House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 14 Valuations

Outline of chapter

14.1 This chapter describes:

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the valuation principles in Division 170 that are applied in working out the value of assets, rights and other things for the purposes of the Minerals Resource Rent Tax (MRRT); and

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the alternative valuation method in Division 175 that is available for working out the MRRT revenue of some smaller miners and miners with vertically integrated transformative operations.

14.2 All legislative references throughout this chapter are to the Minerals Resource Rent Tax Bill 2011 unless otherwise indicated.

Summary of new law

Valuation principles

14.3 MRRT taxpayers may need to value certain assets and rights in order to determine their MRRT liability.

14.4 For example, the value of an asset may be used in determining the starting base of a mining project interest, and as an input in calculating the amount of mining revenue that arises from a particular sale of taxable resources. Valuations are also used when project interests are split or transferred between taxpayers, and when certain non-cash benefits are received.

14.5 Because of their role in determining MRRT outcomes, it is important that these valuations be reasonable, both in isolation and when considered alongside other valuations done in relation to a project interest.

14.6 To this end, valuations must comply with a set of principles, which recognise that reasonable valuations depend on:

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the consistent application of appropriate assumptions;

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each thing that is to be valued being counted exactly once; and

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avoiding hindsight when estimating the value of something at an earlier point in time.

Alternative valuation method

14.7 Miners producing less than 10 million saleable tonnes of taxable resources in a year can choose to use an alternative valuation method to work out the mining revenue attributable to taxable resources from their mining project interests for that year.

14.8 Miners with a vertically integrated transformative operation (that is, an operation that both extracts resources and turns them into a different product) that existed just before 2 May 2010 can always use the alternative valuation method for that operation. If their group production is under 10 million saleable tonnes, they can also use it for the rest of their mining project interests.

14.9 The alternative valuation method is a variant of the netback method. It starts with the consideration for supplies of taxable resources and deducts the project interest's post-valuation point (downstream) operating costs, depreciation on its downstream assets and a return on its downstream capital. The rate of return is the same long term bond rate plus 7 per cent (LTBR + 7 per cent) used to uplift carried forward mining losses and royalty credits.

Detailed explanation of new law

Valuation principles

When the valuation principles apply

14.10 The valuation principles apply broadly, wherever the value of something is used in working out an amount under the MRRT law. [Subsection 170-5(1)]

14.11 An obvious example is the way the value of certain starting base assets is used to determine the starting base losses of project interests that existed on 1 May 2010.

14.12 The starting base is an example where values are used directly in working out an MRRT amount. In other cases, the relationship between the value of an asset and an MRRT amount may be less direct.

14.13 The valuation principles apply whether or not a provision of the MRRT law expressly requires the amount to be worked out by making a valuation. [Paragraph 170-5(3)(b)]

14.14 The valuation principles do not prescribe or prevent the use of any specific valuation method, nor does their operation depend on a certain method being used. They apply in relation to starting base assets, for example, whether the market value or book value approach is chosen by the taxpayer. [Paragraph 170-5(3)(a)]

14.15 However, the valuation principles do not operate to exclude the operation of any specific rules elsewhere in the MRRT law. [Subsection 170-5(2)]

14.16 For example, the alternative valuation method (described below) allows certain taxpayers to calculate MRRT revenue in a specific way, using a version of the 'retail price' or 'netback' method. Under this method taxpayers use a concept of 'total adjustable values' when calculating a return on their capital costs. The specific rule setting out how 'total adjustable values' are to be calculated under this method takes precedence over the valuation principles, in the event of any conflict between them. Similarly, the rule setting out how a mining revenue amount is determined prevails over these principles if there is any inconsistency between the two.

What the valuation principles are

Basic principle

14.17 The valuation principles consist of one basic principle and five supporting sub-principles.

14.18 The basic principle requires each valuation relating to a mining project interest (or pre-mining project interest) to be reasonable, having regard to the objects of the MRRT law. [Subsection 170-10(1)]

14.19 This requirement of reasonableness means that each valuation is to be governed by logic and reflect the application of common sense and sound thinking. Reasonable valuations are also free from contradiction and extreme argument.

Sub-principles

14.20 Each of the five valuation sub-principles is designed to support the basic principle, by explaining in further detail some of the things which must be recognised and criteria which must be satisfied in order for a valuation to be reasonable.

14.21 However, to the extent that there is any conflict between the basic principle and any of the sub-principles, the basic principle applies. [Subsection 170-10(7)]

14.22 The sub-principles require that a valuation done for the purposes of working out an amount under the MRRT law:

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avoids using hindsight when valuing something as at an earlier point in time;

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counts each thing that is being valued exactly once;

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treats identical assets equally;

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applies appropriate assumptions consistently; and

•

takes into account relevant previous valuations.

