extent of analysis of PRRT-related information.

The Tax Office has a sound understanding of most PRRT projects and participants that have paid PRRT. There has also been a stream of projects entering the PRRT environment in recent years. While participants in these projects may not pay PRRT for a number of years, profiling them would support effective ongoing monitoring and inform future compliance case selections. The extensiveness of profiling would depend on assessed compliance risks.

Largely in response to the change in PRRT administration to a self-assessment basis in 2007, the Tax Office has placed greater emphasis on active compliance (risk reviews and audits) rather than addressing potential inconsistencies on a timely basis. While recognising this approach, the ANAO considers there is scope to increase the extent to which apparent nconsistencies are addressed in a timely way, particularly in circumstances with significant tax liability implications for clients.
PRRT compliance activities are undertaken in accordance with guidelines established for income tax purposes, and include risk reviews and audits. As discussed earlier, the Tax Office greatly enhanced its PRRT compliance activities in 2008–09, with substantially more risk reviews and audits. Recent PRRT risk reviews have generally been completed in a timely manner. However, based on progress at the time of ANAO fieldwork, a large PRRT audit is likely to take double the benchmark of two years to complete.

The four PRRT risk reviews examined by the ANAO were soundly based. They covered key PRRT risks,¹³ collected considerable information from the clients as evidence, and analysed this information thoroughly. PRRT compliance activities have sometimes raised substantial additional revenue, and in other instances provided assurance that no material risks were outstanding.

The current company income tax return does not identify the amount being claimed as a deduction for PRRT payments. This means the Tax Office is only able to match PRRT payments and income tax deductions in risk reviews conducted as part of a compliance process. However, the Tax Office has not included this matching exercise in its program of risk reviews and audits.

Promoting certainty in administering the PRRT (Chapter 4)

While there is no disputation between the Tax Office and the majority of taxpayers on most elements of the PRRTA Act, there remains uncertainty in the interpretation of a number of technical PRRT issues. Notwithstanding that the Tax Office had discussed these issues with stakeholders, nine of the 11 petroleum stakeholders contacted as part of this audit advised that they faced considerable uncertainty in assessing PRRT liabilities. Similarly, nine of the 11 industry representatives considered that the Tax Office has provided insufficient guidance to explain its position on a number of key contentious issues. The overall level of public guidance remains low, although the Tax Office has taken actions to increase the level of interpretative assistance and advice to PRRT taxpayers in recent times.

Private Binding Rulings are one of the key mechanisms in Australia's self-assessment system to provide taxpayers with certainty of tax treatment concerning their specific circumstances. Nevertheless, despite the complexity of PRRT issues and the level of sophistication of the taxpayers involved, only two PRRT taxpayers have entered into Private Binding Rulings with the Tax Office. A major reason cited to the ANAO by petroleum companies that have not sought these rulings was that they consider it likely that the rulings would not favour them. These taxpayers consider that taking a reasonably arguable position was preferable to applying for a Private Binding Ruling.

There was relatively little litigation for the first 15 years of operation of the PRRT, but this increased markedly from around 2002. Of 10 PRRT litigation cases since 2002, seven have been resolved in some way, with results mixed but generally favouring the Tax Commissioner.

In disputes about technical PRRT issues, the Tax Office and petroleum companies have sometimes ‘agreed to disagree' on PRRT interpretations and to have the matter decided by a court. However, one company in litigation with the Tax Office over PRRT, and a number of other petroleum industry stakeholders, perceive that the Tax Office has a general pro-revenue bias when administering the PRRT. These stakeholders advised that this has also been a reason for the small number of applications for Private Binding Rulings. With respect to these rulings, perceptions of general pro-revenue bias are common amongst big business generally, but were not substantiated in a review by the Inspector-General of Taxation.¹⁴ Consistent with this finding, a limited review of Tax Office files by the ANAO did not identify evidence that would substantiate claims of a general pro-revenue bias by the Tax Office when administering the PRRT.

The main reason suggested by the Inspector-General for a perception of a general pro-revenue bias by large companies is relevant to petroleum companies paying PRRT. That is, a lack of transparency in disclosing the full circumstances and reasons for interpreting key elements of tax law leaves taxpayers little to go on but their own views of what may be happening. The Tax Office is taking steps to improve transparency in interpreting the PRRTA Act by increasing the extensiveness of public rulings and other advice, and increasing communication with taxpayers to determine positions on emerging issues such as gas-to-liquids. However, there is scope to further improve the extent and effectiveness of these activities.

