On the evening of Tuesday 14 May 2013, the Treasurer delivered his sixth Federal Budget (Budget) since Labor came to power in 2007. Included in the direct tax measures were a number of changes to the taxation of mining companies, and particularly non-resident investors in mining companies. In this article we draw out two of the key measures that will have ongoing relevance to mining investments. Those measures are:
- the changes to the taxation of non-residents with respect to land related investments (including a proposed withholding tax applicable from 1 July 2016); and
- the deferral of deductions relating to mining rights and information.
Changes to non-resident capital gains tax rules
The Treasurer announced that the capital gains tax (CGT) rules will be amended to ensure that non-resident investors into Australian mining companies will be subject to Australian tax on gains they make on their investment. There were two key measures announced: the first relates to determining whether a gain made by a non-resident on a disposal of shares in an Australian company will be taxable in Australia; and the second introduces a specific withholding regime.
Clarification of Australian Taxing Rights over Indirect Australian Real Property Interests
Under Australian tax law as it stood prior to Budget night, non-residents were broadly not subject to CGT on the disposal of shares in an Australian company unless the underlying assets of the company predominantly relates to taxable Australian real property (TARP). Broadly, the test involves comparing the value of the TARP assets of the company with the non-TARP assets of the company (referred to as the Principal Asset Test). If the value of the TARP assets exceeds the value of the non-TARP assets, the shares in the company will, subject to the shares satisfying the “non-portfolio interest test” (broadly a 10% or greater associate inclusive ownership test), be considered taxable Australian property (TAP), and a disposal of those shares will be subject to CGT.
TARP includes interests in Australian land, but also extends to mining rights and exploration tenements. In the recent Federal Court decision in Resource Capital Fund III LP vs Commissioner of Taxation  FCA 363 (RCF), in valuing the TARP assets of a business and the non-TARP assets of a business Edmonds J favoured an approach whereby assets such as mining information and plant (which are not considered “land” assets for the purposes of the test) are severable and distinct assets from mining rights and exploration tenements (which are considered land for the purposes of the test). This resulted in the somewhat unexpected outcome that a gain made by a non-resident investor on the disposal of shares in an Australian gold mining company was not taxable in Australia.
On Budget night, the Government announced measures (seemingly aimed squarely at the Court’s approach in RCF) which mean that in determining the value of the TARP assets of the entity in which the interest is held, intangible assets connected to the rights to mine, quarry or prospect for natural resources (notably mining, quarrying or prospecting information, rights to such information and goodwill) will be treated as part of the rights to which they are related. The practical effect of this change is that investors who hold shares in mining companies who, in light of the RCF decision may not have otherwise held shares which constitute Taxable Australian Property (TAP), will now be taken to hold TAP assets, and be subject to Australian CGT on a disposal of their shares.
The Government also announced measures that will treat intercompany dealings between entities in the same tax consolidated group as not forming part of the Principal Asset Test calculations, thereby ensuring that assets cannot, in effect, be counted multiple times, thereby diluting the true asset value of the group. Accordingly, non-residents contemplating a disposal of shares in a company, which has previously carried out such structuring, will need to revisit their Australian tax position.
Both of the measures described above apply to CGT events occurring after 7:30pm on Budget Night (14 May 2013).
Withholding from Foreign Residents disposing of assets that give rise to an Australian Tax liability.
A more controversial measure announced on Budget Night applies to CGT events occurring on or after 1 July 2016.
A non-final withholding tax regime will be introduced to support the operation of the foreign resident CGT regime. In broad terms, if a non-resident disposes of certain TAP, the purchaser will be obliged to withhold and remit to the ATO 10% of the proceeds from the sale. Residential property transactions valued under $2.5 million will be excluded from this measure. It should be noted that not only will this withholding apply to the taxation of capital gains, it will also apply where the disposal of the relevant TAP asset is likely to generate gains on revenue account, and therefore be taxable as ordinary income rather than as a capital gain. Following the announcement of this measure, the Government proposes to consult on the design and implementation of the regime to minimise compliance costs including permitting pre-payment of tax liabilities by the seller, removing a withholding obligation where it can be shown that no gain will arise and streamlining any payments required including through the use of intermediaries.
Key implications of these CGT reforms
There are a number of key implications for non-resident investors arising from these measures, including:
- Investment decisions may have been made in the past based on the expectation that a disposal of their shares would not be taxable in Australia. With the proposed changes which render mining, quarrying or prospecting information, rights to such information, goodwill and other intangible assets as if they are part of the mining right and hence TARP, foreign resident taxpayers will now need to factor in potential CGT liability on an exit of their investment. Clearly this may not have been contemplated at the time of making the investment.
- The proposed introduction of a withholding regime raises many practical issues. For example, sellers will need to proactively engage with buyers (and potentially the ATO), prior to a sale proceeding, to have an established and certain position on whether:
- the asset being disposed of constitutes TAP; and
- whether a gain even arises.
Absent action from the seller, the possibility exists of a withholding impost which exceeds the amount of gain realised by the seller on disposal of the relevant asset. A simple example illustrates the principle: assume that a non-resident acquires shares in company A for $100 and sells those shares two years later for $90. Even though the non-resident has made a $10 capital loss, under the proposed rules a $9 withholding obligation exists for the purchaser of those shares. The seller would need to then lodge a tax return to claim the tax back.
- There may well be practical difficulties associated with complying with this regime in circumstances where a purchaser is outside the Australian tax system, for instance in circumstances where one non-resident sells to another.
Deferral of deductions relating to mining information
The immediate deduction for the cost of assets first used for exploration will be tightened by excluding mining rights and information. Under the proposals, mining rights and information first used for exploration will be depreciated over 15 years, or their effective lives, whichever is shorter. The effective life of a mining right and associated exploration information will be the life of the mine that it leads to. If the exploration is unsuccessful, the remaining amount will be written off when this fact is established. Despite the above, the following amounts will continue to be immediately deductible:
- costs of mining rights from a relevant government issuing authority;
- costs of mining information from a relevant government authority;
- costs incurred by a taxpayer itself in generating new information or improving existing information; and
- mining rights acquired by a farmee under a recognised “farm-in farm-out” arrangement.
The measures will apply to taxpayers who start to hold the mining right or information after 7:30pm AEST on 14 May 2013 unless the taxpayer is committed to the acquisition of the right or information (either directly or through the acquisition of an entity holding the asset) before that time or they are taken by tax law to already hold that right or information before that time.
This will have a significant impact for taxpayers in M&A transactions amongst other things, for example where a consolidated group acquires shares in an exploration company and resets the tax basis of the underlying assets on acquisition, previously an immediate deduction would have been available to the acquirer. This will no longer be the case.