Sub-principle 1: The use of hindsight is to be avoided when valuing something as at an earlier point in time

14.23 A taxpayer may use the value of something at a particular point in time for the purpose of working out an amount under the MRRT law. For example, a taxpayer choosing to use the market value method to determine the starting base amount for a project interest uses the market value of certain things as at 1 May 2010.

14.24 Such valuations are generally conducted after the time to which they relate. This is unavoidable and in itself poses no great difficulty provided that the valuation takes into account only those facts, estimates, and predictions which prevailed at the time to which the valuation relates. A valuation of something at a point in time is not valid to the extent it draws on observations made since that time.

14.25 This concept is captured by the first sub-principle, which clarifies that a valuation made as at a particular time may only take into account:

•

things that have actually happened before that time; and

•

things that, as at that time, are reasonably expected to happen after that time.

[Subsection 170-10(2)]

14.26 That is, things only known with the benefit of hindsight cannot be taken into account.

Example 14.154 : Valuations cannot reflect the application of hindsight

Block Ore Co has an iron ore mining project interest as at 1 May 2010. As at that time, the market value of the rights and interests which constitute the mining project interest is $1 billion. This figure takes into account all relevant factors, such as the current and anticipated production of the mine and expected iron ore prices and capital and operating costs.

In December 2011, the iron ore price received by Block Ore unexpectedly decreases sharply. This reduces the value of its mining rights and interests to $300 million.

In February 2012, Block Ore (intending to use the market value method) seeks to determine its starting base amount. In doing so, it has no regard to the unexpected fall in the iron ore price because to do so would be to apply hindsight to the determination of a value at a particular point in time (1 May 2010). The amount to be included in the starting base is $1 billion.

14.27 The avoidance of hindsight in no way means that estimates and assumptions about future events and circumstances are prevented from being taken into account. It only means that their likelihood must be evaluated by reference to information available at the time to which the valuation relates.

Example 14.155 : Assumptions about the future are to be taken into account

On 1 May 2010, Seagull Resources has a small pre-mining project interest in remote Queensland. The viability of turning this interest into an operating coal mine depends on whether a railroad is built to service nearby major deposits. The railroad has been talked about as a possibility for some time, but it is generally accepted that it will be built by 2012, or not at all in the foreseeable future. As at 1 May 2010, the chances of the railroad being built are 50 per cent.

Without the railroad, Seagull Resources' pre-mining project interest has little value, $5,000. However, if it were known with certainty that the railroad would be built, the value of the interest as at 1 May 2010 would be $20 million.

Based on this information, if in 2012 Seagull Resources were to use the market value method to determine its starting base amount, then it would be appropriate to include slightly over $10 million for the pre-mining project interest (being 50 per cent of $20 million plus 50 per cent of $5,000). Although the railroad was not built by the valuation date, the likelihood of it being built in the future should be taken into account, along with the effect that building it would have on the value of the project interest.

It would not be valid for Seagull Resources to cite an announcement in early 2012 that the railroad would be built as a justification for increasing its starting base amount towards $20 million, because this fact was not known on 1 May 2010.

Sub-principle 2: Each thing being valued is to be counted exactly once

14.28 The second sub-principle states that the sum of the values of all things in a set must equal the value of the set. This ensures that each thing being valued is counted exactly once. [Subsection 170-10(3)]

14.29 A common situation where this principle is relevant is the use of a residual method to determine the value of the rights and interests of a mining project interest. A valuer might first determine the value of an integrated mining operation (the set, using the language of the principle) and then subtract the value of the physical assets. The residual amount is then attributed, on a collective basis, to those remaining assets which were not valued separately.

14.30 In some situations, the value of an asset within a mining operation may depend not only on its intrinsic qualities, but also on how it functions within the context of the overall operation. The valuation principles do not prevent any synergy value from being recognised, but they do insist that it only be counted once.

Example 14.156 : Valuations must not count the same thing more than once

Blob Energy uses a crusher and a railway in its downstream mining operations. The value of the crusher is $100 million. The value of the railway, which is used exclusively in transporting coal from Blob Energy's mine to the port, is $500 million.

The value of the crusher and the railway, taken together, is the sum of their respective values, $600 million. It would be invalid to seek to ascribe any additional value to any synergy arising from the use of the crusher and railway in close proximity.

Sub-principle 3: Identical assets are to be valued equally

14.31 The third sub-principle requires identical assets to be treated equally in valuations. It states that identical things in identical circumstances have the same value. [Subsection 170-10(4)]

14.32 In practice, it will be rare to find two assets which are identical in all respects, including the circumstances in which they are used. The conditions of the sub-principle may never strictly be satisfied.