Representatives of the petroleum industry typically supported the Department of the Treasury and the Department of Resources, Energy and Tourism having a role in providing advice on technical PRRT issues, including on matters under dispute with the Tax Office. The Tax Office has sometimes brought such issues to the attention of these agencies, albeit through discussions that are not part of defined processes for considering legislative amendment. However, the Tax Office has identified scope to improve the extent of collaboration with other government agencies to provide input to issues involving legislative and administrative issues regarding the PRRT. Taking action to improve this collaboration, and then advising industry of its existence and the key issues being discussed, is likely to improve perceptions that the Australian Government is taking a suitably coordinated approach to administering the PRRT.

To effectively manage the recent increase in litigation and deal with disputes about technical PRRT matters in a timely manner, it is important that the Tax Office allocates an adequate level of resourcing for the PRRT Centre of Expertise. While resource requirements will depend on the scale of the future technical PRRT programme, it is likely that the increase in staffing would be in the magnitude of contributions from two additional senior lawyers to supplement the existing officer.
Since inception, there have been a number of legislative changes to the PRRT. Audit testing revealed that the Tax Office effectively implemented the seven major amendments to the PRRT which became effective from 1 July 2006.

Governance arrangements (Chapter 5)

Current administrative structures for PRRT provide: clear lines of responsibility through to the Tax Commissioner; alignment of PRRT and company tax within a petroleum unit that facilitates synergistic use of expertise; and the use of client managers who aim to obtain a thorough knowledge of petroleum projects to enable informed discussions with stakeholders. The two office approach reflects the geographic distribution of petroleum projects, with the Perth office having primary responsibility for projects in the petroleum growth area of Western Australia, and the Melbourne office retaining a local presence for Victorian producers. As yet, however, there has been insufficient time and information to determine the success of this approach. Stakeholders generally were satisfied with PRRT administrative arrangements.

ANAO fieldwork and views of stakeholders indicate that skilling levels are generally high for PRRT administration, and have been improving in Northbridge as staff gain experience following the establishment of the PRRT Unit in 2007. Updating two key PRRT reference guides will also support PRRT capability.

PRRT strategic planning documentation was effectively integrated with the Tax Office's broader planning framework. However, there is scope to extend the PRRT planning and internal reporting framework. Extending annual PRRT Compliance Strategies to include performance indicators, and expressly monitoring performance against these indicators, would allow the Tax Office to gauge its success in implementing key PRRT strategies, and support continual improvement in performance. To help ensure consistency with broad Tax Office reporting approaches, it is important that the development of any performance indicators for PRRT is undertaken within current systems and reporting frameworks.

The Tax Office utilises a variety of forums to report on PRRT activities including its Annual Report, specific publications, media releases, the Internet, and speeches. These forums provide generally adequate external reporting of PRRT administration. To comply with Section 16(1) of the PRRTA Act, details of any breaches or evasions of the PRRT should be included in Commissioner of Taxation Annual Reports, or alternatively noted if there were no known breaches or evasions.

The full cost to the Tax Office of administering the PRRT is not known but is likely to be low compared to the magnitude of revenue collected.¹⁵ Compliance costs to industry are also important. A common view of petroleum industry representatives contacted as part of the audit was that: compliance costs for general PRRT administration were reasonable; costs of responding to risk reviews could be quite high; and the cost of litigation was high (but worth clarifying through the court given the amounts of tax involved).

Recommendations

The ANAO has made four recommendations. These recommendations are directed at:

• enhancing compliance activities by increasing the extent to which the Tax Office makes timely inquiries to resolve apparent PRRT payment anomalies;
• promoting certainty for taxpayers by providing more extensive written guidance about key aspects of the PRRT;
• strengthening the technical capacity of the Tax Office's PRRT Centre of Expertise by allocating sufficient time of additional senior lawyers; and
• Improving governance arrangements by monitoring and reporting performance in achieving specified PRRT compliance strategies.

Tax Office response

The Tax Office's summary response to the report is reproduced below.

As you noted, the Petroleum Resource Rent Tax (PRRT) has been administered by the Tax Office since its introduction in 1987. In the 2008 year it generated approximately $1.7 billion in revenue for the Commonwealth Government, out of $271 billion collected by the Tax Office. This means it is a comparatively small, but nonetheless important, revenue product.

