On 3 April 2014, the decision in Commissioner of Taxation v Resource Capital Fund III LP [2014] FCAFC 37 (RCF decision) was handed down by the full Federal Court of Australia.

The RCF decision concerned the Australian tax treatment of a capital gain made by a US based private equity fund on the sale of shares in St Barbara Mines Ltd (SBM). The principal assets of SBM were mining rights, mining information and plant and equipment.

The case turned primarily on the interpretation of the Double Tax Agreement between Australia and the USA but the focus of this publication is the contrasting valuation approaches employed by the Court at first instance and then on appeal.

Why is the RCF decision important?

The full Federal Court decision raises a number of difficult questions and offers only opaque guidance. For example:

  • Does this decision result in different values being ascribed under purchase price accounting to those ascribed for different taxation purposes?
  • Does a taxpayer now have to obtain multiple valuations if various taxing statutes (or parts of taxing statutes) apply to a particular transaction? Should taxpayers be entitled to assume that ‘market value’ has a consistent definition?
  • Will the valuation approach suggested by the Full Federal Court be applied consistently when purchasers look to acquire entities or assets at different levels or through different holding structures?
  • How important is opportunity cost and re-creation cost when valuing mining information and plant and equipment?
  • How much emphasis should be placed on the ‘objects’ and ‘purpose’ of a taxing provision when briefing valuation experts?

The Full Federal Court decision

Contrary to the First Federal Court, The Full Court held the assets of SBM should be valued as though they are to be sold as a bundle simultaneously to the same hypothetical purchaser. This was through application of the test in Spencer v The Commonwealth [1907] HCA 82 in a manner different to that of Justice Edmonds in the First Federal Court decision.

Justice Edmonds originally held that the taxing statute (in this case the non-resident capital gains tax rules in Division 855 of Income Tax Assessment Act 1997) requires the separate determination of the market value of each of SBM's assets - not the determination of the market value of all SBM’s assets as a class, and certainly not the determination of the market value of all SBM’s assets on a going concern basis.

Justice Edmonds indicated the appropriate method to valuing mining rights is a discounted cashflow methodology which then incorporates a deduction for the time delay and opportunity cost of re-creating the mining information and replacing the plant and equipment.

The Full Federal Court held that the valuation question is to be answered "in the statutory context and by reference to the statutory purpose". Therefore, regard should be had to the objects and purpose of the relevant division (Division 855).

It followed that the SBM assets should be valued on the assumption that a simultaneous sale to one purchaser occurred “with the capacity to use those assets in combination in a gold mining operation as their highest and best use”. Relevantly, this approach means that the hypothetical purchaser could expect to acquire the mining information, and plant and equipment for less than their re-creation costs with limited or no delay.

In arriving at its judgement, the Full Court specifically noted the approach in Nischu (a WA Stamp Duty case) was not relevant for Division 855, despite Division 855 essentially requiring a similar determination of market value in a mining M&A context. Nischu tells us the market value of a mining tenement is to be determined on a standalone basis, not within the context of a business.

Where to now?

With the Full Federal Court placing significant emphasis on the relevant ‘statutory context’, it necessarily follows that this judgement is only relevant to Division 855. Arguably, the market valuations used for purchase price accounting and tax consolidation could be different again, given they represent a different statutory context.

From a stamp duty perspective it would seem that the approach in Nischu remains relevant. Accordingly, when valuing assets for the purposes of stamp duty, it remains open to value assets on a standalone basis, with particular regard to the costs of recreating mining information.

However, as Nischu only relates to WA, and each State/Territory represents a different ‘statutory context’, it could arguably be open to obtain eight different stamp duty ‘market valuations’ for the same assets, in addition to the market valuations required for accounting and income tax.

In this regard, it appears to be more important than ever to accurately brief valuation experts, and provide them with the appropriate statutory context, particularly when obtaining a valuation that captures an active mining operation.