The Australian Government’s RSPT proposal
The Federal Government’s proposed ‘Resource Super Profits Tax’ (RSPT) announced in the May 11th Budget seeks to tax ’super’ profits by resource companies made from all non-renewable resources at a rate of 40% from July 2012. Super profits are defined as profits that exceed a relatively low threshold rate of return, essentially the risk-free rate of return. In its Budget proposal the government sees the risk-free rate in this case equal to the yield on a ten-year Government bond (LTBR), which is currently 6%.
The RSPT would, if approved, supplant the crude oil tax regime and function in conjunction with State/Territory royalty regimes.
Through the RSPT the Australian Government proposes to become in effect an associate of mining companies by crediting 40% “of accumulated project losses and undeducted capital expenditure even if a project should be closed”.
However the Government does not immediately fund the joint venture. It is the mining company which holds 60% of the joint venture that has to “lend the Government its share of capital costs” (40% at the LTBR).
Since the Government holds 40% of the joint venture, it proposes taking 40% of the mine’s exploitation profits. These profits will nevertheless be reduced by RSTP allowances.
Because 40% of the project is guaranteed by the Government, mining companies should borrow 40% of the total capital of the project at 6% (LTBR = risk free rate). Based on this assumption, the Government starts taking profits as soon as the rate of return on the project outstrips the LTBR.
In theory, the Government believes that, even if the RSTP “reduces” profits, it should not have a negative impact on investment; and that the return on funding needed to finance the balance of the project remains identical.
According to KPMG if this tax is implemented “Australia will have a higher effective tax rate” than those of Canada, Brazil, China, Indonesia, India, South Africa, Argentina.
Current debate
1. The Australian Government’s position
- The Government, supported by a range of economists, argues that “the RSPT will provide a more appropriate return to the Australian community from the exploitation of its non-renewable resources compared with the current charging arrangements.”
- Treasury claims that RSPT will be a more efficient means of collecting a rightful share of the returns to the community and of removing obstacles to mining investment and production. Treasury says the RSPT will foster greater investment and employment in the resource sector.
- According to the Australia’s Futures Tax System Review’s Consultation Paper, Australia is currently shifting towards profit-based royalties in the resource industry. Other OECD countries with important resources endowments have already adopted profits-based taxation, which has influenced the standards for Australia.
- According to Econtech, a prominent economic modelling agency, under the RSPT scheme mining investment should in the long run rise by 4.5%, jobs by 7% and mining production by 5.5%.
- According to Treasury Secretary Dr Henry, the resource industry has enough projects on the agenda for the next 30 to 40 years and investment should continue, despite the claims of the miners.
- The introduction of the RSPT is supported by 20 Australian leading economists. They emphasize that “the existing royalty system reflects the fact that it is desirable to levy a charge for access to publicly owned mineral resources, in addition to normal corporate income tax.” However they admit that the finer details still need to be negotiated.
- According to S&P’s associate director, “the mining tax would have no implications on Australia’s credit rating, which is a barometer for a nation’s sovereign risk.” Australia has been rated AAA since 2003. He adds that “the revenue projected to be earned by the tax, $12bn in the first two years, could strengthen the rating given the positive influence on net national income.” In 2009 Australia reached its 19th consecutive year of growth, with a GDP above 2.7%.
- According to the Coface (a French country-rating agency), “Australia has without doubt the prize for excellence in all categories, as much in terms of its debt or deficit.” The International Monetary Fund predicts that in 2010 Australian national debt will stay below 20% of the GDP.
In the face of strong opposition from the mining industry to RSPT, the Government has embarked on a controversial $38 million advertising campaign to counter what it sees as misinformation. However at this stage, voters are strongly divided on the issue, with most against the measure in its current form.
2. The Australian mining industry’s position
The major players in the mining industry have reacted strongly against the tax and have monitored a major political and advertising blitz. This includes the release of studies and reports.
- In a study commissioned by the Minerals Council of Australia, the Radar Group said that “institutional investors believe the implementation of the RSPT will have a highly detrimental impact on both the Australian equities market and the Australian economy over both short and long term.” Between the announcement of the proposed tax on May 2nd and May 29th, Rio Tinto shares have dropped down 5.5%, BHP 4.8% and Fortescue Metals 9.17%.
- The report also emphasizes that no less than 66% of investors surveyed believed that the proposed RSPT would have a significant impact on future institutional investment in the Australian resources sector while 33% believed it would have a moderate impact.
- In another report commissioned by the Minerals Council of Australia, KPMG argues that “capital markets and in particular debt markets, will be unable to price funding at the LTBR due to risk and pricing issues.” For instance, the bankers of Fortescue Metals - one of the leading producers of iron ore - withdrew from Fortescue’s outstanding projects on this basis.
- The KPMG report also stresses that a higher effective tax rate and funding costs above the LTBR aim at reducing net present value returns of mining projects. Because of risk and pricing issues, the capital market, and more specifically debt markets, will not be able to set the interest rate the same as the LTBR. In the end the report is positive the RSPT at 40% will severely impact the mining sector. Recovery for the sector is only expected to be on the long term.
- The mining industry’s arguments have been strengthened by poor communication and industry consultation by the Australian Government which has led many financial and economic experts to claim that investors seeking to buy Australian assets or sell Australian holdings could be faced with uncertain tax outcomes. This lack of transparency has generated what investors regard as “change law risk”/ Sovereign Risk, which creates uncertainty. Some observers though question the term “Sovereign Risk” as it is more generally linked to company asset expropriation by government, breakdown in the rule of law etc.
- The prospect of tax grabs with no prior consultation or warning - and, worse, the prospect of retroactive tax grabs - has generated uncertainty. It takes mining corporations years of investment before making any actual returns and now, in addition of the risk associated with their operations, they also have to take into consideration the possible decisions the government might take about them.
- The industry argues that profits trigger future investments. The higher the risk, the greater the expected return to justify the risk. Overtaxing profits maintains low productivity, low risk and low pay industries. The interest charged on the Government’s unpaid contributions is based on the risk-free rate, which means interest payments will be too low to prevent risks and costs from being borne by miners, and therefore too low to encourage investments.
My view
Such a major change at time when Australia and the world is emerging from the global recession has surprised many. The RSPT appears as an improvement on the current approach but in some areas the proposal made by the Treasury appears to be too theoretical and disconnected from the reality of the market.
In the end negotiation will be necessary to reach agreement between the government and the mining industry. At the moment, both sides have deeply entrenched positions, and a short term solution is not expected.
However, I believe that political pressure and the looming federal election later this year is likely to see a compromise achieved. This is likely to take into consideration the risk incurred by mining companies and the need for clarity for those institutions to fund more projects.
Any compromise or new scheme will also need to better balance the drivers of future growth and a better return to the Australian people. Australian voters will be watching closely. In the end, perhaps at a reduced level, the RSPT appears as a fair and necessary measure but the timing of its implementation and the way it currently works is definitely not ideal.
Arnaud Eard
Arnaud comes from Paris and gained a MA in International Political Economy at the University of Sheffield. He has been interning at Bluegrass Consulting since May 2010.
