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Focus: Implementing a resource rent tax

22 April 2010

Japanese language version (PDF)

In brief: The Henry Tax Review is widely expected to recommend that the Commonwealth Government introduce a resource rent tax for all mining and petroleum operations within Australia. Partner Grant Cathro (view CV) and Lawyer Ada Lam explain how a resource rent tax would operate, and consider some of the issues that are likely to arise from its implementation.

• What is a resource rent tax?
• The PRRT regime: an RRT taster
• Is it likely that an RRT will be introduced?
• Potential issues arising from introduction of an RRT
• The way forward

What is a resource rent tax?

The concept of an RRT was developed in the mid-1970s by Anthony Clunies-Ross and Ross Garnaut as a tax imposed on the profits derived from the extraction phase of a natural resource project, where those profits exceed the rate of return that is required in order to stimulate investment in the project. That is, the RRT is levied on any 'super profit' that remains after the costs of a project (including infrastructure costs) are recovered and a threshold rate of return has been achieved.

An RRT is perceived as more efficient than other state or Federal government imposts on resource projects, because it only taxes a project after it reaches an appropriate internal rate of return. As profits rise in a project, the amount of RRT imposed on that project would also rise. For the Government, this ensures that it shares in any 'windfall' profits that accrue as a result of booming resource prices.

The PRRT regime: an RRT taster

A form of RRT was introduced in relation to petroleum operations in offshore waters from 1988, applying to greenfields projects developed after July 1984 (though it was extended to the Bass Strait in 1990). Its key characteristics are as follows:

• The tax unit is based on a project – outgoings incurred within the project are offset against revenue (or deemed sale) at the project boundary. Downstream operations, such as refining, are not included in the project boundary, and therefore the costs associated with and the value added by downstream operations are not included in calculating the PRRT payable.
• An immediate deduction is allowed for all expenditure, whether revenue or capital (in income tax parlance) in character.
• Expenses that are not fully offset against income are rolled over into the next year and compounded, to effectively create an internal rate of return that needs to be met before the PRRT applies.
• PRRT is a flat 40 per cent rate once payable, and PRRT paid can be deducted for the purposes of income tax.

Is it likely that an RRT will be introduced?

The concept of an RRT, to be applied to the entire resource industry, was first adopted as ALP policy in the 1977 Labor Party Platform. However, at that time the state governments (which levy royalties on mining operations onshore and in coastal waters by reference to the value of production or the quantity of resources extracted) were unwilling to agree to the introduction of an RRT. Accordingly, the Commonwealth Government elected to proceed with a PRRT in offshore waters (over which the state governments had no jurisdiction).

The state governments' unwillingness to cede their rights to impose resource royalties is likely to remain unchanged, especially as concerns over the equity of distribution of GST between states will be paralleled by any distribution of RRT to state governments. Both the Queensland and Western Australian governments, in their submissions to the Henry Tax Review, refer to the danger that the takeover of the mineral royalties revenue stream by the Commonwealth would represent a loss of sovereignty for the states. The Western Australian Government, in particular, has indicated that it is opposed to the introduction of an RRT.

As an RRT is a tax on the profits of a part of a business, it is likely that the Commonwealth would have the constitutional power to impose an RRT without the agreement of the states. The stated desire to simplify the tax system and introduce a more economically efficient system would, however, not be met unless the state royalties were removed.

Potential issues arising from introduction of an RRT

Some of the key issues that need to be addressed if an RRT were to be introduced include:

• Would the proposed RRT apply only to new projects or also to existing projects? Application of an RRT to existing projects introduces an impost that was not in place at the time that the projects were initially introduced. It might be seen to involve an element of 'sovereign risk'. The state governments (and the industry) may be more amenable to the concept of an RRT if it were only to apply to greenfields projects. In the case of the PRRT, which initially applied only to greenfields projects, the existing Bass Strait petroleum project was brought into the PRRT regime in 1990, three years after the legislation was initially introduced.
• What rate of return needs to be generated before an RRT applies? The rate of return is intended to represent the risk-free rate of return required to encourage investment. The varying range of profitability of different types of mining projects may mean that the rate of return required should differ according to the type of project, depending on what minerals are extracted.
• How will the project be defined? The concept of an RRT relies upon identifying those parts of a taxpayer's operation that are concerned with the extraction of the resource and taxing the 'super profit' arising from those operations. Additional 'value adding' activities that involve the transportation or processing of resources once extracted are not intended to be taxed. While conceptually it might seem fairly easy to identify the extraction phase of any particular project, in practice project definition can be more difficult than one might expect.
• Which costs relating to the activities within the project are to be taken into account in determining the level of 'super profit'? One might expect that all of the marginal costs associated with the extraction phase would be deductible. There can, however, be practical difficulties in establishing which costs relate to a project and the types of costs which are actually allowed may be influenced by integrity issues.
• What records will be required in order to demonstrate that particular costs were incurred in relation to the project? In practice, there may be a difference between the scope of a mining joint venture and the scope of the project for PRRT purposes. Many businesses do not maintain records that are intended to record and evidence the factual basis for any claim for the deduction of costs associated with a project as defined for tax purposes.
• How are integrated developments, which involve more than one mine, or the use of related infrastructure to be dealt with? This is a particularly difficult issue where different entities within a corporate group may own different parts of the integrated investment.

The way forward

The Government is expected to release the Henry Report in the next couple of weeks. Many in the mining and petroleum industry will be awaiting the report and the Government's response with much anticipation.

For further information, please contact:

• Grant CathroPartner, Melbourne
  Ph: +61 3 9613 8644
  Grant.Cathro@aar.com.au
• Igor BogdanichPartner, Melbourne
  Ph: +61 3 9613 8747
  Igor.Bogdanich@aar.com.au
• Katrina ParkynPartner, Brisbane
  Ph: +61 7 3334 3323
  Katrina.Parkyn@aar.com.au
• Gerard WoodsPartner, Perth
  Ph: +61 8 9488 3705
  Gerard.Woods@aar.com.au

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