This guest post from Mule Stable regular Zebra (James Glover) delves into the details of the proposed Resources Super Profits Tax.
The Australian Government (hereby known as the Govt) has proposed a Resources Super Profits Tax (RSPT) for mining companies. Superficially it appears to be a 40% tax on all profits (measured by Return On Investment or ROI) in excess of the Govt Bond Rate (or GBR, the interest rate at which the Govt borrows money, over the long-term).
The key points of this article are:
1. The GBR is the correct threshold level for RSPT,
2. If the Govt increases the threshold above GBR this will represent a subsidy of miners by taxpayers,
3. The RSPT will benefit small and marginal mining projects to get finance through partial Govt backing of risks.
So for example suppose miner Mineral Wealth of Australia (MWA) invests $1bn in the Mt Koalaroo Iron-Ore mine. MWA is a wholly owned subsidiary of Silver Back Mining (SBM). In the year following they make $200m profit or a return on investment (ROI) of 20%. If the GBR = 5.5% then the 40% RSPT means a tax revenue to the Govt of Tax = 40% x (20%-5.5%) x $1000m = $58m.
This seems very straight forward. It appears that the Govt is saying that GBR represents some “fair” level of return and anything in excess of this is a “super profit” to be taxed accordingly. Not at the normal company tax rate of 30% but a “super tax” rate of 40%. This is how it has been presented by both sides in the media. Arguments against the RSPT have focused on whether the GBR as a “risk-free” rate is the appropriate benchmark for a risky profit stream. Indeed it is not but in fact this isn’t what the RSPT is about. For example normally taxes on profits have no negative impact on the Govt if the company loses money. In the case of the RSPT though the Govt has stated that 40% of any losses can either be claimed back from the Govt (as a refund) or carried over to other projects.
So what is the RSPT? A good way to consider it is if the Govt took a 40% stake in MWA as a “silent partner”, leaving SBM with a 60% stake. In this case we would expect the Govt to contribute $400m of the investment costs (raised presumably through issuing bonds at the GBR or equivalent). In return it would get 40% of the profit. The Govt return would therefore be 40% of the profit less the cost of funding its 40% investment ie Tax = ROI x 40% x I – GBR x 40% x I = 40% x (ROI – GBR) x I.
This appears to be the formula that the Govt has presented to calculate the RSPT and in this derivation it is quite straightforward. However the Govt appears to be getting something for nothing since it isn’t actually stumping up the $400m in investment capital. So what’s going on? A clever piece of financial engineering that’s what. The Govt avoids raising the capital itself (and hence have it be counted as Govt debt) by getting the project to raise it on the Govt’s behalf.
(You can easily skip the next paragraph if you aren’t interested in the details of mine financing costs)
Whilst MWA raises 100% of the $1bn in capital the Govt appears to get the upside (and potential downside) as if it has contributed $400m without doing so. Money for old rope you say. However consider MWA not to be the stand-alone mining company SBM, but the joint venture beween the Govt and SBM. Suppose MWA borrows $1bn in capital at its Project Funding Cost (or PFC). This PFC will be lower than the SBM’s Miner’s Funding Cost (or MFC) as the Govt is now backing 40% of all liabilities. In fact in an efficient market we deduce PFC = 60% x MFC + 40% x GBR. If MWA then allocated these funding costs accordingly it would charge the Govt its share, risk-weighted, not PFC, but GBR. If the GBR = 5% and MFC = 8% then we expect PFC = 6.8% not the 8% if SBM was the sole investor. Under this arrangment SBM’s cost of funding (in % terms) its effective 60% share of the joint project is the same as its stand alone cost of funds, as it should be.
An argument against raising the threshold above GBR is that this will effectively lower the miners’ cost of funds, the difference being borne by the Govt and hence us taxpayers. No wonder miners are arguing so vehemently for the threshold to be raised. In fact it can be shown that raising the threshold to 11%, as some propose, and using a GBR of 5.5% would effectively reduce the miners’ cost of funds by a whopping 3.67%! If you want a formula for the Miners’ Taxpayer Subsidy(MTS) it is: MTS = 2/3 x (Threshold – GBR) in terms of the miners’ funding cost discount (paid for by the taxpayers remember); or MTS = 40% x I x (Threshold – GBR) in $ terms. For the Koalaroo mine this would represent $22m of funding cost transferred from the mining company SBM to the taxpayer. That’s you and me. You don’t see that in their ads.
