House of Representatives

Explanatory Memorandum

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

Chapter 4 Mining revenue

Outline of chapter

4.1 This chapter outlines the concept of mining revenue in the Minerals Resource Rent Tax (MRRT).

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

Summary of new law

4.3 Mining revenue is a fundamental concept in the tax as it feeds directly into the calculation of the mining profit for a mining project interest for an MRRT year.

4.4 The main type of mining revenue comes from consideration (or deemed consideration) for supplying or exporting taxable resources, or supplying, exporting or using something produced from taxable resources. Mining revenue is the part of the consideration attributable to the resources at their valuation point.

4.5 Other types of mining revenue include recoupments of mining expenditure and compensation for loss or destruction of taxable resources.

Detailed explanation of new law

What is a miner's mining revenue?

4.6 Mining revenue for an MRRT year is calculated separately for each mining project interest of the miner. [Section 30-5]

4.7 The mining revenue of a mining project interest in respect of an MRRT year is the total of the amounts included in the mining revenue for that interest for that year [section 30-5] . This drafting approach is taken to facilitate the calculation of the mining profit for a mining project interest [section 25-5] .

4.8 Broadly, a miner's mining revenue in respect of a mining project interest includes revenue from:

•

the supply or export of taxable resources extracted from the project area for the mining project interest, to the extent the amount relates to the resources as they were at the valuation point;

•

the supply, export or use of something produced using the taxable resources, to the extent the amount relates to the resources as they were at the valuation point;

•

economic recoupment of mining expenditures for the mining project interest;

•

compensation for loss of taxable resources for the mining project interest; and

•

an amount received under a take or pay contract that cannot be related to the supply of a particular quantity of taxable resource.

4.9 Other amounts may also be mining revenue, such as amounts arising out of balancing adjustment events for starting base assets and from other adjustments where circumstances change. [Divisions 160 and 165]

4.10 An amount to be included in a miner's mining revenue does not include any goods and services tax payable on a supply for which the amount is consideration (in whole or in part), or any increasing adjustments that relate to the supply. [Section 30-75]

4.11 The same amount cannot be double counted. If the same amount is potentially included as mining revenue under more than one provision, it is included only once and under the most appropriate provision. [Section 30-60]

4.12 An amount is not mining revenue unless a provision of the MRRT law includes it in mining revenue. For instance, a hedging gain that is separate from a supply contract is not mining revenue in the same way that a hedging loss that is separate from a supply contract is not mining expenditure (see Chapter 5).

Revenue from the supply, export or use of taxable resources

4.13 An amount is included in a miner's mining revenue if a taxable resource has been extracted from the project area for the miner's mining project interest and during the year a mining revenue event happens in relation to the taxable resource. The taxable resource need not have been extracted by the particular miner. [Section 30-10]

4.14 The need for a mining revenue event reflects the fact that the MRRT applies generally to profits miners have made. Hence, extraction of the resource, or the fact of its reaching the valuation point, is not sufficient in itself to attract the tax in a particular MRRT year.

4.15 Three possible mining revenue events can result in an amount relating to taxable resources being included in a miner's revenue for an MRRT year. [Section 30-15]

4.16 The first way is by the miner making an initial supply of the taxable resource prior to its exportation or use [paragraph 30-15(1)(a)] . For example, if a miner sold coal to an export customer on free on board terms, where risk and title passes 'over ship's rail', such a sale would be a supply prior to export.

Example 4.14

Francis Resources supplies 30,000 tonnes of ore to a third party in Australia and 20,000 tonnes to an overseas purchaser by an agreement executed at or before export. Both supplies would be examples of supplies prior to export.

4.17 The second way is by the miner exporting resources when there has been no initial supply at or before that time. [Paragraph 30-15(1)(b)]

Example 4.15

Francis Resources exports 20,000 tonnes of iron ore to its storage facility in China. It later sells the ore to a third party.

4.18 The third way is by the miner making an initial supply of, using, or exporting, something produced using the taxable resource if an event has not been triggered by an initial supply or export of the taxable resource. [Paragraph 30-15(1)(c)]

Example 4.16

Francis Energy extracts 50,000 tonnes of coal from an MRRT project and feeds the coal directly into a power plant for the production of electricity, which it supplies into the wholesale electricity market.