14.33 However, the corollary of the principle is that a difference in two assets' values must be explainable by differences in their nature or circumstances.

14.34 This is essentially another expression of the requirement for valuations to be reasonable when considered alongside other related valuations. Things not relevant to the value of a particular asset, such as whether it operated upstream or downstream of the valuation point in a particular period, should not influence any estimate of the asset's value.

Example 14.157 : Identical assets in identical circumstances have the same value

Pod Power Co purchases a fleet of 10 identical new trucks in 2013-14 for use in its coal mining operations. Each truck performs the same tasks as the others: picking up coal, transporting it from one place to another, and unloading it. While five of the trucks operate mostly upstream of the valuation point and the other five mostly downstream, the conditions are equivalent and the trucks operate interchangeably.

The total value of the 10 trucks at the end of 2014 is $20 million. The trucks are the same make, model and age. In the absence of any reasonable argument to the contrary, each truck has the same value, $2 million.

It would not be valid to suggest the value of the trucks used mostly downstream of the valuation point was greater than the others, because the location of the valuation point is not relevant in determining the value of an asset.

Sub-principle 4: Valuations are to consistently apply appropriate assumptions

14.35 The fourth sub-principle goes to the consistent application of reasonable assumptions and estimates, when valuing a thing to work out an amount under the MRRT law.

14.36 An assumption or estimate relating to a mining project interest or pre-mining project interest:

•

is to be reasonable when considered in isolation;

•

is to be reasonable when considered together with all other assumptions or estimates made in relation to the interest; and

•

is to be made consistently for all things relating to the interest.

[Subsection 170-10(5)]

14.37 The task of valuing an asset usually involves making assumptions and estimates, which are used as inputs in the application of a particular valuation method.

14.38 The basic principle requires the product of this process (that is, the value ascribed to the asset, or other thing) to be reasonable. The sub-principles discussed so far cover matters relating to the reasonableness of the valuation method.

14.39 This sub-principle focuses on the reasonableness of the assumptions and estimates used as inputs to a process of valuation. Its inclusion recognises that even the soundest valuation method will seldom be able to overcome the use of unreasonable inputs to produce a reasonable valuation outcome.

14.40 The first of the three parts of the sub-principle requires each assumption and estimate used in a valuation to be reasonable when considered in isolation. [Paragraph 170-10(5)(a)]

14.41 In practice, there is likely to be a range of views on the most appropriate assumptions to make when valuing something for the purposes of the MRRT. For instance, there is no single universally accepted 'correct' value of expected future exchange rates or commodity prices that a valuer can draw on, or could be compelled to employ.

14.42 It is wholly to be expected, and perfectly legitimate, for views to differ as to the most appropriate assumptions and estimates to use in a given circumstance. However, this does not mean that a taxpayer is free to choose any assumption, no matter how unrealistic or remote the likelihood of it being borne out.

Example 14.158 : Assumptions used in valuations must be reasonable in isolation

Iron Grid Co is an exploration company with a pre-mining project interest on 1 May 2010. At that time, the interest had an indicated resource of 1 million tonnes of iron ore.

As an input into the determination of its market value starting base for the MRRT, Iron Grid makes an assumption about the proportion of this indicated resource that will ultimately be converted into a measured reserve able to be economically extracted and sold.

This assumption must be reasonable, a standard permitting some discretion but not so wide as to include any conceivable possibility. If the demonstrated success of conversion for comparable tenements in recent years had ranged between zero and 15 per cent, it might be considered reasonable for Iron Grid to adopt an assumption lying somewhere between those limits. It would not be reasonable to assume that, say, 90 per cent of the indicated resource would prove economically recoverable.

14.43 The second part of the sub-principle requires each assumption and estimate to also be reasonable when considered together with other assumptions and estimates made in relation to the interest. [Paragraph 170-10(5)(b)]

14.44 This recognises that, as is the case for the values themselves, it is possible for two assumptions or estimates to be reasonable when considered separately but inconsistent (such as being mutually exclusive), and so not reasonable, when taken together.

Example 14.159 : The relationship between assumptions must be taken into account

In determining as at 1 May 2010 the market value of its starting base assets, Geordie Minerals Co makes assumptions about future movements in several exchange rates, including those between:

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the United States dollar and the Australian dollar;

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the Japanese yen and the Australian dollar; and

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the United States dollar and the Japanese yen.

Having had appropriate regard to market forecasts and other relevant information, Geordie Minerals considers anything between -20 per cent and +20 per cent would represent a reasonable forecast of the change in the strength of the Australian dollar (A$) relative to the United States dollar (US$) over the period relevant to its valuation. Geordie Minerals considers the same range also captures all reasonable forecasts of the change in the A$ relative to the Japanese yen ( ¥ ), and of the change in the US$ relative to the ¥ .

