Submissions on behalf of the Commissioner
82 Mr Wheelahan SC, who appeared with Mr I Stewart for the Commissioner, contended that the evidence does not permit the whole of the expenditure which Esso claimed to be deductible to be characterised as a single service fee paid to EAL including the "mark-up" of 7½%. Rather, Esso had paid a series of individual costs which had been charged to its account using the ExxonMobil Group's "Wizard" system. The deduction claimed in each of the relevant years was an aggregation of those individual costs.
83 From that premise, the Commissioner argued that it was not possible, on the evidence, to find that all of the individual costs for which the deduction was claimed, had been incurred in carrying on or providing the operations, facilities and other things comprising the Bass Strait project, as required by s 38(b) of the Act. Moreover, significant items of the claimed expenditure were excluded from deductibility by reference to one or other of paragraphs (j) and (k) of s 44.
84 In the context of s 44 of the Act, Counsel for the Commissioner referred to a press release entitled "Resource Rent Tax on 'Greenfields' Offshore Petroleum Projects" jointly issued on 27 June 1984 by the Federal Treasurer and the Federal Minister for Resources and Energy. That press release contained the following passages:
• The scope of project expenditure and income to be taken into account will encompass certain infrastructure where this is integral to the production of a 'marketable' product, including social infrastructure (eg housing and associated facilities of the kind that qualify for deduction under the petroleum mining provisions of the income tax law) provided principally for employees of the project and their dependants, and office buildings situated at or proximate to the site of petroleum operations; and
• Expenses not directly related to the project will be excluded. For example, where an entity has diverse interests, only one of which is a project assessable for RRT, only those costs incurred at its head office which are solely attributable to the RRT project will be deductible for RRT purposes. Clearly identified expenditures, such as project engineering design costs carried out in the head office therefore would be deductible, even though this might involve an apportionment of some employees' wage costs between time spent on that activity and the remainder spent on other activities not directly associated with an RRT project. General overhead costs incurred at head office would not, however, be deductible.
Attachment 1 to the same press release recited;
• Expenses only indirectly associated with the project. For example, where an entity has diverse interests only one of which is a project assessable for RRT, no part of head office expenses such as accounting and auditing fees, pay-roll preparation costs, and the costs of maintaining the head office motor vehicle fleet, will be deductible for RRT purposes. (However, those head office expenditures clearly identified with the project assessable for RRT, such as project engineering design costs, will be deductible).
85 Those ministerial statements were said to be consistent with the Explanatory Memorandum for the relevant provisions of the Act and the Second Reading Speech by which they were introduced. That extrinsic material was said to illuminate the use of the word "indirectly" in s 44(j) of the Act. As a result, if expenditure could be apportioned on the basis of time spent on different activities, the part apportioned to a production activity is more likely to have been incurred "directly" in carrying on or providing operations, facilities or other things of a kind referred to in s 38. On the other hand, if expenditure had been apportioned on some other basis, it was more likely to have been incurred "indirectly" and thus excluded from deductibility by s 44(j).
86 The examination of a deduction claimed under the Act was said by the Commissioner to involve two steps. The first was to ask whether the expenditure had a sufficient nexus with carrying on or providing one or other of the operations, facilities, services or amenities enumerated in s 19(4) of the Act. The second step was to determine whether the item of expenditure was "excluded expenditure" by reference to, e.g., s 44(j) of the Act. The fact that the drafters of the legislation found it necessary to make specific provision in s 19(4)(b)(v) for "employee amenities" was said to indicate that the operations, services and facilities enumerated in the preceding sub-paragraphs of s 19(4)(b) were to be accorded a very narrow scope. That was consistent, so the argument went, with the Press Release above and the other extrinsic material noted at [85] above.