The Tax Office welcomes the ANAO recommendations on its administration of the PRRT.

It is encouraging to note that the ANAO found that the Tax Office's recent steps to improve its administration have been effective. In particular, we were pleased to note the ANAO found:

• the Tax Office effectively undertakes the core administrative elements of the PRRT, which was supported by industry stakeholders,
• PRRT compliance arrangements and the plans are cohesive and compliance activities are based on sound risk management processes,
• the Tax Office has taken action to increase the level of interpretative assistance and advice to PRRT taxpayers, and
• PRRT governance arrangements are sound.

It was also pleasing to note external stakeholders indicated that skilling levels of Tax Office staff are generally high for PRRT administration.

Footnotes

¹ Australian Petroleum Production and Exploration Association (APPEA), Submission to the Senate Rural and Regional Affairs and Transport References Committee inquiry into Australia's future oil supply and alternative transport fuels, April 2006, p. 2.

² Oil and gas are petroleum resources and products. The main forms of oil are crude oil, distillate and liquefied petroleum gas, while the main forms of gas are natural gas and liquefied natural gas. Petroleum production and exploration represent the upstream petroleum industry. The downstream petroleum industry mainly comprises refining, transportation and retailing of petroleum products.

³ Crude oil accounted for around 35 per cent of oil and gas extraction industry output in 2006–07. About 55 per cent of crude oil output was exported, with the remainder supplied to the domestic petroleum refining industry. The production of natural gas accounted for about 60 per cent of the industry's output in 2006–07. About 43 per cent of Australia's natural gas production was exported in the form of liquefied natural gas. Most of the remainder was purchased and distributed by firms operating in the gas supply industry.

⁴ A project consists of facilities in the project title area, and any facilities outside that area necessary for the production and initial storage of marketable petroleum commodities. Each entity with an interest in a PRRT liable project will be liable for PRRT. In essence, each entity's interest in a project becomes a ‘taxing entity'.

⁵ An MPC is a marketable product that can be sold. It establishes the point at which petroleum recovery stops and other activity begins.

⁶ Under the terms of the 1979 Offshore Constitutional Settlement and the division of powers provided for under the Australian Constitution, the power to impose taxation and other charges on oil and gas production has been divided between the Commonwealth and States/Territories. The Commonwealth holds title for all areas seawards of the outer boundary of the territorial sea while the States/Territories control areas landwards of this boundary. As part of the Settlement, a common mining code was adopted covering all petroleum regulation in submerged lands. <http://www.appea.com.au/index.php?option=com_content&task=view&id=25&Itemid=47> [accessed 24 April 2009].

⁷ The Timor Sea Treaty came into force on 2 April 2003 and sets out the framework for joint administration and revenue sharing by Australia and East Timor of petroleum exploration and development in an agreed area of the Timor Sea—the Joint Petroleum Development Area.

⁸ All eligible project expenditures are tax deductible for PRRT purposes in the year incurred. There is no distinction between capital and revenue expenditures for this purpose. Eligible expenditures include exploration and project development and operating expenditures, subject to the specific exclusions.

⁹ Estimates of total tax for the oil and gas extraction industry are from APPEA Annual Financial Survey results. These results indicated that taxes and charges represented 38 per cent of industry costs between 2001–02 and 2006–07.

¹⁰ The Moonee Ponds team retains some PRRT responsibilities, particularly relating to specific taxpayers.

¹¹ The ANAO held discussions with 11 PRRT taxpayers or their tax agents. These companies and agents represented over 90 per cent of companies paying PRRT and of total PRRT revenue in 2007–08.

¹² Uncertainty in the interpretation of two issues, the classification of indirect expenditures and determining the taxing point for gas, has involved two large PRRT taxpayers and has been ongoing for each year of assessment since the early 1990s. The total amount of PRRT revenue affected by disputes is potentially over $1 billion or around five per cent of total collections since inception.

¹³ These risks include shares of income and expenditure, taxing points, excluded and indirect expenditure, foreign exchange calculations and sale of holdings.

¹⁴ Inspector-General of Taxation, Review of the potential revenue bias in private binding rulings involving large complex matters (2008), p. 3.

¹⁵ For example, direct salary costs of the 12 full-time equivalent staff working on PRRT in 2007–08 would have been well under one million dollars, which was around one twentieth of one per cent (0.05 per cent) of PRRT revenue raised.