Resource Super Profits Tax

Articles Written by Prashanth Kainthaje (Partner)

Introduction

The mining industry's reaction to the Australian Government's proposal to enact a Resource Super Profits Tax (RSPT), a rent based tax, as recommended by Australia's Future Tax System (Henry Review) and as announced in The Resource Super Profits Tax: a fair return to the nation (Government Response) has ranged from sceptical to utter dismay.

This article addresses the following questions:

  • What is a rent based tax?
  • Why does the Australian Government want to implement the RSPT?
  • What are the key features of the RSPT?
  • How does the RSPT interact with the income tax system and Australia's tax treaties?
  • What are the proposed transitional arrangements for the RSPT?
  • What is the Australian Government's timeline to develop and implement the RSPT?
  • Are there any other associated changes?

Executive summary

In summary, the RSPT and associated changes involve:

  • a 40% tax on the 'super profits' earned from the extraction and sale of nonrenewable resources from 1 July 2012 with a credit for any royalties; and
  • a refundable tax offset for exploration expenditure.

As the RSPT will be deductible for income tax purposes, the effective combined tax rate on the 'super profits' will be 58% (at the current corporate tax rate of 30%, which will reduce to 28% over time).

What is a rent based tax?

Economic rent and resource rent

The RSPT is a tax imposed on economic rents. Simply put, an economic rent is profit over and above the 'normal' profit (i.e. it is the profit remaining after all costs, including a return to all factors of production such as labour and capital). Economic rents are said to arise in the resources sector because the finite supply of non-renewable resources allows an operator of a resources project an opportunity to earn above normal profits (i.e. economic rents) from the extraction and sale of those resources in certain circumstances - hence the term 'resource rents'. In contrast, economic rents in other sectors attract new entrants, thereby increasing supply and decreasing prices and economic rents.

Alternative forms of rent based taxes

The Henry Review describes three alternative forms of rent based taxes:

  • Brown Tax: The Brown Tax is a cash flow tax levied at a constant percentage of the difference between receipts and expenditure, or net cash flow. In the case of a 'negative cash flow' (for example, expenditure on the construction of a mine), the Government refunds the tax value (e.g. 40%) of the negative cash flow to investors and thereby contributes to a share of the cost of investment. At the same time, the Government shares in the receipts of the project, thereby allowing the Government to collect a share of the rent equal to the tax rate.
  • Garnaut and Clunies Ross resource rent tax: The Garnaut and Clunies Ross resource rent tax is a cash flow tax levied at a constant percentage of the annual positive net cash flow. It is similar to a Brown Tax, but does not provide a cash refund for the tax value of negative cash flows. Instead, negative cash flows are carried forward with interest (known as the uplift rate).  The Petroleum Rent Resources Tax (PRRT) is an example of such a tax.
  • Allowance for Corporate Capital resource rent tax: An Allowance for Corporate Capital (ACC) resource rent tax is cash flow equivalent tax levied on profits measured as a net income less an 'allowance'. The allowance compensates the owners of projects for the delay in the Government's contribution to the cost of investment due to the slower recognition of  expenses through depreciation and the lack of an immediate refund of losses.

Each form of resource rent tax seeks to tax the resource rent associated with the underlying activity, irrespective of how the project is financed. There is therefore no deduction for financing costs incurred by investors.

The Australian Government has accepted the Henry Review's recommendation to implement a RSPT that is in the form of an ACC resource rent tax.

Why does the Australian Government want to implement the RSPT?

In summary, the Henry Review and the Government Response state a number of reasons for introducing the RSPT. First, both the Henry Review and the Government Response state that the Australian community has not been obtaining an appropriate return for the exploitation of non-renewable resources. The Henry Review notes that Australian Governments have traditionally charged for resources by imposing an output based tax regime (i.e. royalties). The Henry Review observes that output based regimes collect a greater share of the returns to resources when profitability is low or negative, and collect a smaller share of returns when profitability is higher. It notes that Australian Governments can respond to greater profitability with increased output based taxes, albeit potentially increasing 'sovereign risk' (that is, the risk of future adverse changes to Government policy).

