In brief

  • The federal government has set up a Policy Transition Group (PTG) to advise on implementation of its proposed reforms to taxation of the resources industry (announced on 2 July 2010).
  • The PTG has released a lengthy issues paper that discusses technical design issues for the Minerals Resource Rent Tax and the extension of the Petroleum Resource Rent Tax to onshore projects.
  • A number of alternatives raised in the issues paper are likely to be concerning for industry, and the scheduled timeframe for stakeholder submissions and consultation is very tight.  

Policy transition group

Background

Following its recent re-election, now as a minority government with the support of cross-benchers, the Labor Party remains committed to introducing its reforms to taxation of the resources industry as announced on 2 July 2010. A Policy Transition Group (PTG) has been formed, co-chaired by Resources Minister Martin Ferguson and Don Argus. PTG members are representatives from government departments and the resources industry.

Matters for PTG consideration

In a statement on 24 September 20101, the PTG announced that it will not be revisiting the fundamental design principles announced by the government on 2 July 2010.2 It is instead to advise the government on detailed application of these key principles, ie the technical, transitional and administrative aspects of:

  • development of the new Mineral Resource Rent Tax (MRRT), and
  • treatment of onshore petroleum and coal seam gas projects under the extended Petroleum Resource Rent Tax (PRRT) regime.

The PTG is considering the following issues in respect of mined iron ore and coal (which will be covered by the MRRT) and where applicable3, onshore oil, gas and coal seam gas (to be covered by the extended PRRT):

  • the taxing point and valuation method to be used for each commodity
  • the definition of a resource project and an interest in a project
  • the definition of eligible project expenditure (ie relating to a particular project)
  • the definition of exploration expenditure
  • the determination and calculation of the starting base for existing projects, including the rules for electing a particular starting base
  • tax treatment of the starting base and of capital expenditure incurred between 2 May 2010 (when a specific resource tax system was first announced) and 1 July 2012 (the proposed start date)
  • a workable exclusion from taxation where resource profits are below $50 million per annum
  • crediting of state and territory royalties
  • integrity rules, and
  • identifying opportunities to minimise compliance and administration costs.

Issues paper: some points to note

The PTG released a lengthy issues paper (130 pages) on 1 October 2010.4

The issues paper thoroughly canvasses the topics referred to above and in most cases sets out the different options that could be implemented. In some cases the issues paper indicates the PTG’s initial preferences, but these are typically tentative and submissions (including alternative views) are encouraged.

The discussion below is not intended to be a comprehensive summary of the issues paper, but to note some interesting points and opinions offered in the issues paper that industry participants should be aware of.

Definition of a ‘project’

MRRT and the extended PRRT will be calculated on an individual taxpayer’s direct ownership interest in the project, like the current PRRT.

The issues paper appears to prefer the use of state ‘production licences’ to define the boundaries of a project. An example is also provided (page 19) where three geographically separate mines are serviced by a centralised processing facility. Each mine could have a separate mining licence, but be treated as a ‘project unit’. The three mines and the centralised hub could be combined into a single project to which the MRRT applies.

Similarly, coal seam methane projects may involve a much larger number of wells and a broader geographic boundary than conventional oil and gas projects. The ability to combine wells which feed a common processing facility at the taxing point (eg the gas plant which produces the marketable petroleum commodity) is thought to be appropriate.

The definition of a project will be important because deductibility of the ‘Starting Base’ is quarantined to each project and royalty credits are also quarantined against each project. Accordingly, a wider definition of project is likely to be favoured by industry.

MRRT taxing point and taxable value

The taxing point will be the earlier of an arm’s length sale of the resource or a defined stage (physical step) in the production value chain. Were the resource to be exported prior to one of these events occurring, the point of export would be the taxing point. The PTG is inclined to set the taxing point after initial crushing, screening and grading, but prior to beneficiation (page 29). This may significantly reduce the assessable value of the resource (and hence the MRRT paid) for certain iron ore projects eg magnetite.