From the Govts perspective the advantage to them is that the investment does not sit on their balance sheet but the project company MWA’s and in effect SBM’s balance sheet. From a financial engineering point of view all this makes perfect sense. Having said that, it was precisely this sort of clever off-balance sheet flim-flammary that got Greece (and Lehman’s et al) in trouble. We need to make absolutely sure it is properly accounted for.
Update: Several commenters have pointed out the effect on mine financing of the RSPT. Specifically with the Govt backing 40% of any losses smaller stand-alone projects will find it easier to get project finance. As discussed above the funding cost will be lower with the Govt’s partial backing. The operating profit (so called EBITDA) of the project is unchanged so this makes them more, not less, viable. This is at odds with what the miners have been saying. Even existing projects with refinancing clauses in their loans should find it easy to convince their lenders to reduce their interest payments. For large global miners such as BHP-Billiton, who issue bonds, it will be harder to disentangle the Australian RSPT benefit to their overall cost of funds and hence spreads. But the market should over time price this in with lower spreads on their bonds. With a reduced cost of funds miners will be able to leverage their existing equity across more projects and make up for the 40% the Govt now takes out of individual profits (and losses) through the RSPT.
Update: Tom Albanese, CEO of Rio Tinto was on Inside Business on ABC on Sunday May 30. It is interesting that in arguing against the RSPT he referred to the unfairness of the Govt coming in as a 40% “silent partner”, and not about the GBR threshold. He clearly understands the true nature of the RSPT. While it was self-serving he emphasised (in my terminology) the determination of Investment or “I” for existing projects. Depreciation comes into it but some of these projects are decades old and it would an accountant’s dream/nightmare to work out the correct value of I to base the Govt’s GBR deduction on. He also questioned the “principle” (his word) of the Govt forcibly coming in as a “silent partner” on projects which are clearly profitable going forward, having survived to this point. After all they are not compensating mining companies for mining projects that failed in the past. I’m afraid I have to agree with this point, though I think it is more complex than I currently comprehend. It is good to see the RSPT being debated for once without the disinformation we have seen from less eloquent opponents. After all the Govt did say at the beginning that it was these sort of aspects of the RSPT they were prepared to negotiate on, not the 40% and not the GBR threshold.
UPDATE: Zebra looks at a fair value approach to the RSPT.
Possibly Related Posts (automatically generated):
- RSPT – A Fair Valuation Based on True Value of New and Existing Mines (12 June 2010)
- RSPT RIP – Long Live the MRRT (2 July 2010)
- The Australian Resources Tax (14 May 2010)
- Carbon tax (8 March 2011)
SP – I am sure the people of Cornwall, Wales and Lancashire would disagree with you that mining resources are effectively infinite. And since the RSPT is based on profitability marginal mines will attract very little tax and with a bit of creative accounting probably none at all.
Oh Dear Zebra mighty and strong
Why does thou live in a throng
Do you yearn for the company of others
Or are you in fact one of those communist brothers
The Pimpernel says yes to the latter
But is he on the payroll of some mining magnate
Outrageous – billionaires spreading fear and hate
So Zebra, gather your friends in a herd or is it a pack
Take to the streets and demand it all back
Oh Willy (is Loman your last name?), you should know the Zebra is a proud and independent animal who unlike the horse cannot be corralled or tamed however unlike the ass he is not so stubborn or stupid as to fail to recognize that security against the big beasts is sometimes best found standing striped shoulder to shoulder with his comrades.
Zebra makes a good point. One of the many tidbits I remember from Jared Diamond’s Guns, Germs and Steel is that it is essentially impossible to lasso a zebra. They watch the rope and duck every time.
The Cornish Miners had no choice but to export their technology, themselves and capital abroad as they were taxed to death.
The Tin coinage of an independent Cornish state was ended in 1838 and the Tin duties act established. This was the beginning of the long dark years of taxation.
