Explanatory Memorandum
(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)Chapter 1 Charging for Australia's non-renewable resources
Outline of chapter
1.1 This chapter explains the rationale for charging for Australia's non-renewable resources.
Australia's non-renewable resources
1.2 Australia is naturally endowed with a large, high quality non-renewable resource base.
1.3 Non-renewable resources are stocks of minerals and petroleum that are exhaustible and depletable.
1.4 The majority of Australia's non-renewable resources are publicly owned. The rights to these non-renewable resources are vested in the Crown.
Non-renewable resources and taxation
1.5 It is the characteristic of non-renewability that allows exploitation of these resources to generate economic rent or above normal profit. Economic rent can generally be taxed without distorting the decisions of investors if the tax is well designed.
1.6 There are two main types of resource taxes: royalties and resource rent taxes.
Royalties
1.7 In Australia, State and Territory governments typically tax non-renewable resources by applying a royalty to production. Royalties are generally applied on the basis of volume or value and do not take into account how profitable a mining operation is.
1.8 Royalties therefore may only recover a portion of mining rents when mining profits are high, but will also tax mining operations where no economic rent is present, such as when profits are low.
Resource rent taxes
1.9 Resource rent taxes are profit-based, cash flow, taxes. They differ from most royalties in that they take into account the profitability of a mining operation. A resource rent tax collects a percentage of the resource project's economic rent.
1.10 One form of resource rent tax is the Brown tax, invented by Cary Brown in 1948. A Brown tax is a pure cash flow tax levied (at a constant percentage) on the difference between revenue and expenditure.
- (i)
- When there is a positive cash flow, the government taxes that positive cash flow. When there is a negative cash flow, typically at the investment phase, the government provides an immediate refund at the tax value.
- (ii)
- The tax rate determines the portion of economic rent that the government collects, and the value of the refund that they provide.
1.11 Under a Brown tax, the government is effectively sharing in the profits and costs of the mining project in proportion to the tax rate.
1.12 However, the Brown tax model is difficult to implement because of the immediate nature of the refund. So governments typically rely on other models of resource rent taxes that mimic the effect of the Brown tax.
1.13 The Garnaut - Clunies-Ross resource rent tax is a resource rent tax model that attempts to replicate the effects of a Brown tax. It is named after the Australian economists Ross Garnaut and Anthony Clunies-Ross. The Garnaut - Clunies-Ross resource rent tax is levied on the positive cash flows, or profits, of a project, but there is no refund when the cash flow is negative or the taxpayer is making a loss. Instead, losses are carried forward and 'uplifted' by an interest rate, so that they can be used as a deduction against positive cash flows in later years.
1.14 The uplift rate preserves the value of the taxpayer's losses because they do not get an immediate refund for the tax value of the government's contribution to the mining project. The uplift rate also includes a premium to compensate for the risk that the taxpayer may never get to use its losses.
1.15 The Petroleum Resource Rent Tax (PRRT) is an example of a Garnaut - Clunies-Ross resource rent tax.
Background to the Minerals Resource Rent Tax
1.16 The Minerals Resource Rent Tax (MRRT) has its origins in the recommendations of the Australia's Future Tax System (AFTS) Review.
1.17 The AFTS Review found that the royalty regimes applied by the States and Territories were among the most distorting taxes in the Federation. In addition, royalty regimes are not particularly flexible.
1.18 As a consequence of being distorting and relatively inflexible, royalties tend to be set at rates low enough for the mining industry to continue to operate in periods of low to average commodity prices. However, this means that royalties will often fail to provide an adequate return to the community when commodity prices are high.
1.19 The company tax is a profits-based tax, which generally applies to incorporated businesses and will tend to raise more revenue from mining operations when profits are high. However, the AFTS Review found that there would be benefits to the economy more broadly through lowering the company tax rate to assist in attracting internationally mobile capital investment.
1.20 The AFTS Review concluded that a lower company tax rate was desirable for Australia but only if a specific profits-based tax was extended to mining operations to ensure a sufficient return to the community in periods of high commodity prices.
1.21 In response to the AFTS review, the Government decided that, from 1 July 2012, the MRRT would apply to profits from coal and iron ore operations, while the PRRT would be extended to all offshore and onshore gas and oil projects, including coal-seam methane. These commodities account for the bulk of Australia's mineral wealth.
1.22 The detailed design of the MRRT is based on the recommendations of the Policy Transition Group. The Policy Transition Group was chaired by Don Argus AC and the Hon Martin Ferguson AM MP, Minister for Resources, Energy and Tourism. The Policy Transition Group consulted extensively across Australia on the new resource tax arrangements and reported to the Government in December 2010.
The Minerals Resource Rent Tax
1.23 The MRRT is a type of resource rent tax based on the Garnaut - Clunies-Ross model.
1.24 Under the MRRT, the government taxes positive cash flows, or mining profits, and allows taxpayers to carry forward and uplift losses with interest for use in later years.
1.25 As the MRRT taxes profits from minerals that are commonly subject to State and Territory royalties, it provides a credit for royalties.
1.26 The tax base for the MRRT is confined to net profits at the valuation point. The valuation point is the point in the mining production chain that separates upstream and downstream operations.
1.27 As the MRRT is intended to apply only to upstream profits, it is a tax on a narrow portion of mining profits unlike, for example, the income tax, which seeks to tax all sources of income comprehensively.
1.28 The MRRT is a tax on realised profits. As the proceeds from the sale of a resource are typically realised downstream of the valuation point, the MRRT requires taxpayers to determine the amount of those proceeds that are reasonably attributable to the resource and upstream operations for tax purposes. The tax is not intended to tax the value added in downstream activities.
1.29 To calculate the MRRT profit at the valuation point, the sales proceeds are reduced by an amount that recognises the arm's length value of the downstream operations using the most appropriate and reliable method. Allowable upstream capital and operating expenditure is then directly and immediately deducted, along with royalty credits, carry forward losses, starting base depreciation, starting base losses and losses transferred from other projects.
1.30 If losses and royalty credits cannot be used within an MRRT year, they are transferred where possible, or carried forward to later years with the relevant uplift rate applied.
1.31 Through providing effective deductions for all allowable capital and operating expenditure, with an uplift of carry forward losses, the tax base for the MRRT approximates a Brown tax on the profit attributable to the resource in the state it was in at the valuation point.
1.32 As the sources of mining rents are difficult to identify separately in practice, the MRRT aims to strike an appropriate balance between recovering a sufficient return to the community for the profits attributable to the underlying resource rent at the valuation point, and recognising that some mining expertise and capital may also be taxed in a process which has regard to realised profits and their equivalents. This balance is achieved through the combined effect of the features of the tax, including the tax rate, the extraction factor, the valuation point, the interest allowance (uplift) and the scope of assessable revenues and allowable deductions.
1.33 An overview of the operation of the MRRT is provided in Chapter 2.