4.19 These mining revenue events are mutually exclusive and only one can happen in relation to the relevant taxable resources relating to a mining project interest of a miner. There will be one, and only one, mining revenue event for each quantity of resources extracted in Australia that is not otherwise consumed in mining operations. [Section 30-15]

4.20 The approach taken is to focus on, in order, whether there has been an initial supply of the resource and, if not, an export of the resource, and, if neither of those, an initial supply, export, or use of something produced using the taxable resource.

Supply

4.21 'Supply' has the meaning given by section 9-10 of the A New Tax System (Goods and Services Tax) Act 1999 and subsection 995-1(1) of the Income Tax Assessment Act 1997 , but is to be interpreted in the context of the MRRT. In the context of the MRRT, a supply will usually happen where the miner relinquishes title to the resource. Generally, this will be a sale of the resource to a third party.

Initial supply

4.22 The usual way that the revenue provisions will be triggered is by the miner making the initial supply of the taxable resource. [Paragraph 30-15(1)(a)]

4.23 The initial supply of a taxable resource extracted under the authority of a production right is generally the initial supply that a miner makes after it has extracted the taxable resources. [Subsection 30-20(1)]

4.24 An initial supply must be a supply of taxable resources made by a miner who has a mining project interest that relates to the taxable resources. Typically, therefore, it would not include a supply made by the owner of the resource in situ (unless the owner is also a miner).

4.25 A supply is not an initial supply if it does not result in a change in the ownership of the taxable resource. For instance, if a miner blends a quantity of iron ore from one of its mining project interests with iron ore from another of its mining project interests, the blending will not constitute a supply; only once the blended ore is sold would there be an initial supply. [Paragraph 30-20(2)(b)]

4.26 The concept of an initial supply is also subject to an exception relating to supplies made between participants in the course of an undertaking that is a mining venture. This mainly affects joint venture arrangements. [Paragraph 30-20(2)(a)]

4.27 The exception ensures that, if a supply of taxable resources is made between participants in a mining venture, and the supply is made in the course of that venture, the supply is not an initial supply. The initial supply would be the next supply of those resources.

Example 4.17

X Co and Y Co are participants in a joint venture undertaking where X Co undertakes the extraction activities and Y Co the blending activities. Each takes a share of the resulting resource. The joint venture undertaking is a mining venture. The supply of the resource from X Co to Y Co (giving Y Co possession) is not treated as an initial supply of the resource as it occurred in the course of the joint venture undertaking.

Example 4.18

Taking the facts in Example 4.4, if, after the extraction and blending activities have occurred and the respective shares of X Co and Y Co determined, X Co sells its share in the resource to Y Co, this supply is not excepted because it did not occur in the course of the joint venture undertaking. So, that sale would be the initial supply of the resource.

Example 4.19

In a separate situation, Extractor Co extracts the resource and sells it to Blender Co who blends it and sells it to third parties. The sale to Blender Co is the initial supply.

4.28 A supply is not excepted from being an initial supply if it is made between participants in separate undertakings.

Example 4.20

Taking the facts in Example 4.4, a supply by X Co to a participant in another mining venture in which X Co is also a participant would be an initial supply. That is because it would not be a supply between participants in the course of a single mining venture; it would be a supply between participants in two different mining ventures. It would make no difference if the separate mining ventures both relate to the same production right.

4.29 When a supply occurs, the time of the supply is taken to be the earliest of when consideration for it is received or becomes receivable, when the resource is delivered, and when ownership passes in the resource. [Section 30-35]

4.30 However, if consideration for the supply is received or becomes receivable at a time before 1 July 2012, the time of the supply is taken to be the earliest of when the resource is delivered, and when ownership passes in the resource. [Schedule 4, item 2 to the Minerals Resource Rent Tax (Consequential Amendments and Transitional Provisions) Bill 2011 (MRRT (CA & TP) Bill)]

Export

4.31 If the miner exports the taxable resource from Australia before there has been an initial supply, the export will trigger a mining revenue event. [Paragraph 30-15(1)(b)]

4.32 The word 'export' is not defined. It takes its ordinary meaning of sending the resource to another country for sale or exchange, or merely taking the resource out of Australia with the intention of landing it in another country.