Geordie Minerals decides to assume that the A$ will remain unchanged against both the US$ and the ¥ over the relevant period. These assumptions are reasonable in the circumstances, both when considered separately and when considered together.

It would not be reasonable though, for Geordie Minerals to concurrently assume that the US$ would markedly increase (or decrease) against the ¥ . While such an assumption could be reasonable in isolation, it is not reasonable when considered alongside the other assumptions made in relation to the project interest. This is because it would not reflect the very strong correlation observed in practice between the exchange rate movements of highly liquid currencies such as the A$, US$ and ¥ .

14.45 The third part of the sub-principle requires each assumption and estimate to be made consistently for all things relating to the interest. [Paragraph 170-10(5)(c)]

14.46 For example, if a forecast increase in the coal price is used to estimate the overall value of an integrated mining operation at a particular time, then this forecast must be applied consistently when valuing the separate assets used within that operation.

14.47 It would not be valid, for example, to assume that interest rates will increase for the purposes of valuing a crusher, while at the same time assuming that interest rates will decrease when valuing a digger used in relation to the same project interest.

Example 14.160 : Assumptions and estimates can reasonably vary over time

Boro Coal Co is a miner subject to the MRRT. It takes the value of its mining rights as at 1 May 2010 into account when determining its market value starting base. For the purpose of that valuation, Boro Coal uses its assumption as of 1 May 2010 that the average coal price it will receive over the following five years would be $250 per tonne. It is required to use this assumption (or one consistent with it) when valuing other assets relating to this project interest at that time.

In 2013-14, Boro Coal again values its mining rights for the purpose of splitting a mining project interest. It is not required to use the same assumption for future coal prices it used previously. Boro Coal should make an assumption which is reasonable in the circumstances (and then apply that assumption consistently for all its valuations done at that time).

Sub-principle 5: Valuations are to be reconcilable with relevant previous valuations

14.48 The fifth (and final) sub-principle recognises that, just as the estimates and assumptions used in a valuation should be reasonable when considered together, so too should the set of valuations be reasonable.

14.49 The sub-principle states that each valuation done for the MRRT after 1 May 2010 should be reconcilable with certain other valuations relating to the interest (including, if relevant, a valuation relating to a pre-mining project interest from which a mining project interest originated). [Subsection 170-10(6)]

14.50 Only valuations made after 1 May 2010 and for the purposes of working out an amount under the MRRT law are required to be taken into account. [Paragraphs 170-10(6)(a) and (b)]

14.51 In some cases an asset or other thing will have been valued multiple times for the purposes of working out an MRRT amount. The sub-principle requires a new valuation of that thing to be reconcilable only with the most recent relevant valuation, rather than every previous valuation. [Paragraph 170-10(6)(c)]

14.52 Requiring valuations relating to the same project interest to be reconcilable, or broadly consistent, is designed to avoid, over time, a set of valuations which is not reasonable, perhaps because some of its elements are mutually contradictory, despite each individual valuation being reasonable considered in isolation.

14.53 The requirement for valuations done in relation to a project interest to be reconcilable does not mean that they must be the same. It is sufficient that they accord with each other, are compatible, and are free from contradiction.

14.54 In practice, there will be many valid reasons for the value of an asset within a mining project interest to change over time. It is entirely appropriate for a valuation to take into account any changes in circumstances since any previous valuation.

Example 14.161 : Two valuations can be reconcilable without being the same

In 2012-13, Buzz Coal Co values a digger at $20 million and a crusher at $10 million.

By 2015-16, the collective value of the digger and crusher decreases to $15 million, owing to a change in the configuration of Buzz Coal's operations and the wear and tear placed on the assets due to their continual use. Buzz Coal ascribes this decrease in value between the two assets proportionately, so the digger is now worth $10 million and the crusher $5 million. This is reconcilable with the previous valuation, even though it produces different results.

14.55 In practice, there will nearly always be some change in circumstances and available information from one valuation to the next, even if this change is nothing more than the passage of time.

14.56 This sub-principle does not prevent such changes from being taken into account when an asset is valued. However, it does require a miner performing a valuation of something to have due regard to the value previously ascribed to the thing.

Example 14.162 : A valuation must be reconcilable with previous valuations done in relation to the project interest

In 2012, Buzz Coal Co estimates the value as of 1 May 2010 of a digger and a crusher for the purpose of working out the starting base amount for its interest in the Basic Coal project. The digger is used upstream of the valuation point (so its value is used directly in calculating the starting base) and the crusher forms part of its downstream mining operations.

