On 21 December, 2010, the Policy Transition Group (PTG), headed by former BHP Billiton chairman Don Argus and the Federal Resources and Energy Minister Martin Ferguson, delivered its recommendations to the Federal Government on the design and implementation of the Minerals Resource Rent Tax (MRRT). The PTG report is the next step in the formulation of the MRRT that will, if passed by Parliament, apply to coal and iron ore producers from 1 July, 2012.
There were 67 recommendations in relation to the MRRT. The PTG and its secretariat consulted over a number of months with key stakeholders from the affected industries and more broadly. Overall, the recommendations appear well balanced, providing some concessions for industry and standing firm in areas that had potential to put revenue at risk. Importantly, the Federal Treasury has advised that the recommendations are broadly revenue neutral over the forward estimates, consistent with the PTG?s terms of reference. It would appear some progress is being made which is no doubt attributable to the appointment of the co-chairs. Ignoring the political background and its possible implications for the MRRT, this article outlines some of the main recommendations made by the PTG.
So what are the main changes or clarifications from the previously issued public documents?
CREDITING OF ALL ROYALTIES
The PTG has recommended that all State royalties be credited including all future increases and that mechanisms be put in place ?to ensure that State and Territory Governments do not have an incentive to increase royalties on coal and iron ore?. Creditable royalties will also include those collected by State Governments on behalf of private land owners. This is a significant recommendation in light of the recent stances of the industry and government. Freezing royalty credits at May 2010 levels will impact the ability of Australian iron ore and coal industries to compete internationally as well as create uncertainties around the overall level of taxation on industry that would impact future investment decisions. The pressure will be put onto the Federal and State Governments to come to the table.
THE TAXING POINT
The taxing point is the point where the MRRT profit (revenues less deductions) is determined and is, therefore, critical in determining the MRRT liability. Significant time was consumed in the consultation process discussing the taxing point and where it should be. The PTG has recommended the taxing point be at the run of mine (ROM) stockpile. This is a logical result as any point after this would have introduced enormous complexities in delivering equity in taxation across different operational models. Most operations have a ROM stockpile and account for the costs at this point. Hence, the uncertainty in respect of the accounting for the direct costs of operations for most miners could be removed to a large degree. For those operators that do not have a ROM stockpile, the taxing point will be the first unit of production after extraction, eg the conveyor to the power station in an integrated mine mouth operation.
TAXABLE VALUE OF PRODUCT AT THE TAXING POINT
The MRRT revenue is the value of the commodity at the taxing point. Most producers do not have a value for their product at the ROM stockpile or similar. In order to determine MRRT revenues, taxpayers will be required to derive a value for each transaction at the taxing point. The PTG has recommended that value be determined by applying similar concepts which exist for transfer pricing under income tax. This will create a significant layer of complexity for most taxpayers. The PTG has recommended a safe harbour option for taxpayers producing less than 10 tonnes per annum of product or those operating vertically integrated operations such as coal mines and power stations or iron ore and steel manufacture at 2 May, 2010 (the MRRT announcement date). The safe harbour appears to apply to a limited number of taxpayers and most will have to seek advice in respect of pricing their transactions. This will prove to be fertile ground for dispute between the Australian Taxation Office (ATO) and taxpayers if the income tax transfer pricing experience is any indication.
ASSETS INCLUDED IN THE STARTING BASE
The starting base is the book or market value (at the taxpayer?s election) of the assets of a project at 2 May, 2010. Taxpayers are allowed to depreciate this value against future MRRT revenues. The objective of the starting base is to shelter from taxation the value of investment decisions at the date of the MRRT announcement. There was significant concern that the market value of pre-production tenements would not be available for depreciation under the starting base concept. With many green- and brownfield sites having significant value, this would have led to a significant increase in MRRT tax collections in future years when these projects started production. The PTG has recommended that all tenements be included in the starting base but only be deductible against MRRT revenues from when production commences. Of course, the valuation of tenements, particularly green- and brownfields, is somewhat subjective and this will undoubtedly be an area of high interest to the ATO as was the case when market valuations were used to restate asset values under tax consolidations nearly 10 years ago.
The PTG has recommended that the costs incurred from 2 May, 2010 to 30 June, 2012, which are added to the starting base, also include costs that might otherwise have been expensed such as overburden removal. This is a significant recommendation, as it will remove the possible distortionary effect the MRRT could have had on mine planning as taxpayers sort to defer such costs until the start of the MRRT in order to obtain a deduction.
DEFINING A PROJECT
The definition of a project is central to the concept of the MRRT as a project-based tax. The concept of a project varies significantly across the industry, depending on many factors. Some projects comprise multiple joint ventures over several tenements while some are stand-alone, single operator mines. In order to accommodate this variability, the PTG has recommended that the definition of project be flexible to allow integrated operations to be defined as a single project within the constraints of the current definition of a consolidated group for income tax purposes. The project would exist from the date the production licence is granted. This recommendation should reduce the compliance burden on the industry particularly in respect of the allocation of shared expenditures.
WHAT IS TAXABLE UNDER THE MRRT?
The PTG has recommended that the underground coal gasification industry and methane extracted as an integral part of coal mining be subject to taxation under the MRRT. Further, the incidental production of coal or iron ore from other mining should be subject to the MRRT. In practice, incidental mining of coal or iron ore should be removed from MRRT taxation in many cases as a result of the $50 million MRRT profits threshold. These recommendations recognise the commercial realities of the industries as well as keep the integrity of the system in place.
EXPLORATION AND PRE-PRODUCTION EXPENDITURE
The PTG has recommended a balanced approach to the treatment of these costs. All exploration and pre-production costs are eligible for transfer to other projects owned by the same taxpayer but only those producing the same commodity. Losses generated by these costs will be transferred to an acquirer of a tenement (with some limitations on quantum) but can be transferred to offset other profits of the acquirer. The costs can be carried forward for 10 years and uplifted at Long Term Bond Rate (LTBR) plus seven per cent and at LTBR after 10 years. There was some fear that the PTG would recommend exploration be narrowly defined and not take into account failed exploration. The PTG has recommended that exploration include failed exploration.
ADMINISTRATION
There will be an enormous burden on the ATO and Treasury in the next two years as the MRRT is designed and implemented. There are significant issues still to be resolved and the PTG has recommended early guidance to taxpayers on certain topics. The ATO will need to increase its level of expertise in the mining sector and bulk up its transfer pricing practice to handle the MRRT effectively.
Larras Moore is a partner at BDO (Queensland) Pty Ltd. Email: larras.moore@bdo.com.au