87 According to the Commissioner, the use of the word "payments" in s 38 of the Act was significant because it directed attention to the payment of individually identifiable cost items rather than a compendious "service fee". In a related way, it was said that, because the nexus required by s 38 was closely tied to the actual production process, the Act was predicated on a narrow concept of deductible expenditure rather than the much broader concept apparent in the Income Tax Assessment Acts.
88 Accordingly, the ability to claim a deduction under the Act depended on the extent to which a payment could be dissected as referable to particular cost elements. Thus, for example, s 44(b) of the Act, by excluding from deductibility "interest components of hire-purchase payments" made it necessary for assessment purposes to carry out a sufficient dissection to ascertain whether a payment had been made in respect of such an interest component. On this analysis, the only component of the payments made by Esso to EAL which could be described as a "fee" was the 7½% "mark-up".
89 It was next contended that the Service Agreement was not confined to the Bass Strait project. Rather, EAL had provided services to Esso in respect of other projects as well. Where they had been supplied in respect of "upstream" activities, the costs were booked to relevant segments of the ExxonMobil Group's "Wizard" system. The "labour ratio" was then applied to those upstream costs and the resultant amounts charged to segment 05 (the Gippsland Basin Joint Venture) or 06 (the Blackback Joint Venture). Esso's acceptance of the need for some dissection of the costs charged by EAL was implicit in its application of the "labour ratio".
90 In relation to s 41 of the Act, Counsel for the Commissioner argued that it was engaged even where the "eligible person" itself carried on some activities in relation to the project. In the present case, s 41 was not excluded from applying to the operations, facilities or other things which were procured from EAL. Section 41 must be read as qualifying the effect of ss 37 and 38.
91 In construing s 44(j) of the Act, Mr Wheelahan SC drew attention to the presence of a comma after the expression "accounting costs" and of another comma after "other work costs". As a result, he said, the phrase "incurred indirectly" governed or qualified all that went before. Any cost which was not related solely to the "project" as defined in s 19(4) was a cost "incurred indirectly" within the meaning of s 44(j).
92 The effect which s 44(k) of the Act was contended to have was encapsulated in these paragraphs of the Commissioner's written outline of submissions:
109. Section 44(k) differentiates between sites at which the operations facilities or other things comprising the project are carried on or provided, and remote sites at which administration or accounting activities are carried on. The differentiation is consistent with the legislative intent evidenced in the extraneous material and referred to in paragraph 24 above.
110. The effect of s 44(k) is that payments in respect of land or buildings for uses in connection with administration or accounting activities in respect of operations facilities or other things not carried on at, or adjacent to, that site, are excluded expenditure.
93 In relation to accommodation expenses, the Commissioner conceded that the cost of providing accommodation at Southbank for engineers and geoscientists who were dedicated to the Bass Strait project was deductible expenditure and had not been allowed as a deduction. It was therefore accepted as appropriate for that part of the case to be remitted for re-assessment. However, all payments for accommodation not related to, for example, engineering work were excluded by s 44(k) of the Act. The Commissioner accepted that the analysis of s 44(k) for which he contended requires a very elaborate and complicated dissection of the relevant costs.
94 The Commissioner also sought to derive assistance from dictionary definitions of "indirect cost" and "indirect costs". The latter expression has been explained in the CCH Macquarie Dictionary of Accounting by the entry:
Indirect costs are often allocated to specific products or departments on some arbitrary basis.
95 The conclusion of Gummow J at first instance in Robe River Mining Co Pty Ltd v Commissioner of Taxation (1988) 19 FCR 294 was also invoked by the Commissioner. His Honour, in considering whether certain costs constituted "expenditure in carrying on prescribed mining operations", said, at 307, that;
… the direct or close connection which is necessary between the expenditure and the carrying on of the prescribed mining operations, such close connections being supplied by the word "in".