Buzz Coal estimates that, collectively, the digger and the crusher were worth $30 million on 1 May 2010. Because the digger and crusher play an interdependent role in an integrated operation, Buzz Coal finds it could split this $30 million in any one of a number of ways, with any valuation of the digger between $10 million and $20 million being reasonable in the circumstances. For the purpose of determining its starting base amount, Buzz Coal values the digger at $20 million, and the crusher (which is not a starting base asset) at $10 million.

In 2013, Buzz Coal seeks to use the value of the crusher during the 2012-13 MRRT year for the purpose of splitting a mining project interest. Assume that the circumstances of the Basic Coal project are such that the combined value of the digger and the crusher in 2012-13 remains $30 million. In splitting this value between the two items, Buzz Coal must do so having regard to its earlier valuation. In the absence of any specific factor suggesting otherwise, Buzz Coal would value the crusher at $10 million.

If the task of estimating the value of the crusher in 2012-13 were to be looked at in isolation, any value between $10 million and $20 million might be considered reasonable. However, this task is not to be performed in isolation, but in the context of previous valuations done in relation to the project interest. It would be unlikely to be reasonable for Buzz Coal to suggest the value of the crusher was twice as much, say, as the value of the digger, for the purpose of the mining project split, having previously suggested the opposite for the purpose of determining its starting base amount.

Alternative valuation method

14.57 It can sometimes be difficult to apply the normal methodologies for working out what part of the consideration for selling resources is attributable to the condition and location of the resources at their valuation point. The difficulties may be greater for smaller miners who have less access to the specialist advice necessary to apply those methodologies properly. They can also be greater for miners who transform resources they mine in an integrated operation, such as steel manufacturing or electricity generation.

14.58 Accordingly, an alternative, and simpler, valuation method is provided for those miners to work out the mining revenue attributable to their resources. [Section 175-5]

The alternative valuation method is a choice

14.59 The alternative valuation method is a choice, available to a miner who satisfies the conditions, in relation to each of its mining project interests. A miner can choose to use the method for some interests but not for others. [Paragraph 175-10(2)(a)]

14.60 The election is also available on an annual basis. A miner can choose to use the method for some years but not others [paragraph 175-10(2)(b)] . However, choosing to use the method for a mining project interest in one year could affect the future transferability of allowance amounts arising in that year and whether the interest can combine with other interests in later years (see Chapters 6 and 9).

14.61 A miner must make the choice by the time it lodges its MRRT return for that year, or by the time it was due to provide its MRRT return if it does not lodge it within time. The Commissioner of Taxation (Commissioner) can allow for further time. This is a standard approach to choices under tax laws, so the Commissioner's usual processes for deciding whether to extend time can be expected to apply. [Schedule 1 to the Minerals Resource Rent Tax (Consequential Amendments and Transitional Provisions) Bill 2011 (MRRT (CA & TP) Bill), item 8, subsection 119-5(3) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953)]

14.62 A choice to use the alternative valuation method for a mining project interest for a year, once made, is irrevocable. This ensures that miners consider carefully whether to make the choice, rather than later seeking to undo it if circumstances change. [Schedule 1 to the MRRT (CA & TP) Bill, item 8, section 119-10 of Schedule 1 to the TAA 1953]

Effect of making the choice

14.63 If a miner makes the choice to use the alternative valuation method for a mining project interest for a year, the revenue relating to the interest's resources is worked out using the alternative valuation method rather than the other methods that might be used. The resources would still have to be supplied, exported or used before any amount would be included for them in mining revenue. [Section 175-20]

Conditions for making the choice

14.64 Before it can choose to use the alternative valuation method, a miner must:

•

have group production of taxable resources of less than 10 million saleable tonnes in the year; and/or

•

carry on an operation, which existed before 2 May 2010, that supplies things made using the resources extracted from the mining project interest's project area.

[Subsection 175-10(1)]

14.65 If a miner's group production is 10 million saleable tonnes or more in the year, it cannot make the choice generally but it could still make it for each mining project interest that is part of an operation that existed before 2 May 2010 that uses the resources to produce something else.

Group production

14.66 A miner's group production includes the production of taxable resources across all its mining project interests and pre-mining project interests and those of all the entities connected to, or affiliated with, it. [Subsection 175-15(1)]

14.67 Broadly, entities are connected to or affiliated with one another if either controls the other (or both are controlled by a third entity) or if it is reasonable to expect that one would act in accordance with the wishes of the other. These concepts are dealt with by sections 328-125 and 328-130 of the ITAA 1997.