Secondly, the Henry Review argues that the introduction of the RSPT may reduce sovereign risk on the basis that a rent based tax will collect a constant share of the rent under different economic conditions. The Henry Review cites recent examples of State Governments increasing royalties. The Henry Review does not discuss the sovereign risk associated with the introduction of the RSPT.

Thirdly, the Henry Review argues that the current system of output based taxes distorts investment and production decisions. It is argued that a more economically efficient tax is less likely to make commercially viable projects unviable and to create a bias toward less risky investments. The prime reason for this is that output based taxes are generally levied irrespective of the costs of production. Consequently, investors receive a lower post-tax return from a more expensive operation because costs are not recognised for tax purposes. This is also of particular significance for those undertaking risky projects. The Henry Review argues that output based taxes are biased against riskier investments because the entirety of the risk is borne by the operator of the project. In contrast, the risks associated with a project are shared with the Government under a rent based tax system. It is claimed that the use of output based royalties can be expected to result in fewer discoveries, less output from discovered deposits and earlier closure of projects than would otherwise be the case.

A rent based tax does not apply to the normal return generated by projects. Rather, the Government is a silent partner in the project under a rent based tax system, sharing in both profits and losses from the project. Overall, each partner contributes something to the partnership - private firms contribute rents associated with their expertise and the Government contributes rents associated with the rights to the community's non-renewable resources. Both of these rents are shared according to the resource rent tax rate. Having regard to the proposed form of the RSPT (as to which see below), it is not difficult to see why some view it as a nationalisation of 40% of the resources sector in Australia.

Fourthly, the Henry Review recognises that corporate tax applies to economic rents as well as the normal return. According to the Henry Review, this has placed a constraint on the Australian Government on setting the corporate tax rate as the Australian Government has to weigh the benefits of attracting internationally mobile investment against the loss of tax revenue that could have been collected from location specific investments, such as investment in resource projects. Thus, to carry the argument further, the introduction of the RSPT can perhaps add some policy flexibility to the Australian Government's corporate tax policy in relation to attracting internationally mobile investment. To this end, the Australian Government has announced its intention to reduce the corporate tax rate to 29% for the year of income ending 30 June 2014 and to 28% for the year of income ending 30 June 2015 (although the Henry Review had recommended a reduction to 25%).

What are the key features of the RSPT?

As noted above, the Australian Government's proposal for the RSPT involves the implementation of an ACC resource rent tax as recommended by the Henry Review.

The RSPT will be charged at 40% of the assessable resource profits (in general terms, assessable revenue, less deductible expenses (which includes an allowance for capital expenditure but excludes certain costs such as financing costs, as discussed further below)). This is in line with recommendations of the Henry Review. Both the Henry Review and the Government Response state that the RSPT rate provides an appropriate balance between ensuring the community receives what is described as a fair return for its non renewable resources, while maintaining incentives for resource firms to invest and to improve their productivity by leaving them with 60% of the so-called 'super' profits, reflecting that only 60% of their investment is at risk.

The RSPT will apply to all tax entities - companies, partnerships and trusts - directly involved in the extraction or sale of non renewable resources in Australia, with the exception of projects already subject to the PRRT. Opt in arrangements will be developed with industry consultation. The RSPT will not be levied on shareholders of a company or beneficiaries of a trust where the company or trust is involved in the exploitation of non renewable resources. The RSPT will be calculated separately for each project interest. This design feature will be important for joint ventures where joint venturers contribute different amounts of capital to a project.

In principle, the RSPT will only be payable on resource extraction activities. The Henry Review suggests that the taxing point be set as close as possible to the point of extraction of the resource - for example, the mine gate or the well-head, to be consistent with the taxing of the market value of the underlying non renewable resource. However, the Henry Review notes that the value of the resource at this stage in the production process is sometimes not observable and may need to be derived. The Government Response states that a 'practical approach would be to set the taxing point where a saleable commodity exists (the earliest point that a world-price or arms-length sale occurs), similar to the case under the existing PRRT'. The Government Response observes that for some commodities this may include processing and transportation. This has been a contentious issue in the PRRT arena and it is likely to be a contentious point in the design of the RSPT.

