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Focus: The resource super profits tax

3 May 2010

Chinese language version (PDF)

In brief: The Federal Government has announced that it intends to introduce a resource super profits tax as the centrepiece of the tax reforms announced as part of the Henry Review. Although the new tax bears some similarity to the existing Petroleum Resource Rent Tax which applies to many off-shore petroleum projects, it differs in a number of very significant respects. Partner Grant Cathro (view CV) and Senior Associate Rory O'Brien report.

 

What will the RSPT apply to?

The resource super profits tax (RSPT) which will commence on 1 July 2012, will apply to all mining and petroleum projects, other than those currently subject to Petroleum Resources Rent Tax (PRRT).1 This includes both existing projects for which there will be special transitional treatment and new greenfield projects.

Each participant in a mining or petroleum project will be required to calculate their RSPT taxable profit arising from that project and pay RSPT on that taxable profit (if any). 

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What is the rate of tax?

The rate of tax proposed is 40 per cent of the RSPT taxable profit.  Like the PRRT, this tax will be deductible for income tax purposes, reducing the effective additional impost to 28 per cent (at the current 30 per cent corporate tax rate).2 

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Treatment of state royalties

Adoption of the RSPT is not dependent upon the states abolishing their royalty regimes.  While the Commonwealth would obviously prefer that they do so, the arrangements announced provide a refundable credit for state royalties payable.  The refundable credit may be capped based on royalties chargeable as at 2 May 2010, plus scheduled increases as at that date and appropriate indexation factors.

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How will the RSPT taxable profit be calculated?

Like the existing PRRT, the RSPT is said to relate only to the profits from resource extraction activities and to be calculated in a manner which only brings to account the 'super profit' from the project as part of the RSPT taxable profit. 

The Government recognises that it is often difficult to define the point at which resource extraction activities end and downstream value adding processing commence.  This has been a significant issue in the PRRT context.  The Government intends to consult with industry to 'explore the feasibility of a flexible approach to setting the taxing point'. 

The RSPT taxable profit will be computed by deducting from the revenue, a number of costs associated with those extraction activities. 

Assuming that a product is sold at the end of the extraction phase, on an arm's length basis, revenue will be calculated by bringing those sales proceeds to account. Where it is not sold, the market value of the commodity at that point would be brought to account.

The Government proposes to consult with industry about the scope of expenditure which is to be deductible.  Such expenditure would almost certainly include direct operating costs involved in extracting the minerals, exploration costs and an allowance for capital expended as part of the resource extraction phase. 

Difficulties have arisen in the PRRT context in apportioning expenses between project and non-project activities.  In the PRRT system, operational hedging gains and losses have not been deductible.  The Government has announced that it intends to consult with industry about these matters and their treatment under the RSPT. 

One significant difference between the RSPT and the PRRT, is that the RSPT taxable profit will be calculated on an annual basis, taking into account an allowance for capital.  Capital expended in project activities will not be immediately deductible as it is under the PRRT.  Rather, capital will be recovered over a period of time in a manner somewhat similar to income tax.

In order to ensure that it is not the whole profit of a project which is taxed, but only what the Government terms the 'super profit', an RSPT allowance will be calculated at the end of each year and deducted the following year. This RSPT allowance is calculated by multiplying the balance of any undeducted capital at the end of the previous year and any carry forward loss at the end of that year, by the long-term bond rate.  This RSPT allowance ensures that investors receive a return on their unrecouped expenditure equal to the long-term bond rate free of the RSPT, with a 60/40 sharing of the 'super profit' above that level between investors and the Government.

Many would argue that escalation of costs at the long-term bond rate is far too low and that investors ought to be allowed a rate of compounding equal to the rate of return which would ordinarily be required in order to encourage investment in a project.  The Government argues that its treatment of undeducted expenditure or losses occurring and additional benefits available to encourage exploration, justify the use of a required rate of return which is 'the risk free rate for which the government bond rate is a proxy'. 

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Treatment of existing projects

Existing resource projects other than those subject to PRRT, will be brought into the RSPT automatically.  Those currently subject to the PRRT will have an option to elect-in.  The treatment of existing exploration projects in Commonwealth waters is unclear and is no doubt an issue to be discussed as part of the planned consultation process. 