That view was confirmed by a Full Court on appeal in Robe River Mining Co Pty Ltd v Commissioner of Taxation reported at (1989) 21 FCR 1 ("Robe River"), where it was observed, at 12;
… The use of the phrase "in carrying on prescribed mining operations" suggests a quite direct relationship between the expenditure and the operations, to be distinguished from the looser relationship which would be expressed by the words "in connection with" if they were used in a provision of this kind. The point is emphasised by the apparent breadth of the exclusion under s 122A(2), where the comparable words are "on or in relation to"; however, subs (2) is concerned with expenditure on or in relation to ships, buildings, plant etc, whereas subs (1)(a) is concerned with expenditure having the relationship indicated by the word "in" to the carrying on of prescribed mining operations, in itself a concept of some width, as is exemplified by subpars (i) to (iv).
96 Counsel for the Commissioner was at pains to point out that Gyles J, as a member of a Full Court on the appeal in Commissioner of Taxation v Pine Creek Goldfields (1999) 91 FCR 263 ("Pine Creek Goldfields"), at 288 had not disapproved the reasoning in Robe River. His Honour had merely said that he had found the decision in Robe River to be of no assistance in the exercise of interpretation which was called for by Pine Creek Goldfields. Nor was it appropriate, the Commissioner asserted, to ask whether, "but for" the expenditure, the operations, facilities and other things comprising the project would not have been carried on or provided. In support of this assertion, reference was made to Commissioner of Taxation v Mount Isa Mines (1991) 28 FCR 269, where Pincus and Ryan JJ, in a joint judgment, said, at 279;
There is no general rule that such a condition - that is, one expressly or implicitly requiring the existence of a purpose - is satisfied, if it is shown that a stipulated purpose was one of the proponent's purposes, nor is it so that ordinarily the purpose must be a dominant one; each provision must be considered in its own context. Here, there is no express mention of "purpose" and the words used are simply "in providing … water … for use on … the site …". In an ordinary use of language, expenditure is not spoken of as having been incurred "in" a certain way unless that is the way in which it has been at least substantially, if not solely, incurred. For example, a person who is told by another that the latter has spent a certain sum in providing for his family would not take it that the expenditure was also directed to other, quite separate, ends.
97 Counsel for the Commissioner then referred to cl 4 of the Service Agreement which is set out at [5] above. That was said to require, expressly or implicitly, Esso to "provide the consideration payable [which] is referable to the costs incurred" so that Esso became liable to pay direct costs incurred by EAL in performing the Service Agreement and a portion of EAL's overhead costs "properly allocable" to the performance of the Service Agreement. The latter costs, it was said, were likely to be "indirect" because provision was made for their "allocation" for the purpose of quantifying them.
98 Attention was drawn to the fact that no monthly invoices from EAL to Esso were in evidence. That was said not to be surprising because costs payable to EAL which had the relevant nexus to the Bass Strait project were a subset of all the costs payable to EAL under the Service Agreement. That contention was said to be reinforced by the fact that there were "upstream" activities, such as the Kipper and Scarborough fields, in connection with which EAL provided services which were not related to the Bass Strait project. Esso had excluded the costs referable to those other projects by applying the labour ratio. That was an indication that all of EAL's costs in the relevant categories were "indirect" costs.
99 In support of the contention to which I have just referred, attention was drawn to the use of the "Wizard" system to identify "upstream" costs in the course of preparing tax invoices submitted by Esso to BHP. Costs referable to the joint venture were posted to segments 05 and 06 of the "Wizard" system which had various "layers". "Upstream" costs referable to the Wandoo project were booked to the layer applicable to the Mobil subsidiary which was the owner of that project. All Esso "upstream" costs were booked to Esso. Some of those costs were not related entirely to the Bass Strait project and were apportioned using time estimates. Similar time estimates were used to re-allocate "upstream" costs to "downstream" activities and vice versa. Having been charged all the "upstream" costs, Esso then decided how much of those costs should be passed to BHP using the "labour ratio" to allocate that proportion to segments 05 and 06 within the "Wizard" system. That was said to demonstrate that the costs allocated to the Bass Strait project were "indirect".