The RSPT will assess receipts from the sale of resources and allow deductions for the cost of extracting resources and getting them to the taxing point. The RSPT will not allow deductions for the following types of expenditure:

  • payments of interest and financing costs, including the cost of issuing shares, the repayment of equity, the payment of dividends, and financial hedging costs (cf. Woodside Energy Limited v Commissioner of Taxation (2009) 174 FCR 91);
  • payments to acquire an interest in an existing exploration permit, retention lease, development licence, production licence, pipeline licence or access authorities;
  • payments to acquire interests in projects subject to the RSPT; and
  • payments of income tax and goods and services tax.

Unlike PRRT, capital expended on the development of a project will not be immediately deductible, although exploration expenditure will be immediately deductible. The Government Response has stated that the capital allowance rate arrangements used for income tax purposes could also be used under the RSPT. The RSPT capital base will not change with ownership. Where a project or entity is sold, the RSPT will continue to operate based on the original tax value. In other words, the residual value of the assets for RSPT purposes will not be revalued when a project or entity is sold.

It is intended that each payer of the RSPT will have a capital account for RSPT purposes that records undepreciated tangible capital expenditure and unutilised losses. The RSPT capital account will keep a record of the tax credit carried forward. The closing balance of the RSPT capital account from previous tax years is used to calculate the RSPT allowance, which is deducted from revenue to determine the RSPT liability.

The Henry Review describes the government as a 'silent partner' in a project. However, unlike a Brown Tax, the ACC resource rent tax model does not require the government to contribute directly to 'negative cash flows'. Rather, the government provides a guaranteed tax credit for all expenditure. This is achieved through immediate deductions, depreciation, carry forward and loss transfer provisions and, unlike PRRT, the refunding of 40% of a RSPT loss in the event of a project's closure, provided that the RSPT loss cannot be transferred to another project.

To ensure investors are not made worse off by the deferral, the RSPT will provide entities with an uplift allowance that compensates for the delay in accessing credits. The allowance is designed to ensure that the real value of the RSPT capital account is maintained. Both the Henry Review and the Government Response have argued that the allowance rate should be set at the 10 year Government Bond rate.

In the Australian Government's view, the required rate of return or the weighted average cost of capital for a particular company is not appropriate for the RSPT allowance rate. The argument is that the Australian Government guarantees to recognise the tax credits when a project winds up (at the very latest) and, as such, the required rate of return to compensate investors for the delay of tax credits is independent of the risk of the project. Thus, it is argued, the use of a rate higher than the 10 year Government Bond rate would result in a subsidy to the resource sector and distort investment away from other sectors of the economy. An alternative way of looking at this is that an operator of a project provides a loan equal to 40% of the project's cost to the Australian  Government at the 10 year Government bond rate to enable the Australian Government to be a 'silent partner' in the project. However, as the operator's cost of capital is unlikely to be the same as the 10 year Government Bond rate, it is not difficult to see why the RSPT allowance rate is likely to be a contentious point.

There is no proposal to abolish the existing royalty systems that exist across Australia. Rather, a credit will be provided for any royalties paid. The objective of the credit is to reduce the impact of royalties and negate concerns that the RSPT will amount to a double tax. The refundable credit will be available at least up to the amount of royalties imposed as at 2 May 2010, including scheduled increases and appropriate indexation factors. Concern has been expressed that there may potentially be a cap on the credit for royalties.

The RSPT will exclude receipts from the transfer of ownership in the resource project, but the transfer of assets in the project will be subject to a balancing adjustment.

How does the RSPT interact with the income tax system and Australia's tax treaties?

It should be noted that the RSPT is designed to tax the 'super' profit. Both the 'normal' profit and the 'super profit' are subject to income tax. However, RSPT payments will be deductible for income tax purposes and RSPT refunds will be assessable for income tax purposes. Payments of RSPT will not generate franking credits. This is similar to the existing PRRT regime.

Both the Henry Review and the Government Response are silent on the interaction between the RSPT and Australia's tax treaties. As a general proposition it is debatable whether the proposed RSPT is a tax that is covered by Australia's tax treaties. This should be contrasted with PRRT. Australia's tax treaties in many cases oblige Australia's treaty partner to provide relief against double taxation with respect to PRRT. This is notwithstanding the Australian Government's position that the PRRT is an income tax: see, for example, paragraph 2.36 of the Explanatory Memorandum to the International Tax Agreements Amendment Bill (No. 2) 2009 (Cth).

