Exploration expenditure comprises of the expenditure other than the excluded expenditure which is incurred by a taxpayer in exploration for petroleum in the eligible recovery or the exploration area in relation to the petroleum project. Generally, if the scheme is an onshore petroleum project or if the production license is granted after 30th June 2008, then the relevant area for this purpose will be the entire exploration permit area till the time the production license is granted. Once the production license is granted, the relevant area includes only the production license area.
Exploration expenditures are also defined as the overheads which are earned by a mining organization. It is used to express the quality and location of the mineral deposits which was not exploited commercially before. The characteristic of exploration expenditure is not determined by the fact that a taxpayer holds an interest in a retention lease or an exploration permit, but it is a question of fact which should be determined in light of all circumstances.
As a general rule, exploration expenditures are recoverable and subjugated through depletion. Generally, the taxpayers do have the option to deduct a small percentage of the exploration expenses in the year in which they are incurred and then recapture those expenses when the property is transferred or when the production stage is reached. Exploration expenditures are typically high risk investments which are essential for the existence and growth of the mining industry.
Methods for recovering exploration expenditures
The two possible methods for recovering exploration costs or expenditures are:
1) It may be recorded as income in the first year of production.
2) It may be recovered by disallowing the depletion allowance until the cost is recaptured.
If the exploration expenditure is not included in income in the first producing year, then they must be recaptured through the allowance for depletion. The deduction for depletion will be disallowed until the recovery of the total amount of depletion expenditures that has been expensed previously.