100 By way of illustrating this point Counsel for the Commissioner contended that the costs charged to the Bass Strait project by the Law Department did not reflect actual time spent by legal staff on that project. Rather, those costs were a product of time recording in the production and exploration departments at Southbank. Because the "labour ratio" was applied to determine how much should be charged to a particular project, the allocation was arbitrary.
101 The Commissioner also drew attention to pars 247 and 248 of Mr Noble's affidavit which explained as follows how fringe benefits tax was treated within the "Wizard" system;
247. The amounts of $1,069,206 for the 2003 Year and $277,022 for the 2004 Year which Esso has claimed are half of the amounts which were charged to cost centre 05-005 during the Dispute Period. (BHP was invoiced in relation to the other half).
248. These amounts were wholly comprised of fringe benefits tax which was payable by EAL in respect of its employees but was not allocated as being specifically referable to any particular employee. Such fringe benefits tax included, for example, tax arising from the use of EAL owned pooled cars which were used by numerous employees, the use of the EAL car park, employee entertainment, meals and Christmas functions.
102 Those passages were said to show that Esso had paid fringe benefits tax referable to employees engaged on the Bass Strait project and the operation of s 44(h) of the Act had thereby been attracted. Similarly, it was said that audit costs related to the joint venture were not deductible because they had not been incurred in providing or carrying on the operations, facilities or other things comprising the Bass Strait project. Rather, they were analogous to the hedging costs considered by French J in Woodside Energy Ltd v Federal Commissioner of Taxation (No 2) (2007) 69 ATR 465; [2007] FCA 1961, where his Honour observed, at 531 [276];
In my opinion the requirement that expenditure contemplated by s 38 is liable to be made in carrying on or providing operations, facilities and other things comprising the project is incapable of covering the hedging expenses the subject of these proceedings. The section contemplates a close connection between the expenditure and the physical activities involved in the petroleum project. Interestingly, one of the cases cited on behalf of Woodside Energy, albeit for a different purpose, was Robe River Mining Co Pty Ltd v Commissioner of Taxation (1989) 21 FCR 1 in which the Full Federal Court said:
The use of the phrase "in carrying on prescribed mining operations" suggests a quite direct relationship between the expenditure and the operations, to be distinguished from the looser relationship which would be expressed by the words "in connection with" if they were used in a provision of this kind.
The passage was used to support the proposition that by not using, in s 24(b), language suggesting the kind of direct connection required in the provisions under discussion in Robe River Mining Co Pty Ltd 21 FCR 1, Parliament had intended to provide for a wide range of relationships between expenses and sales for the purposes of s 24(b). As indicated above, for reasons which I have given, I do not accept that proposition. And it is plain that so far as s 38 is concerned it cannot extend to expenses of the kind in issue in this case.
103 The Commissioner next drew attention to the Accounting Manual noted at [11] above and contended that the way in which costs had been allocated to the joint venture partners reflected the provisions of the Operating Agreement rather than establishing a basis for treating those costs as deductible for the purposes of the Act. As an example, reference was made to cl 2.11(b) of the Accounting Manual which recited:
… The Operator shall charge the Joint Account for these services in accordance with the following:
(i) Salaries and expenses applicable to operating activities - such as, but not limited to, production, exploration and transportation, superintendence, petroleum engineering, geology and geophysics - shall be allocated to the Joint Undertaking - and all other operations on the basis of time spent for the benefit of the respective operations and activities.
(ii) Salaries and expenses applicable to all other activities - such as, but not limited to, General Manager, accounting, employee relations, legal, Exploration Manager, Production Manager and other Managers - shall be allocated to the Joint Undertaking in the same proportion as the total salaries and wages charged to the Joint Undertaking bear to the total salaries and wages of the Operator excluding salaries and wages covered by this Section 2.11(b)(ii).