In 1985 the Tin market crashed making it even harder for marginal operations to survive.
The draconian effective tax rate in the UK at this time has been a terrible dampener on any marginal or low grade ore mining in that very wealthy mining district.
No doubt UK investors once determined on an investment in Australia are reviewing their options more close to home.
Readers will note that the local team at:
http://www.westernunitedmines.com/operations
are doing their best even with this amazing taxation load to carry.
Readers will also note that there are still vast resources available to modern mining techniques in Cornwall, Wales and Lancashire.
The British Geological Survey has even made a easy to read document here:
http://www.bgs.ac.uk/mineralsuk/planning/economy.html
All taxation restricts the mining of low grade ore bodies and abolishes jobs. That is the reason so called “royalties” and income taxation should again be abolished, as they were, until reintroduced 1914.
Our current Australian government policy reminds me of what Ludwig von Mises says in his masterpiece “Human Action” (pp. 686/87):
“Many of the richest deposits of various mineral substances are located in areas whose inhabitants are too ignorant, too inert, or too dull to take advantage of the riches nature bestowed upon them.
If the governments of these countries prevent aliens from exploiting these deposits, or of their conduct of public affairs is so arbitrary that no foreign investments are safe, serious harm is inflicted upon all those FOREIGN peoples whose material well being could be improved by a more adequate utilisation of the deposits concerned.
It does not matter whether the policies of these governments are the outcome of a general cultural backwardness or of the adoption of the now fashionable ideas of interventionism and economic nationalism. The result is the same in both cases..”
Wise thoughtful words to which we all should note well.
Zebra. In the above you said on 2 June 2010 at 9:38 am “Miners don’t create the minerals.”
In one sense that is so. However, nearly all of the minerals currently being mined were present, but not known to man. That is, the deposits were hidden under sometimes hundreds of metres of earth and rock.
How do you think that the Olympic Dam copper/uranium deposit was discovered? It was not always known to be there. It was not discovered by any government. It was discovered by WMC using capital and amazing technical ability. It was one successful project in perhaps hundreds of failed exploration projects. WMC invested that capital and expertise to find Roxby Downs in the expectation that they (and their shareholders) would be appropriately rewarded for the risks they took, and the initiative that they showed.
Also, through this thread there seems to be a misconception about the miners exploiting, for free, the resource assets that are ‘owned’ by the Australian people. I have explained that in nearly every case, the resource assets are there, but not discovered until a mining company invested the capital and expertise to find them. In that sense they did “create” the asset.
But they don’t get to use the asset that they discovered for free. In WA for example, iron ore producers pay a royalty of 7.5% of REVENUE to the state for the use of the resource that they discovered, evaluated, developed and operated. You think that is free??
Further, no one seems to consider the share of total revenue that ends up in the hands of government. Mining companies pay royalties, and 30% corporate tax on profits. They pay payroll tax. Their employees pay income tax. There is GST on supplies. Their suppliers pay income tax to their employees, payroll taxes, corporate tax (if incorporated) and so on. Somebody needs to do the calculation, but I think you would find that for a mine generating $100m a year revenue, a surprisingly large proportion of the revenue ends up in government hands.
Finally, there are many misconceptions in the above about how projects are actually financed. Banks look primarily at net cash flows (after all taxes and royalties) in relation to the capital required. Clearly the RSPT reduces the net cash flow, and thus the financeability of the projects. Another way to think of it is using the concept of payback. The RSPT will inevitably increase the payback period, often to point where the project cannot be financed.
Also, think about the banks attitude to a tax that cuts in on EBITDA, ie before their interest and loan repayments are addressed. Not likely to be attractive to them.
Mondo, thanks you for your comments. I agree with what you are saying but the statement “Miners don’t create the minerals” is a statement of fact. When I go shopping I have to find out where the store is and expend resources (petrol, car depreciation and parking fees) to get there but it doesn’t mean I have a right to take the fruit&veg I “discovered” for free. Why? Because it is the law. Just as it is the law that minerals are owned by The Govt/People of Australia/States – take your pick. It is pretty much the same law in every other country. Mining companies already pay royalties so they accept this law. I’ve never heard a mining company argue they shouldn’t pay royalties or taxes. Would they like to pay less? Of course! Do they want to pay more? Never! None of this is worth debating about, at least on this post. I would prefer to see people argue about whether the RSPT is the best way to tax miners rather than general discussions about the evil of taxation.