14.68 A project area for a miner's mining project interest could also be the project area for another miner's interest (for example, in a joint venture). In such cases, only the miner's share of the resources extracted from that project area would be counted towards the 10 million tonnes (unless, of course, the miners in question were connected to or affiliated with each other). [Subsection 175-15(1)]

14.69 Resources only count towards the 10 million tonnes if the miner has the interest from which the resources were extracted at the end of the MRRT year. It may not have extracted those resources itself. For example, if a mining project interest is transferred from one miner to another during the year, the resources extracted from it would count towards the threshold for the transferee and not towards that for the transferor. [Subsection 175-15(1)]

14.70 The weight of taxable resources is measured when they reach the form in which they are to be supplied or exported. In many mining processes, the weight of the taxable resource extracted declines during processing as waste material is separated and discarded. The 10 million tonnes is determined, not by reference to the weight of the resource at extraction, but by reference to its weight after it has reached the relevant point in the operation. This is commonly referred to as 'saleable tonnes' in the mining industry. [Paragraph 175-15(1)(b) and subsection 175-15(2)]

14.71 The 10 million tonnes is also measured regardless of the type of taxable resource. It includes the cumulative weight of all the taxable resources produced: the tonnes of gas extracted as an incident of coal mining as well as the tonnes of coal and iron ore. [Subsection 175-15(1)]

14.72 However, for gas subject to the MRRT because it is converted from coal in situ , the tonnes of coal consumed in the gas production are measured (rather than the weight of the gas) and they are measured when they are consumed. [Subsection 175-15(3)]

14.73 Obviously, coal in the ground cannot actually be weighed but there are accepted methods for estimating the weight of the coal consumed based on relevant factors, such as the amount of gas produced. Using such a method is sufficient for this purpose.

Vertically integrated transformative operations

14.74 Some miners supply something they produce using the coal or iron ore they mine, rather than supplying the coal or iron ore itself (they may, of course, supply both). The most common cases are operations that convert iron ore into steel and operations that burn coal to produce electricity.

14.75 It can be more difficult than usual to work out the value of the taxable resources at their valuation point in such operations, because of the extent of capital investment after the valuation point and the less direct relationship between the value of the resources and that of the product sold.

14.76 The legislation recognises this by allowing miners with such operations to access the alternative valuation methodology even if their group production exceeds 10 million tonnes. This only applies to miners whose vertically integrated transformative operation produces something other than a taxable resource. It would not apply, for example, to a miner who simply refines iron ore or produces coal briquettes. [Subparagraph 175-10(1)(b)(i)]

14.77 The operation in question must have existed before 2 May 2010, so the method is not available to newly created vertically integrated transformative operations (which would have the opportunity to establish an advance pricing agreement with the Australian Taxation Office (ATO). However, it is not necessary that the miner with the operation is the same miner who had it just before 2 May 2010. This ensures that the legislation does not affect commercial decisions about selling an operation that qualifies for the alternative valuation method. [Subparagraph 175-10(1)(b)(ii)]

14.78 Whether an operation is one that existed just before 2 May 2010 is a question of fact. This can involve difficult judgments. Obviously, it would not be an existing operation if the miner acquired either the mine or the transformative operation after that date.

14.79 But it is not always obvious even if the same miner did own both of those elements before that date. The question in that case would be whether those two elements were part of a vertically integrated operation at that time.

14.80 Changing components of each of the two elements can also raise difficult problems. Using a different power plant or steelworks would probably change the operation so that it was no longer one that existed at 2 May 2010. But replacing buildings, plant and staff would probably not change the operation, even if upgrades were involved.

14.81 Similarly, using a new mining project interest to supply the transformative operation would probably change the operation. However, combining further interests with an existing mining project interest that was supplying the transformative operation at 2 May 2010 would probably not change the operation because the effect of the combination rules is that it would still be the same mining project interest.

Example 14.163 : Steel making operation

As at 2 May 2010, Freiheit Resources owns two adjacent mining leases. Mining lease 1 is being mined and produces ore to supply Freiheit's steelworks. The other lease is inactive. Freiheit has two mining project interests.

In 2015, the mining leases are renewed. The renewals do not change Freiheit's vertically integrated operation. The 2 May 2010 elements of the operation are still intact.

In 2017, Freiheit extends its mine into the second mining lease. Because both of the mining project interests satisfy the upstream integration tests and were owned by Freiheit on 2 May 2010, the interests are combined into a single mining project interest.

Some of the ore from an area covered by the second mining lease is put into the steelworks. Again, the 2010 elements of the operation are intact because the combination of the two mining project interests means that the same mining project interest is still supplying the steelworks (even though the combined interest did not exist at 2 May 2010). The whole of that combined interest can use the alternative valuation method even if Freiheit exceeds the 10 million tonnes limit.