The last-mentioned sub-clauses were accepted by the Commissioner as authorising the application of the "labour ratio" to upstream costs for the purpose of accounting to the Gippsland Basin and Blackback Joint Ventures. That incorporation, by reference of the Accounting Manual, was said to enable BHP to be charged with a pro rata share of the Operator's costs which were not attributable solely to the joint venture project.
104 Similarly, a letter dated 2 November 1995 from EAL to Esso stipulating how costs of accommodation at Southbank should be charged to Esso was said to contain nothing requiring application of the "labour ratio". That ratio was applied by Esso, not EAL, to comply with the Accounting Manual.
105 As an example of EAL having incurred "indirect costs", Counsel for the Commissioner referred to evidence of Dr Mushin about updating the Esso workplace manual and other activities which were not engaged in as part of carrying out or providing the operations, facilities or other things comprising the Bass Strait project. As a result, Esso had been charged with costs which did not have the necessary nexus with the project or would be excluded as deductions by s 44(j) of the Act. The same could be said, it was argued, of the human resources activities to which Mr Yiannis had attested.
106 Counsel for the Commissioner noted that, as recorded at [31] above, payroll administration for the Gippsland locations had been contracted to a third party, ADP. It was explained that no record appeared in the Human Resources spreadsheet (Exhibit JRN 24) to identify a payment to ADP for that service. That suggested that the payment had been made by Esso rather than EAL.
107 It was also pointed out on behalf of the Commissioner, in relation to the ExxonMobil Law Department, that Mr Worrall had estimated, on the basis of the quarterly time allocation sheets, that 65% of the "upstream" work of his Department had been done for the joint venture. That was inconsistent with the "labour ratio" for the relevant period which was between 82% and 83%. Irrespective of that discrepancy, the work of the Law Department included processing a superannuation claim and litigation involving a royalty holder. Those matters, it was contended, could not engage the relevant sections of the Act; the expenses incurred in relation to them were similar to hedging costs or foreign exchange losses and therefore not deductible. Other matters deposed to by Mr Worrall were apparently unrelated to "upstream" activities.
108 Similarly, in respect of the GIS organisation, the Commissioner argued that the provision of information technology and electronic communications was in the nature of an administrative or support function. The cost of performing that function could be deductible only if a "but for" test were applied instead of the criteria prescribed by the Act.
109 It was acknowledged that the evidence about the Procurement Department, like that directed to other departments, showed an allocation of costs between "upstream" and "downstream" activities. However, there was nothing to demonstrate that the expense of business support activities referable, for example, to the tank farm at Long Island Point or the pipeline from Longford to Long Island Point had been excluded from the "upstream" costs. Likewise, the activities of the Procurement Department described by Mr Sorg were said not to engage the tests for deductibility elected by the Act.
110 Counsel for the Commissioner then canvassed the evidence of Mr Moskow about MRC, which was said to demonstrate that part of that cost had been allocated to the Scarborough and Kipper projects in accordance with the "exploration labour ratio." The cost of MRC had then been brought to account for the purposes of the Gippsland Basin and Blackback projects pursuant to s 45A of the Act which dealt with the transfer of exploration expenditure incurred on or after 1 July 1990.
111 In a related way, it was argued that there was no necessary connection between the MRC fee attributable to the Scarborough and Kipper fields and the way in which the fee had been treated for tax purposes. It was simply an arbitrary allocation. Moreover, there was only a tenuous connection between the benefits to a particular project from MRC and time spent by members of the exploration department on the same project.
112 The research undertaken by URC was claimed to be "general research". The product of some of that research may have been used for the Gippsland Basin and Blackback projects but that provided no more than a commercial justification for incurring the expenditure which was not directly related to the projects in question. Esso was entitled to use the product of URC's research however it chose, including for purposes unrelated to the relevant projects. The knowledge or information derived from the URC was "portable" anywhere within the ExxonMobil Group as demonstrated by the evidence of Mr Symes and Mr Djakic that they had both worked overseas for various subsidiaries of the Group. The former had applied the glycol technology in "the development of new offshore gas reserves currently under development at Kipper, Tuna and Turrum" as well as at installations in the Gippsland Basin.
