Mr. Rudd’s Super Profit Tax

10 05 2010

Oh my, 40% tax on resource profits sounds like a lot. Actually, it is. In effective terms, it will bring the tax rate on mining to 57% (up from 43% currently), making it the highest taxed resources industry in the world. There is currently a lot of debate about the extent to which the Australian mining industry will be negatively affected by this new tax. While the debate rages on, I decided to put my two [tax analyst] cents in to assess whether this new tax is 1) the plague, 2) cholera or 3) just a storm in a tea cup. But before that, Ladies and Gentlemen, the facts:

The Beast

The Super Profit Tax, effective in 2012, will apply a 40% tax rate on profits from Australian operations that are above what the Government considers reasonable. Reasonable in this case will be defined as the value of a mine’s asset multiplied by the interest rate of the 10-year Government bond (of 6%). The amount of profits above that amount will be taxed at 40%. The existing Petroleum Resource Rent Tax kicks in at profits five percentage points above this rate. To make this new tax policy more bearable, the Government will introduce an exploration tax rebate of 30%. The new tax is expected to raise AUS$3 billion in its first year.

This new tax, a by-product of the Henry Tax Review, will replace the current royalty regime as part of which companies were taxed on production rather than on profits. The Henry Tax Review is also suggesting that the corporate income tax be reduced by 2%.

Reaction Shot

Let’s cut away from the facts and focus on the industry’s reaction to the announcement of the tax. First there was the general outcry from industry which now seems to have been replaced by an organized a more coordinated response through the Keep Mining Strong website, media advertisements and the mobilization of their shareholders.

Remember that last week some firms have responded quite erratically to the announcement of the new tax. For example, Cape Lambert Resources halted plans to drill for iron ore in the Pilbara citing the legislative uncertainty caused by the tax. The Chairman of the company apparently still went on to buy a million shares in the company, though. While this is an extreme, and purposely cherry-picked, it seemed that many were anxious about the ability to sustain investments in the mining industry in the conditions created by the new tax.

Perceived Risks

The announcement of the new tax will “kill the goose that lays the golden egg” by making Australia less attractive for investors. While it is true that a tax reduces the return on investment, mining assets are not mobile across borders and it would be a bit far-fetch to predict that investment would evaporate. I am a bit sceptical of a lot of the negative impacts attributed to the entry in force of the new tax.

For example, the assumption that small mine developers will be literally clobbered by this new tax. This is perhaps a bit bold but I would think that they may be positively impacted by the new tax policy as they’re unlikely to post excessive profits (or even posts profits to begin with) but on the other hand they will get a refund of 30% of their exploration expenses and reduce their taxes owing substantially. The implementation of a flow-through share system, if envisioned, to pass these deductions onto shareholders could also have the effect of helping these guys attract capital.

There is also the risk that firms be tempted to reduce their output to maintain profits below the threshold of reasonable profits in order to keep their taxes low. Yet, doing this, would come at the (likely greater) costs of relinquishing opportunities arising from rapid growth, inflation, emerging market demand. I am sceptical that this scenario could materialize on a large scale.

In Sum, it’s more like a chronic neck pain

Overall, I think that the industry should be able to stomach the tax increase. The attractiveness of Australia as a mining jurisdiction is based on factors beyond taxation. The Fraser Institute’s Survey of Mining Companies for 2009-2010 ranked South Australia in the top 10 of mining jurisdictions. According to the survey, the taxation regime in most Australian jurisdictions (under the previous regime) was considered as only a mild deterrent to investment. Jurisdictions with taxation regimes considered to be strong deterrents to investment are developing countries with unstable regimes and a high level of corruption (but still advertising low statutory tax rates). Note that the survey did not provide for the possibility to answer that a taxation regime was conducive to investment, confirming that taxation is indeed a pain in the neck.

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5 responses

11 05 2010
LittleMiss

Actually, it doesn’t make Australia the highest resource tax environment in the world. That title goes to Norway who apply a 78 per cent effective tax rate to the petroleum sector.

18 05 2010
Martha Black

I guess that the stat that I quoted refered strictly to mining and perhaps did not cover other extractive industries like oil and gas (I should look it up). At first glance I am not surprised that Norway applied such a high effective tax rate for the oil industry (taxes at large are high in nordic countries). Although, I find interesting that Norway taxes at such a high rate considering that oil is exploited mostly by a state-owned company which suggests that taxed or not revenues would still reach the Government in someway. Perhaps revenue collection is more efficient that way, who knows….

13 05 2010
businessmining

I agree with your conclusion that the industry should be able to stomach the tax increase. However, the impact on the mining firms will be an interesting combination of output-effects, price impact, investment cuts and a decrease in the levels of acquisition. For the Australian government, only the short term price-impact will turn out positive.
The most important reason for the industry to complain (unsuccesfully) is the decrease of free cash flow generated by the operations. The new tax system will make projects previously deemed profitable a lot less attractive, which will certainly reduce capital investment in the industry, although exploration might stay on the same levels. For a graphical representation of above visit http://businessmining.wordpress.com/2010/05/13/miners-vent-fury-at-australias-tax/

31 05 2010
Effective Tax Rates on Mining « Just Digging: a Mining and Metals blog

[…] have made you aware in a previous entry, that the mining industry’s organized response to the new Australian mining tax would be […]

1 11 2010
Deal Imploding? « Just Digging: a Mining and Metals blog

[…] of rising iron ore prices, delays in getting regulatory approvals and uncertainties related to the Australian super-tax, the Pilbara joint venture between Rio Tinto and BHP Billiton may be called off. The two companies […]

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