4.33 In general, a miner 'exports' resources if they are exported while the miner has ownership or title to them.

4.34 The miner 'exports' the resource even if there are arrangements to facilitate the export of the resource which are carried out for, or on behalf of, the miner by a third party.

4.35 Similarly, the miner 'exports' the resource even if the miner is not actually responsible for the exporting activities. The time of 'export' determines whether it (or a supply that occurs at the same time or earlier) is the relevant mining revenue event. [Paragraph 30-15(1)(b)]

4.36 Export occurs when the resource finally clears Australia's territorial limits (which will usually be its coastal waters). Merely leaving the final Australian port is not sufficient to constitute export.

4.37 The usual case of export will be where there has been no sale or other arrangement in relation to the resource when it leaves Australia. For example, a miner will export resources when it transfers them to one of its overseas branches.

4.38 More complicated cases can arise where a transaction has occurred prior to the resource leaving Australia. In those cases it must be determined whether the relevant mining revenue event is the initial supply or the export.

4.39 A sale under which ownership passes at the port or while the ship is in Australian waters is dealt with under the 'initial supply' test, not the 'export' test. So, for instance, sales of coal or iron ore using free-on-board or cost-insurance-freight will usually be dealt with under the 'initial supply' test.

4.40 In this regard, it should be noted that, while an initial supply does not occur until ownership passes in the resource, the time of that supply may be earlier if consideration is received or receivable or the resource is delivered. The time of the supply is the earliest of these things. For example, if a miner is entitled to invoice a customer once the resource crosses the ship's rail, that point will be the time of supply. Alternatively, if the point at which the consideration is received or receivable has not arrived but the miner has delivered the resource to an agent of a customer for transport to a destination outside Australia, that point will be the time of supply. [Section 30-35]

4.41 If title does not pass in the resource until after it leaves Australian coastal waters, and consideration for a supply has not yet been received or become receivable, and there has not yet been a delivery of the resource, the export test will apply.

Example 4.21: When export is the relevant mining revenue event

Redrock Resource Co. sells iron ore to an export customer under terms that pass title in the ore at the destination port. Title to the ore passes on delivery of the ore at the destination but, if consideration is received or receivable before then, the supply will be taken to have occurred at that earlier time. If that is before the ore is exported (that is, before it leaves Australia's territorial waters), the relevant mining revenue event will be the supply. If consideration is received or receivable only when the ore reaches the destination port, the relevant mining revenue event will be the export.

Use

4.42 The 'use' of something produced from the taxable resource is a revenue event if an event has not already been triggered by an initial supply or export of the taxable resource or thing. [Paragraph 30-15(1)(c)]

4.43 There is no mining revenue event for the 'use' of the resource itself, as opposed to the 'use' of something produced from it. For example, if coal is burned to produce electricity, it is the use of the electricity rather than the coal that triggers the mining revenue event.

4.44 If, however, the miner uses the thing produced from the resource in carrying on mining operations or transformative operations (for example, if the miner uses electricity in it mining operations that it has produced from coal it extracts), the use of the electricity is not treated as a mining revenue event. That is because the consumption of the electricity is not an expenditure and will not, therefore, give rise to a deduction. [Subsection 30-15(2)]

4.45 'Use' takes its ordinary meaning in the context of the MRRT.

Working out the amounts to be included in a miner's revenue

4.46 The amount to be included in a miner's revenue for a particular mining revenue event that has happened is determined through a two-step process:

•

first, the 'revenue amount' for the mining revenue event is determined (Step 1); and

•

second, so much of the revenue amount as is reasonably attributable to the taxable resource in the form and place the resource was in when it was at its valuation point (Step 2). This amount is worked out using the most appropriate and reliable measure of that amount.

[Subsection 30-25(1)]

4.47 The two-step process ensures that the profits that are brought to tax under the MRRT law will be profits that relate to the resources in the form and the place they were in when they were at their valuation point. The MRRT law does not seek to tax profits from operations conducted downstream of the valuation point. [Section 1-10]

4.48 Price increases in the taxable resource that occur after the resource has passed the valuation point and which are reflected in the consideration realised by the miner for selling the resource or things produced using the resource (or which would have been realised if the miner had sold the resource or the thing produced instead of exporting or using it) will be captured as mining revenue. Conversely, price decreases after the valuation point that are reflected in the consideration realised by the miner (or would have been if there had been a supply) will reduce the amount of mining revenue.