In 2018, Freiheit also starts supplying the steelworks with ore from a second, unrelated, mine. The new mine is not part of a vertically integrated operation that existed at 2 May 2010. If Freiheit exceeds the 10 million tonnes limit, it would not be able to use the alternative valuation method for the new mine but it could continue to use it for the old mine (as extended).

Relationship between different mining project interests

14.82 Special quarantining rules prevent the mining losses and royalty credits from vertically integrated projects being transferred to other projects. [Paragraphs 65-20(1)(b) and 100-20(1)(b)]

14.83 Lower than normal resource values could be generated by the alternative valuation method (because the required valuation methodology might inflate the value of the downstream capital or because the prescribed rate of return on downstream capital is too high for a particular operation). Quarantining the mining losses and royalty credits from an interest using the alternative valuation method ensures that mining losses and royalty credits available because of those low values cannot be used to shield the mining profits of other interests, limiting the effects of any inappropriately low resource values.

What is the alternative valuation method?

14.84 The alternative valuation method is a version of the 'netback' method, which starts with a verifiable price and deducts costs to 'net back' to the value at an earlier point. Miners who have not elected to use the alternative valuation method may use the netback method to value their taxable resources, but they will have to work out the inputs using the most appropriate method instead of using those prescribed for the alternative valuation method.

14.85 The alternative valuation method starts by working out the amounts for supplying the miner's resources (or something produced using the resources) for the year. These are the same amounts used as the basis for working out mining revenue:

•

the consideration received or receivable for a supply;

•

what would be the arm's length consideration for a supply at the time and place the resources are (or something produced using the resources is) exported from Australia; or

•

what would be the arm's length consideration for a supply of something produced using the resources at the time and place the thing is used by the miner.

How those amounts are worked out is discussed in Chapter 4. [Section 175-25, steps 1 and 2, and section 175-30]

14.86 The miner then reduces that amount by its post-valuation point (or 'downstream') costs, leaving it with the mining revenue from the taxable resources. The downstream costs are:

•

the miner's downstream operating costs;

•

depreciation on the miner's downstream assets; and

•

a return on the miner's downstream capital costs.

[Section 175-25, steps 3 and 4]

14.87 It is important to note that the legislation only 'reduces' the amount by those costs; it is not a mathematical subtraction. The difference is that a reduction cannot produce a figure below zero, while a subtraction could produce a negative result. That means the value of the taxable resources worked out under the alternative valuation method can never be less than zero.

Downstream operating costs

14.88 The miner's downstream operating costs for a mining project interest are the expenditures the miner necessarily incurs in carrying on the activities related to the taxable resources from the interest that occur after the resources have passed the valuation point [paragraph 175-35(1)(a)] . They do not include any expenditure of capital or of a capital nature [paragraph 175-35(1)(b)] .

14.89 Expenditure cannot be deducted as a downstream operating cost if it would be excluded expenditure in working out the upstream expenses. This ensures there is a symmetrical treatment of upstream and downstream expenditure. [Subsection 175-35(2)]

Depreciation of assets

14.90 The alternative valuation method allows a reduction for the depreciation of assets held by the miner that are used, installed ready for use, or being constructed for use, in relation to a mining project interest's activities after the valuation point and before the resources are supplied, used or exported [subsection 175-40(1)] . The assets themselves might not be depreciating assets but the calculation will provide a depreciation deduction as if they were [paragraph 175-40(3)(a)] . Assets that are eligible for depreciation include improvements to, and fixtures on, land as if they were separate assets in the same way they are for income tax purposes [subsection 175-40(7)] .

14.91 Depreciation is worked out using the broad approach described in the uniform capital allowance provisions in Division 40 of the Income Tax Assessment Act 1997 (ITAA 1997) but is not limited to the prime cost and diminishing value methods that can be chosen under that Division. The alternative valuation method allows any method of depreciation that is accepted for the particular asset in accordance with accounting principles (for example, the units of production method could also be available). [Subsections 175-40(2), (3) and (5)]

14.92 However, a miner must use a consistent depreciation method for a particular asset; it cannot use one method in one year and a different method in the next. [Subsection 175-40(4)]

14.93 If a miner chooses to use the alternative valuation method in the MRRT year starting on 1 July 2012, the depreciation of assets the miner held immediately before 1 July 2012 starts from a value at that date worked out using the depreciated optimised replacement cost method. In effect, that value becomes the asset's opening adjustable value for the year and it would be written-off over the remainder of the asset's effective life. Assets the miner did not hold at that time would be depreciated from the time they are acquired, and from their cost. [Paragraph 175-40(3)(d)]

14.94 If a miner does not choose to use the alternative valuation method in the first MRRT year but chooses to use it in a later year, the method would depreciate the miner's downstream assets from their opening adjustable value for that later year. [Subsections 175-40(2) and (3)]

14.95 The legislation does not define 'depreciated optimised replacement cost' but relies on its meaning within the valuation industry. Broadly, an asset's depreciated optimised replacement cost is the amount it would cost to buy a new asset of identical or similar utility, written-down to reflect the shorter remaining life of the actual asset. The reference to the cost being 'optimised' means that it is adjusted to account for the existing asset having excess capacity or being redundant. In other words, the depreciated optimised replacement cost of an operation's assets reflects the cost of replicating the whole operation in the most efficient way possible, written-down to reflect the age and extent of use of the existing assets.

