The respondent agreed with the applicants that when the contractor disposes of an interest in a petroleum agreement previously acquired, S 89G of the ITA applies. The respondent submitted that regardless of whether the cost base is calculated under S. 89G(c) or S. 89G (d) the applicants are not entitled to include their exploration, development or production costs in their cost base in calculating the gain they realised on the disposal of their interest because the costs are only recoverable against cost oil. In contrast, under S. 89G (d) of the ITA, the applicants are not entitled to include incidental expenditures in their cost base.

The respondent contended that the applicants received US$ 150,000,000 as excess costs, from Heritage when they purchased the latter’s interest. The respondent argued that although CNOOC and Total may recover excess costs from cost oil, the applicants’ argument that their cost base should include the US$ 150,000,000 ignores the application of S. 89G (d) of the ITA. The respondent argued that under S. 89G (d) (i) the applicant’s cost base for purposes of calculating gain on the sale of Heritage’s interest cannot include the US$ 150,000,000. In calculating the applicants’ gain from the sale, the respondent reduced the applicants’ cost base by US$ 150,000,00 which were exploration costs that were deemed as excess costs under S. 89C(2) of the ITA and must be subtracted pursuant to S. 89G(d)(i) of the ITA. The respondent asked the Tribunal to allow the reduction of US$ 150,000,000 as excess costs that would be deductible by CNOOC and Total.

The respondent contended that the exploration costs of US$ 320,545,819 claimed to have been incurred by the applicants on EA1, EA2 and EA3A were not substantiated nor audited by the respondent. The applicants claim to have transferred these costs to Total and CNOOC, at the same time they seek to recover them by including them in their cost base. The respondent submitted that the US$ 320,545,819 were part of the bundle of rights and interests in the PSAs that was sold for the consideration of US$ 2,933,330,400. The respondent contended that they should not include them in the cost base because they are recoverable against cost oil. The respondent contended that Sections 89C (1) and 89C (2) do not disallow deductions for petroleum operation expenditures in the years where there is no sufficient cost oil; they merely suspend the deductions until future years.

The respondent contended that the applicants’ argument that prior to the commencement of commercial production, no deductions are allowed as there is no excess costs is a misreading of Part IXA of the ITA. The respondent argued that exploration, operation and development operations are by their very nature undertaken prior to the commencement of commercial production. S. 89C(1) of the ITA specifically permits deductions for exploration and development operations costs and limits these deductions to cost oil in the year they were incurred. The respondent concluded that the portion of excess costs that has been passed along to subsequent purchasers under S. 89G (a) of the ITA cannot be included in the applicants’ cost base for purposes of calculating their gain.

The respondent argued that an alleged loss claimed by the applicants is fictitious. The respondent claims that the applicants transformed what was a profitable transaction into a loss for tax purposes by applying the ‘last in, first out’ accounting method. The respondent submitted that what the applicants sold were undivided interests. The respondent, inter alia, cited Black’s Law Dictionary which defines “undivided interest” as “an interest held in the same title by two or more persons, whether their rights are equal or unequal as to value or quantity”. The respondent submitted that given the nature of such an interest, a taxpayer cannot choose the cost base that it wishes to allocate to a subsequent sale. The respondent cited the case of John K. McNulty v Commissioner of Internal Revenue, Tax Court (United States), T.C. Memo, 1988-274 where the court held that “A taxpayer who owns two undivided one- half interests in property received at different times, and disposes of an undivided one-half interest, is deemed to have disposed of 50 percent of each of the halves he owned.”

Pages: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57