4.49 Although the legislation does not prescribe the use of any particular method for attributing the revenue amounts, the method used must produce the most appropriate and reliable measure of the amount, having regard to, amongst other things, the functions performed, assets employed and risks assumed by the miner across its value chain and the information that is available. [Subsection 30-25(3)]

4.50 There are also a number of statutory assumptions which must be made, but only to the extent to which they are relevant in applying the method that is the most appropriate and reliable method. The assumptions are that the things done by the miner in carrying on its downstream mining, transformative and resource marketing operations (as applicable) are done by a distinct and separate entity that does not own the taxable resource and which deals wholly independently with the miner in a competitive market for the things done. [Subsection 30-25(4)]

4.51 There is also a safe-harbour method which, if chosen by the miner, is taken to give the most appropriate and reliable measure of the amount to be attributed. [Subsection 30-25(5)]

Arm's length principles and methodologies

4.52 The arm's length principle plays an important role in determining amounts to be included in a miner's mining revenue.

4.53 The arm's length principle requires that the profits derived by an enterprise should be consistent with the profits that the enterprise would have derived had its commercial and financial dealings been consistent with the commercial and financial dealings that independent enterprises would have had in comparable circumstances.

4.54 The arm's length principle can apply at three points:

•

to test whether the revenue amount for a supply is an arm's length amount [Division 205] ;

•

to impute a revenue amount where the mining revenue event is the export of a taxable resource or the export or use of something produced using a taxable resource [subsection 30-25(2), items 2 and 3 in the table] ; and

•

to work out how much of a revenue amount is attributable to a taxable resource as at its valuation point [subsection 30-25(3)] .

4.55 The Organisation for Economic Co-Operation and Development (OECD) has provided guidelines for the application of the arm's length principle using arm's length methodologies. The OECD Guidelines are titled the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines).

4.56 The methods outlined in the OECD Guidelines were developed to assist tax administrations and multinational enterprises deal with cross-border transfer pricing of transactions. Regard may be had to the OECD Guidelines, adapted as appropriate, for the MRRT law.

4.57 Arm's length methodologies that may be relevant in applying the MRRT law, alone or in combination, and as direct or indirect methods, include the comparable uncontrolled price method, the cost-plus method, the resale price method, the transactions net margin method and profit-split methods. These methods are outlined in more detail in Chapter 17 in the context of the anti-profit shifting rules.

4.58 In some cases other methods, not described in the OECD Guidelines, but which are consistent with the arm's length principle, may produce a result which is the most appropriate and reliable method.

4.59 Because the working out of the mining revenue starts with the revenue amount, this is discussed first, and then there is a discussion about how the revenue amount should be attributed to the taxable resource as at the valuation point.

Determining the revenue amount

4.60 There are two broad categories of mining revenue events for which revenue amounts must be determined: actual supplies, and imputed supplies for exports of resources and dealings in things produced from resources. [Subsection 30-15(1)]

Supplies

4.61 Where the mining revenue event is a supply, the revenue amount will be the actual consideration received or receivable for the supply. [Subsection 30-25(2), item 1 in the table]

4.62 An amount that is not actually paid to a miner is taken to be received by the miner if and when it is applied or otherwise dealt with on behalf of the miner or as the miner directs. [Section 30-70]

4.63 The consideration received or receivable could be adjusted if the anti-profit shifting rules apply. [Division 205]

4.64 In effect, the revenue amount operates as a 'cap' on the amount that can be attributed to the taxable resources, ensuring that only realised profits of the miner can be brought to tax.

Imputed supplies

4.65 In the remaining revenue events there is no actual transaction. An arm's length consideration is worked out instead.