What are the proposed transitional arrangements for the RSPT?

All existing projects and new projects will be subject to the RSPT, with the exception of projects already subject to PRRT (as noted above). Projects subject to PRRT will be able to opt into the RSPT.

The Government Response has indicated that the owners of existing projects will be permitted to commence with a 'RSPT starting base'. The RSPT starting base is intended to provide a credit to reduce future RSPT liabilities in recognition of the investment that has already taken place. In principle, the accounting book value (measured in accordance with Australian Accounting Standards) based on the most recent audited accounts available as at 2 May 2010 (the date of announcement) will be used to compute the RSPT starting base. The historical cost of the assets will be included in the RSPT starting base if the assets are acquired after the accounts were audited but before the announcement of the RSPT. Where an asset is disposed of, or taken out of the project during the interim project, the asset's indexed-RSPT base value will be removed from the RSPT starting base. Importantly, the RSPT starting base referable to preannouncement investment will not be transferable or refundable.

The Government Response states that investment during the interim period (i.e. from 2 May 2010 to 30 June 2012) will be treated as it would under the proposed RSPT system. All acquisitions of capital and exploration expenditure during the interim period will be included in the RSPT capital account value at its historical cost and indexed, from the time of purchase, at the RSPT allowance rate. Acquisitions of capital and exploration expenditure will not be depreciated for RSPT purposes during the interim period, but such expenditure will be subject to the RSPT loss transfer rules and loss refund rules following commencement. An asset's indexed RSPT capital account value will be removed from the RSPT capital account where an asset is disposed of during the interim period.

The Government Response acknowledges that the RSPT will increase the tax paid by entities operating in the resources sector with consequential effect on the cash flow of these entities. Accordingly, the Government Response states that the RSPT starting base will be subject to a form of accelerated depreciation at the rate of 36% in the first year, 24% in the second year, 15% in the third and fourth years and 10% in the fifth year. Where a project does not generate sufficient profits for RSPT purposes to utilise the accelerated depreciation deduction, the loss can be carried forward to offset future taxable profits under the RSPT regime. That said, the RSPT starting base will not be transferable to other projects and will not be refundable if the project closes.

What is the Australian Government's timeline to develop and implement the RSPT?

Are there any other associated changes?

Recommendation 32 of the Henry Review recommended that exploration expenditure should obtain the benefit of a 'refundable tax offset' (i.e. a rebate) at the corporate level for exploration expenses incurred by 'Australian small listed exploration companies', with the offset at the corporate tax rate.

The Government Response has indicated that a resource exploration refundable tax offset will be provided under the income tax system. It is intended that a refundable tax offset will apply to the expenditure that currently obtains an immediate deduction under section 40-730 of the Income Tax Assessment Act 1997 (Cth). Expenditure incurred in exploring for geothermal energy will also be eligible for the new refundable tax offset.

Practical things to consider or do now

Companies should:

  • note the difference between pre-announcement expenditure and postannouncement expenditure and keep adequate records to assist in determining future RSPT liabilities or RSPT refunds;
  • review existing contracts, paying close attention to:
    • any clauses dealing with price variations based on tax changes; and
    • profit sharing arrangements to see if the profits are measured on a pre- RSPT or post-RSPT basis;
  • review the impact of the RSPT on existing financing arrangements; and
  • review acquisitions and expenditure from a RSPT perspective.

Concluding comments

The Henry Review and the Government Response have provided introductory details on the RSPT. If the RSPT is ever implemented, it is destined to be an extremely complex tax and there is likely to be much devil in the detail. Whether the RSPT can be described as a 'reform' (a word that generally connotes improvement) or a synthetic nationalisation of 40% of the Australian resources sector will be the subject of intense debate in Australia and elsewhere. Those who consider the RSPT to be a reform should perhaps consider the words of Senator Roscoe Conkling:

Some of these worthies masquerade as reformers. Their vocation and ministry is to lament the sins of other people. Their stock in trade is rancid, canting, self-righteousness. ... Their real object is office and plunder. When Dr Johnson defined patriotism as the last refuge of a scoundrel, he was unconscious of the then undeveloped possibilities of the word 'reform'.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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