113 In this context, attention was drawn to the evidence of Dr Russ, EAL's corrosion, materials and inspection engineer, which is summarised at [53] above. The Commissioner pointed to Dr Russ's assessment that "advance corrosion modelling and testing [carried out by URC] was directly relevant to my work as a corrosion engineer. In particular, during the early and mid 2000's this research was applied to the design work which I was working on in regard to the development of the Kipper field …". Similar references to benefits accruing to the Kipper field from URC's research were found in the evidence of Dr Shinners and Mr Griffith who had also worked overseas for ExxonMobil Group subsidiaries and had applied the EM power reservoir simulator developed by URC in the Turrum, Kipper and Bream fields as well as on the Bass Strait project.
114 Accordingly, the benefit of Mutualised Research was claimed to flow to Esso as a company. Although, at the relevant time, the only project of the kind described in s 38 of the Act in which it was involved was that of the Bass Strait Joint Venture, it was also carrying out exploration in the Scarborough and Kipper fields. However, elements necessary to engage a transfer of expenditure under s 45A of the Act had not been proved by Esso. As well, Esso derived a staff training benefit from its participation in the Mutualised Research program.
115 The analysis of Mutualised Research which the Commissioner preferred was said to be borne out by the fact that Esso's joint venture partner BHP was not charged any part of Esso's contribution to URC. That contribution, therefore, was neither exploration expenditure under s 37 nor general project expenditure under s 38. When regard is had to the operations, facilities and other things enumerated in s 19(4) as comprising a petroleum project, it can be seen that the contribution to URC was not a payment liable to be made by Esso in carrying on or providing the operations, facilities and other things comprising the Bass Strait project. The share to be borne by each member of the net cost of upstream research undertaken by URC in a particular calendar year was to be calculated by a formula which took into account the member's total exploration expenditure for the preceding two calendar years expressed as a proportion of all exploration expenditures by all members in the same period. Another integer in the same formula was the member's proved and probable hydrocarbon reserves at the end of the preceding calendar year expressed as a proportion of all members' proved and probable hydrocarbon reserves at the same year's end.
116 Similarly, the Commissioner drew attention to Art 10.6 of the URC Upstream Cost Sharing Agreement which provided, in part;
Except as provided hereinafter, any termination of this Agreement shall automatically terminate: (a) MEMBER's license to use URC's Upstream Patent Rights and technical information which was made available to MEMBER by URC under this Agreement and (b) any licenses which MEMBER extended to Extendees pursuant to Paragraph 7.2 hereof. However, upon the termination of this Agreement, except as provided in paragraph 10.3, or except on account of default by MEMBER, URC will grant to MEMBER a limited, paid-up, non-transferable, nonexclusive license to use technical information in MEMBER's possession upon termination and to practice inventions covered by URC's Upstream Patent Rights, but only with respect to inventions which resulted from Upstream Research conducted, or which are covered by patents licensed, during participation by MEMBER in this Agreement. …
117 By way of summarising the Commissioner's submission, Mr Wheelahan SC contended that the consideration payable to EAL was not a single, indivisible fee. The upstream expenditure was calculated and all charged to Esso. Components of that expenditure were then allocated to segments 05 and 06 to enable them to be distributed between Esso and BHP. That was done using a "labour ratio" which bore no relationship, at least in respect of some departments, to time spent by particular employees on the petroleum project. Consequently, all costs allocated in that way were "indirect" and did not attract the operation of s 37 or s 38 so as to render applicable s 41 of the Act. The latter section required account to be taken of expenditure which was deductible by force of s 32 and expenditure which was excluded from deductibility by s 44.