Existing projects entering the RSPT will enter the regime with an RSPT starting base for invested capital.  In principle, that RSPT starting base will be 100 per cent of the accounting book value of their existing capital as at the date of announcement.  Investment (including exploration) undertaken between the date of announcement and commencement of the RSPT on 1 July 2012 (the interim period) will be treated in the same way as expenditure undertaken once the regime commences.  There will be further consultation with industry on the design of the transitional arrangements.

Provision of an RSPT starting base to existing projects should ameliorate, at least to a limited extent, the otherwise significant harsh consequences of the application of an RSPT to existing projects.  The alternative, providing no allowance to existing projects, would, in effect, have left those projects subject to RSPT on their entire profit every year, without any capital base on which a normal tax free rate of return could be computed.  This will clearly be of benefit to projects on which there has been significant capital expenditure in recent years.

While the impact of the RSPT on existing projects will no doubt be significant, the impact is ameliorated at least in part by:

  • the delay in the start date to 1 July 2012;
  • the provision of an RSPT starting base for existing invested capital and the indexation of that starting base from the date of announcement until 1 July 2012 at the long-term bond rate; and
  • an acceleration of the write-off period for the existing capital base.  This RSPT starting base will be able to be written off over five years at the rate of 36 per cent in the first year, 24 per cent in the second year, 15 per cent in the third and fourth years and 10 per cent in the final year. 

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Treatment of exploration expenditure

Exploration expenditure will be immediately deductible for RSPT purposes.

In addition, the Government has announced changes to the company tax regime which will allow companies undertaking exploration activities, which are not able to utilise a deduction for that exploration expenditure, a refundable tax offset at a rate equal to the applicable company tax rate from 1 July 2011.  While the company tax rate remains at 30 per cent, the tax credit would itself be at 30 per cent, and as the company tax rate is reduced, the tax credit would be correspondingly reduced. 

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Transfer of deductions between projects

It appears intended that the Government will allow undeducted expenditure from one resource project to be deducted against the profits arising in another resource project.  Unlike the existing PRRT, this transfer of expenditure would not be limited to exploration expenditure.  The Government states in section 4.4 of the paper The Resource Super Profits Tax – A Fair Return to the Nation that:

Qualifying expenditure incurred within a year can be transferred from the loss-making project to other profitable projects within the entity or company group.

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Treatment of RSPT losses

Where in any given year the project costs, including the RSPT allowance, are greater than the project's receipts, there will be an RSPT loss. 

As mentioned earlier, that RSPT loss could be transferred to another profitable project within the entity or company group.  Where there are no other profitable projects, the loss will be carried forward and compounded at the long-term bond rate.

One very significant feature of the RSPT, which differs from the existing PRRT regime, is that if, ultimately the project is closed and the RSPT loss has not been able to be transferred to another project, it is proposed that there will be some mechanism for the RSPT value of losses at 40 per cent to be refunded on a reasonable basis.  In effect, the Government may have to refund 40 per cent of this balance in cash.

While we are yet to see the detail, this is a very significant proposal.  Taken to its logical conclusion, it represents a guarantee in time to contribute up to 40 per cent of the investment cost of unprofitable resource projects, including potentially, 40 per cent of the cost of unsuccessful exploration projects.  This is in addition to the proposed refundable tax offset at the company tax rate, under the company tax changes announced.

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Transfers of interest in projects and farm-ins

Where an interest in a project is transferred from one taxpayer to another, the transferee will inherit the transferor's RSPT tax base in the project.  This is consistent with the treatment under the PRRT regime.  It means that the amount of RSPT collected from a project is not affected by the transfer of an interest in the project from one person to another.  Any gain made on the sale of an interest in a project would not be subject to RSPT. 

 

Footnotes
  1. Projects which already have a production licence and are subject to PRRT will have the option to elect into the RSPT.  The treatment of existing exploration permits in offshore Commonwealth waters is unclear. 
  2. The Government has announced that it will cut the rate to 29 per cent for the 2013-14 income year and to 28 per cent for the 2014-15 income year.

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