Arm’s length principles and/or transfer pricing methods will likely be used to derive a resource’s assessable value if the first arm’s length sale occurs after the taxing point. For example, for the majority of mining projects it may be necessary to break an integrated operation into the various components that comprise the value chain and determine an appropriate return for each of the activities. The value of downstream activities (after the taxing point) may be a function of the downstream operating expenses, the downstream asset base and an appropriate return to capital (profit margin). This calculated value would be netted from sales revenue to determine MRRT assessable revenue.

Deductibility and uplifting of project and exploration expenditure

Expenditure must have a direct link to the project to be deductible. The MRRT and PRRT will not cover other activities or downstream investments / operations beyond the taxing point. The issues paper also confirms that financing costs will not be deductible.

It is clear the PTG is grappling with the difficult task of how to apportion expenditure that relates to a taxable commodity (eg iron ore and coal) from expenditure relating to a non-taxable commodity (eg nickel).

For example exploration activities may be directed to exploring for taxable and non-taxable minerals. Accordingly, the PTG explores several options for determining the extent to which exploration expenditure will be deductible and the level of uplift that can be applied. The issues paper suggests that exploration expenditure may need to be attributed within the boundaries of the resulting mining lease, and (if applicable) to different minerals. Alternatively, exploration expenditure incurred prior to issue of a mining lease could simply be non-deductible. Similar issues of apportionment may arise in respect of the profits of multi-product mines. Both concepts could be complex to apply in practice.

The issues paper also indicates that the real value of exploration could significantly escalate, due to the application of the LTBR + 7% uplift factor over many years between exploration and development of the resource. ‘Ideally’, according to the issues paper, the design of the MRRT would mitigate any incentive for entities to defer developing the resource to gain an advantage from the uplift. This could be addressed through the timing of when a project commences or a special interest allowance rule, which sounds potentially like a lower uplift rate for expenditure incurred a number of years prior to the issue of a mining lease (analogous to the PRRT).

A similar issue is identified in respect of mines with carried losses that are placed on care and maintenance for extended periods—as a generous uplift may provide an incentive not to decommission a mine. According to the issues paper, this could be addressed through deeming the closure of a mine or again a special interest allowance rule for such losses.

Most of the alternatives mentioned by the PTG are likely to be alarming for industry!

Starting base for existing projects

Project assets are likely to be defined as upstream tangible assets, improvements to land and (where the taxpayer elects to use a market value starting base) mining rights. The issues paper suggests that other intangible assets (eg mining information or intellectual property) should not be part of the starting base.

The flexibility for a taxpayer to choose between book and market value for different projects, or for different participants in the same project to make different elections are issues for consultation; little guidance is given in the issues paper.

It is also suggested that where an asset is removed from the project, a corresponding adjustment should be made to the starting base. Any net gain/loss should also be treated as an assessable receipt / deductible expense. Tracking of assets across projects could prove burdensome to apply in practice.

Any undepreciated starting base will be inherited by a new owner if the project interest is sold. However, it will not then be transferable to another project. Any losses arising from unutilised depreciation of the starting base would be treated in the same manner, as would other carry forward losses and royalty credits.

Worryingly, the issues paper suggests that the ability to utilise a starting base could be limited to projects that have a production licence / mining lease at 2 May 2010. Where a project meets this stage after 2 May 2010, eligible project expenditure incurred after that time and before 1 July 2012 would comprise a starting base for that project. The issues paper also states that ‘ideally’, the value of the resource as at 1 May 2010 would be reduced in accordance with any depletion of the resource in the period to 1 July 2012.

The MRRT $50 million profit ‘de minimis’ exemption

The exemption refers to aggregated profits of the entity and related entities from MRRT projects. It seems that profits from PRRT projects are not counted, and there will be no similar exemption under the extended PRRT.

Interestingly, it is proposed to be an annual profits test ie assessable receipts less deductible expenditure for that year. Carried forward losses and starting base depreciation would be excluded. This seems to make it more akin to a turnover test which is far more likely to be exceeded.

If the exemption applies, the entity will not get the benefit of royalty credits for that year.