Being in favour of the RSPT is not to be anti-mining. Miners make good profits for their investments. Their efforts are measured by the $ cost of their investment not the sweat on the brow of their geologists or strained muscles of their miners. A $ spent investing in mining is the same as a $ spent investing in a fashion store. Except the $ spent on mining has a much better return. That is how capitalism works. If they weren’t amply rewarded they’d put their capital and resources into other industries.
As for the bankers, we already know that is how mine finance (for stand-alone projects) is arranged currently but it doesn’t mean it has to be that way in the future. Collateral is a way of backing a guarantee and is taken into account in all financing decisions “where it is available”. It is not currently available for stand-alone project run by shelf companies. That is why it is not considered. Why would a mine be treated differently from any other business? Cashflows, collateral, guarantees. These are the inputs into lenders decisions to answer the question “what is the probability I’ll get my interest and capital back?”. An Australian Govt guarantee is AAA rated and doesn’t require collateral. Arguments as to whether it will mean something in the future are already taken into account in the way Moodys and S&P decide sovereign ratings. You may argue against the true validity of AAA ratings but the miners aren’t.
It is interesting that major tax reforms seem to take place every 10 years or so and attracts all sort of heat. The Keating Govt’s reduction of the company tax rate and the introduction of the GST. In both cases these were going to (according to their opponents) destroy the Australian economy if not the very fabric of our society. It is all very familiar. I suppose there is some irony in that the same sort of scare campaign ads are being used against a Labor govt that they used against the coalition over the GST.
Remember the Gold Tax which was going to destroy the gold mining industry because it was “special”? Now the whole mining industry is special. It is an old and argument and seems to apply to every industry.
Zebra – Even speaking as someone who tends to smaller government/lower taxes, I agree it would be more enlightening to see more pragamatic discussions and less Marxist vs Adam Smith debate going on here. It never goes anywhere and it’s sooooo000 1980s.
On your points as to the lenders behaviour, whatever you think bankers should do in assessing creditworthiness, the fact is that they don’t.
Introducing a RSPT in its current form is effectively placing an extremely high stakes bet that project financiers will start to incorporate any perceived value of the 40% rebate in their credit assessments.
If they don’t (or even it if takes a while for them to do it) you can forget about getting finance in place for a long list of projects that would otherwise have been economic – with obvious consequences for employment and growth.
Have you forgotten the poor performance of the finance industry over the last decade in assessing risk? And the way they’ve effectively dropped the guillotine on commercial lending since 2007?
On that subject, I would suggest that, given the protected banking industry in Australia that is a function of the 4 Pillars Policy, there is a robust argument that the Big 4 banks in Australia should be paying a super profits tax to compensate the country for the economic rents they are generating from being protected. Which is not the same thing as saying the 4 Pillars Policy should be abolished – just that those banks who benefit (at consumers’ expense) should pay for it.
Couldn’t agree more, why Rudd didn’t hit th banks with a super tax shows what a dimwit he is. Public anger is running very high towards the banks (is usually is) and they have all just been bailed out by the govt (yes, they would have all failed absent the govt g’tee). If Rudd bothered to actually presents ideas to his cabinet, maybe just maybe, someone would have suggested the banks would have been a much better target in an election year.
I also think the govt. should approach the banks now with an opt in opt out guarantee scheme. Basically if you opt in you can use the govt g’tee at any future date when/if the govt decides it is necessary to offer it (and can only be used if the govt offers it) but the trade-off is massive restriction on executive/staff remuneration.
Whereas if you choose to opt out now, to bad if markets close you are on your own.
This would really separate boards/executive from their shareholders.
Maybe Zebra will write a piece on this proposal!
GaryJ – it might have been worth having a Bank SPT instead of an RSPT just to see Gail Kelly and Mike Smith on the back of a flatback truck in flouro jackets yelling “axe the tax” whipping up a crowd of frenzied bank tellers.
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