As explained on the previous page, there are two types of investments that are allowed to be recovered and deducted from revenue for tax calculation. These two types include: the investments that can be expensed (deducted in full amount on the year occurred) and capital costs that have to be deducted (“capitalized”) over more than one year.
It’s obvious that the faster an investor can deduct the recoverable investments from the revenue, the better economic benefits will be for the project. For example, if there is no limitation, the investor is better off if deducting all the investments in full amount in the year of occurrence and paying lower tax in early years than later years. (We learned in this course that money is worth more on closer future). But tax law doesn’t allow all the investments to be expensed, and there are strict regulations for different types of investments.
Operating costs that may be expensed include costs for direct labor, indirect labor, materials, parts, and supplies used for product produced and sold. Only costs associated with product actually sold may be deducted. Some other common costs in the operating expense category include utilities, freight and containers, borrowed money interest paid, royalties, severance taxes, sales taxes, ad valorem taxes, and certain excise taxes. Note that costs such as spare parts inventory, accounts receivable, required cash on hand, etc., are not deductible for tax purposes until such items are actually used up or sold. These costs are called working capital.
Research and Experimental Costs
Research and experimental costs including labor, supplies, etc., are considered to be the equivalent of operating costs and may be expensed in the year incurred.
Mining Exploration Costs
Mining exploration costs are expenditures required to delineate the extent and quality of an ore body and may include core drilling, assaying, engineering fees, geological fees, exploratory shafts, pits, drifts, etc. Exploration costs may be either capitalized into the cost depletion basis or expensed in the full amount in the year incurred by individual taxpayers.
Mining Development Costs
Mining development costs are defined as expenditures incurred after the determination has been made that an ore body is economically viable and the decision has been made to develop the property. Development costs may include exploration type costs after the decision has been made to develop a mine. Mining development costs typically include costs for overburden stripping, underground shafts, drifts, tunnels, raises, audits, etc. Development expenditures end when a mine reaches a level of full production. Then, costs that previously were mine development costs are treated as operating expenses from the time forward.
Petroleum Intangible Drilling Costs (IDC's)
Petroleum Intangible Drilling Costs (IDC's) are defined as the cost of drilling oil and gas wells to the point of completion and may include:
- Costs of agreements with operators and drilling contractors
- Survey and seismic work related to location of a well
- Road cost to well location to be used during drilling
- Dirt work on location for pit, etc.
- Rig transportation and set-up costs
- Drilling costs including fuel, water, drilling mud, etc.
- Costs of technical services including engineering, geologists, logging, and drill stem test services
- Cost of swabbing, fracturing, and acidizing
- Cementing of surface casing and main casing (not the cost of casing)
- Reclamation of well site
Similar to mining development costs, intangible drilling costs may either be capitalized into the cost depletion basis or expensed in full amount in the year incurred.
Italicized sections are from Stermole, F.J., Stermole, J.M. (2014) Economic Evaluation and Investment Decision Methods, 14th edition. Lakewood, Colorado: Investment Evaluations Co.