14.96 A proportion of the asset's opening adjustable value will be depreciated in each year, worked out according to the asset's remaining effective life, as is done under Division 40 of the ITAA 1997. The year's depreciation will then be apportioned in accordance with the extent of use of the asset (or its installation for use) in relation to the mining project interest's downstream activities. [Subsection 175-40(6)]

14.97 Therefore, if an asset is used in both a mining project interest's upstream and downstream activities, its depreciation will be apportioned to reflect only the downstream use. If an asset is used in relation to several mining project interests, its depreciation will be apportioned between them.

Return on capital costs

14.98 The final amount that reduces the revenue amount to produce the value of the resource under the alternative valuation method is the return on capital costs.

14.99 The return is equal to the adjustable value of the assets for which depreciation was allowed under the previous step, multiplied by the LTBR + 7 per cent:

[Subsection 175-45(1)]

14.100 This is the same rate of return used to uplift those mining losses and royalty credits that cannot be applied as allowances in an MRRT year. However, if the miner is using a transitional accounting period for a particular MRRT year that is longer or shorter than 12 months, it will adjust the return by multiplying it by:

Days in the MRRT year / 365

so that the miner gets a return that properly reflects the actual number of days in its MRRT year. [Subsection 175-45(1)]

14.101 If the depreciation allowed for an asset is reduced because it was not fully used, installed ready for use, or being constructed for use on the mining project interest's downstream activities for the year, the return on capital for the asset is reduced by the same proportion. [Subsection 175-45(2)]

Example 14.164 : Applying the alternative valuation method - under 10 million tonnes

Wind Sun Energy Pty Ltd operates two coal mines, one that supplies coal to Wind Sun's power station and another that supplies coal for export. Each is a separate mining venture and therefore each represents a separate mining project interest.

The operations are unchanged since 2005. In the MRRT year starting on 1 July 2012, it produces 9 million tonnes of coal, 8 million tonnes of which it uses in its own power station and 1 million tonnes of which is exported.

Its downstream operating costs for the year are $100 million. The opening adjustable value of its downstream assets (namely, the plant at its power station), worked out using the depreciated optimised replacement cost, comes to $1.5 billion and their remaining effective lives are each 20 years.

Wind Sun sells the 1 million tonnes for $120 million. It sells the electricity it generates using the rest of the coal for $600 million.

Because its production in the year is less than 10 million tonnes, it can choose to use the alternative valuation method for that year for both of its mining project interests. To work out the MRRT revenue for the coal it extracts, it would start by adding together the amounts it derives from selling the coal and the electricity ($720 million). From that, it would deduct its $100 million downstream operating costs, its $75 million downstream depreciation ($1.5b/20 years - it chooses to use the prime cost depreciation method), and its $180 million return on downstream capital ($1.5b x 0.12, assuming a long term bond rate of 5%). That gives Wind Sun a total mining revenue of $365 million attributable to the taxable resources it produces from the two interests in that year.

Example 14.165 : Applying the alternative valuation method - 10 million tonnes or more

Continuing the previous example, in the next year, Wind Sun is acquired by another mining company that produces 20 million tonnes of coal a year. Wind Sun cannot use the alternative valuation method for its whole operation because its group production is now 29 million tonnes (that is, its own 9 million tonnes + its affiliate's 20 million tonnes). However, it could use the method to work out the value of its resources from the mine supplying its integrated electricity generation operation.

Wind Sun chooses to use the alternative valuation method for its mine supplying its vertically integrated transformative operation. It would have to separate its downstream assets into those used for each operation (some might have to be apportioned between the two). Assume that, of the $1.425 billion opening adjustable value of its downstream assets ($1.5b - $75m for last year's depreciation), $1.2 billion relates to the integrated electricity generation operation. Of its downstream operating costs, $75 million relate to that operation.

For that operation, Wind Sun would start with $600 million for its electricity sales and deduct its $75 million downstream operating costs, its $63.16 million depreciation ($1.2b/19) and its $144 million return on capital ($1.2b x 0.12). That gives it mining revenue for the resources used in its electricity generation operation of $317.84 million. It would also work out the MRRT revenue for the coal it exported but would have to use the normal methods to do that.