The issues paper acknowledges that given the inter-temporal nature of the MRRT calculation, exempt entities would still be required to maintain MRRT records. As a consequence, the $50 million threshold will do little to reduce the compliance costs of small entities. The PTG is open to suggestions about ways in which the threshold might be redesigned to better address the issue of compliance costs.

The PTG’s terms of reference suggest an entity that exceeds the threshold is liable to pay MRRT on profits above and below the threshold. This has the potential to alter entities’ investment and production decisions. A phased withdrawal of the tax concession could address this behaviour. Other options include providing some form of fixed concession over the life of a project.

Other coal-related projects

Extraction of coal will be subject to the MRRT; production of coal seam methane will be subject to the PRRT. The issues paper notes that it will need to be specified which regime is to apply to other coal technologies that produce petroleum products from the underlying coal resource. For example, underground coal gasification (UCG), the utilisation of coal mine methane (CMM), coal to liquids (CTL) and gas to liquids (GTL) projects.

The paper indicates that an objective is to tax coal technologies in a neutral fashion, and identifies three possible approaches:

  • tax all production processes involving the consumption of the coal resource (CTL and UCG) under the MRRT and those involving the extraction of gas without the consumption of the coal resource (GTL and CMM) under the PRRT
  • tax the production processes involving the extraction of coal (CTL) under the MRRT and those involving the extraction of methane (GTL, UCG, CMM) under the PRRT, or
  • determine the nature of the resource at the taxing point. If the resource is in the form of coal, the MRRT would apply irrespective of any subsequent processing. If the resource is in the form of gas then the PRRT would apply.

PRRT

In general, the existing PRRT legislation will apply, with appropriate adaptation where necessary so that it is also suitable in respect of onshore projects. The existing uplift rate for unutilised general project expenditure and capital write-offs may be appropriate for royalty credits.

The issues paper does not clearly identify what will constitute an existing onshore project under the extended PRRT. Paragraph 371 suggests a wider approach than for MRRT: a project that had an existing exploration permit, retention lease or production licence in force on 2 May 2010. However, paragraph 376 is analogous to the MRRT proposal: the ability to recognise a starting base could be limited to projects with a production licence in existence at 1 May 2010. This could have significant implications for some coal seam methane projects.

Compared to MRRT, less detail is provided on the deductibility of the starting base eg it is unclear if accelerated depreciation of a book value will be permitted, and the depreciation periods and any uplift factors are not specified.

Policies to promote exploration expenditure

The PTG will consider the best way to promote future exploration activities. This consideration is not limited to iron ore, coal, oil and gas, but is intended to cover all resource exploration activities in Australia.

Three possibilities are discussed:

  1. exploration tax offset (which is also refundable to the company if it exceeds its tax liability) at the company tax rate for exploration expenses
  2. exploration tax credit—which allows (at the discretion of the company) a flow-through to shareholders of the tax benefit (at the company tax rate) associated with deducting exploration expenditure. Credits could not be distributed where the company pays income tax, and distributed credits would reduce the cost base of the shares
  3. flow-through share scheme—investors deduct exploration expenditure at their marginal tax rate (and possibly have access to a further non-refundable credit), with CGT payable on the full value received on sale of the share.

Importantly however, funding for new incentive mechanisms would need to be fully offset from within the PTG’s recommendations.

Timetable

Face to face consultation sessions with affected companies will take place in five capital cities during October and November 20105, beginning in Perth on 7-8 October. There will also be a further round of ‘targeted consultation activity’, anticipated for late November.

There is an opportunity for stakeholders to make detailed written submissions on the issues paper, for which the closing date is 28 October 2010. The PTG has requested affected companies quantify the impact of the new tax regime on their operations. In this regard, the PTG has provided MRRT and PRRT online template financial models.6 Appropriate arrangements are to be put in place to ensure that commercially sensitive information provided to the PTG is kept confidential.

The PTG is at this stage scheduled to conclude its work and provide its advice and final policy recommendations to the government by the end of 2010. These recommendations will inform the preparation of exposure draft legislation and explanatory materials, to be released for comment in the first half of 2011 before Bills are introduced to Parliament.