Hon Dr Michael Cullen
Minister of Finance
Hon Peter Dunne
Minister of Revenue

4 March 2008 Media Statement

Govt to close petroleum mining tax loophole

The government will close a legislative loophole to prevent New Zealand missing out on significant tax revenue from the burgeoning petroleum mining industry, Finance Minister Michael Cullen and Revenue Minister Peter Dunne announced today.

“Under current law, New Zealand petroleum miners can offset their expenditure in other countries against the revenue from their New Zealand operations,” Dr Cullen and Mr Dunne said.

“That means New Zealand might receive less income tax than expected on profits from oil production in New Zealand, which is particularly unacceptable when oil production revenue from New Zealand is at an all time high and predicted to grow.

“To safeguard our taxing rights on our petroleum resources, the government will amend the Income Tax Act to ensure that expenditure on petroleum mining operations undertaken through a foreign branch cannot be offset against petroleum mining income from New Zealand.

“That will bring New Zealand’s taxation of petroleum mining revenue into line with the practice of a number of other countries.

“The changes will be included in the next taxation bill and, once enacted, will be effective from today. Expenditure incurred before today will not be affected by the changes.

“In the meantime, the government will be consulting with the petroleum mining industry on the details of the planned changes.

“New Zealand oil and condensate production is at levels not seen since the time of the Maui B development in the 1990s, with four major developments that are in production or due to begin within the next 12 months.”

“It is estimated that over the next ten years the gross revenue from petroleum mining in New Zealand will be about $20 billion.

“It is therefore essential to ensure that New Zealand receives its proper share of benefit from its petroleum resources,” they said.

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Questions and answers – Petroleum mining announcement

1. What are the main features of reforms announced today?

The reforms are intended to protect the significant tax revenue being generated by New Zealand’s growing petroleum production.

Expenditure incurred on petroleum mining operations through a branch in another country will be allowed to be deducted only from income from those foreign petroleum mining operations. The effect is to prevent foreign branch petroleum mining expenditure being offset against income from petroleum mining in New Zealand, so that tax is paid on it. This change will also prevent this expenditure from being used to offset non-petroleum mining income.

While discussion with the industry on the details is still to occur, expenditure incurred from today will be affected by the new rules. Expenditure incurred before today will not be affected by the new rules.

2. What is the concern?

The concern is that there is a risk that income from petroleum mining operations in New Zealand will not generate any tax revenue for New Zealand.

The current tax treatment of petroleum mining is primarily designed to encourage petroleum exploration and production in New Zealand. However, the rules effectively allow expenditure on petroleum mining operations outside New Zealand to be deductible in New Zealand, as shown in the example.

Example: how mining operations overseas become tax-deductible here

New Zealand Company has net income of $100 million from its petroleum operations in New Zealand. The parent of New Zealand Company is based in Country X. The parent company wishes to invest $100 million on exploration in Country Y. The parent company would normally invest directly in Country Y. The concern is that the current tax law encourages the parent company to have New Zealand Company set up a branch in Country Y. This way the expenditure on exploration in Country Y can be immediately offset against the petroleum mining income of New Zealand Company. The result is that New Zealand collects no tax on the $100 million of New Zealand petroleum mining income earned by the New Zealand Company.

An additional concern is that companies that operate in a number of countries are also able to structure arrangements in such a way that no income from the foreign branch petroleum mining operations will ever be returned to New Zealand.

3. How much tax is at risk?

It is difficult to say with any certainty because many factors are at play. Four major developments have recently started production or are about to start production in the next 12 months. The government expects that over the next ten years known New Zealand petroleum fields will generate over $20 billion of gross revenue. This suggests that there is significant tax at risk.

Safeguarding New Zealand taxing rights on its petroleum resources is in line with the practice in a number of countries. For example, the United Kingdom ring-fences income from North Sea oil operations and does not allow expenditure on foreign oil fields to be offset against it.

4. Why the urgency?

Revenue from oil production tends to peak early in a field’s production life. The concern was that delaying this announcement could potentially result in New Zealand missing out on a large amount of tax because petroleum miners might use foreign branch expenditure to offset their petroleum mining income from New Zealand. The government therefore had to proceed with urgency to protect the tax base. The government will consult with interested parties on the technical details of the new rules.

The fact is that oil production revenue from New Zealand is now at an historical all-time high and expected to grow. The export of petroleum and petroleum products was valued at $250 million for the third consecutive month in December 2007. Nearly half of the GDP growth in the September 2007 quarter was due to production from the Tui oil field.

5. Who will be affected?

The reforms announced today do not change the tax treatment of petroleum mining operations in New Zealand. Petroleum miners will be able to fully offset exploration expenditure and amortise development expenditure from their New Zealand operations against income as normal.

The changes will affect those companies that have, or are planning, petroleum mining operations in other countries through a foreign branch structure. While companies can still structure arrangements in this way, they will not be allowed to offset this expenditure against petroleum mining income from New Zealand.

6. What are the next steps?

The main amendments preventing expenditure on petroleum mining operations outside New Zealand being used to shelter petroleum mining income from New Zealand operations will be included in the next available taxation bill.

Tax policy officials will consult with the petroleum industry on the details of how this quarantined expenditure may be treated in the future.

ENDS

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