4.66 Where the mining revenue event is an exportation of the resource or a thing produced from the resource, the revenue amount is the amount that would be the arm's length consideration if the miner had supplied it at the time and place the taxable resource or thing is loaded for export. [Subsection 30-25(2), item 2 in the table]

4.67 Where the mining revenue event relates to the use of a thing produced from the taxable resource, the revenue amount is the amount that would be the arm's length consideration if the miner had supplied the thing at the time and place of the use. [Subsection 30-25(2), item 3 in the table]

Meaning of arm's length consideration

4.68 The arm's length consideration for a supply is the amount that the miner would reasonably expect to receive if, instead of exporting or using the resource or a thing produced from the resource, it had sold the resource or thing to another entity with which it was dealing wholly independently. [Subsection 30-30(1)]

4.69 The taxpayer must use the most appropriate and reliable method to determine the arm's length consideration. Regard must be had to all the miner's relevant circumstances, including:

•

the characteristics of the resource at the point of export or use;

•

a functional and factual analysis of the economically significant activities undertaken by the miner in its mining operations and, if relevant, its transformative and resource marketing operations;

•

market conditions;

•

the miner's market strategies;

•

the terms and conditions of arrangements entered into; and

•

the degree of comparability that exists between the controlled and the uncontrolled dealings or between enterprises undertaking the dealings, including all the circumstances in which the dealings took place and whether adjustments can and should be made.

[Paragraph 30-30(2)(a)]

4.70 Regard, must also be had to the availability, coverage and reliability of data necessary to apply particular methods. [Paragraph 30-30(2)(b)]

4.71 For these purposes, the concept of mining operations is broadly defined. Mining operations are all those activities or operations that are 'preliminary or integral to' or 'consequential upon' extracting or producing taxable resources for sale or export or for producing taxable resource to be applied in producing some other thing for sale, export or use [section 35-20] . A detailed explanation of mining operations is in Chapter 5.

4.72 Transformative operations are those activities and operations that involve the application of taxable resources in the production of some other thing that is subject to a mining revenue event when sold, exported or used. [Subsection 30-25(6)]

4.73 Resource marketing operations are operations or activities involved in marketing, selling, shipping and delivering taxable resources (or things produced using taxable resources) that are sold or exported. [Subsection 30-25(7)]

4.74 The most appropriate and reliable method must produce an arm's length result that is reasonable and makes sense on a commercial basis in all the circumstances of the miner and its dealings in taxable resources or (things produced from taxable resources).

4.75 If, however, it is not possible to work out the arm's length consideration, the revenue amount is the amount that is fair and reasonable in the opinion of the Commissioner of Taxation (Commissioner). [Subsection 30-30(3)]

Determining how much of the revenue amount is attributable to the taxable resource

4.76 Having ascertained the revenue amount, the task is then to determine how much of that amount is reasonably attributable to the taxable resources in the condition and place they were in when they were at the valuation point.

4.77 If there is an initial supply of the taxable resources just after the valuation point [subsection 40-5(4)] the whole of the mining revenue amount will be reasonably attributable to the resources at the valuation point and the mining revenue amount will, subject to the application of the anti-profit shifting provisions, correspond with the consideration received or receivable for the supply.

4.78 In other cases, the revenue amount must be attributed to the taxable resources using the method that produces the most appropriate and reliable measure of the amount. That method must be chosen having regard to:

•

the circumstances of the miner, including a functional and factual analysis of the economically significant activities undertaken by the miner in its mining operations and, if relevant, in its transformative and resource marketing operations; and

•

the availability of reliable information needed to apply the selected method or methods.

[Subsection 30-25(3)]

General approach

4.79 Revenue amounts will be attributable to taxable resources to the extent to which the resources, and the activities involved in getting them to the valuation point in the condition they were in at the valuation point, are the factors that have, in substance, generated the revenue amounts.

4.80 To work out when this is the case, a functional and factual analysis of the economically significant functions performed, assets used, and risks assumed by the miner across its entire value chain would be required. [Paragraph 30-25(3)(a)]

4.81 This is the same analysis that is required when working out the revenue amount for taxable resources (and things produced from taxable resources) that are exported before they are sold or used. [Section 30-30]

4.82 The next step would be to allocate those functions, assets and risks across the miner's value chain - that is upstream and downstream of the valuation point. Only objectively relevant and material circumstances need to be taken into account.

4.83 Obviously the allocation of functions, assets and risks between two parts of what is a single value chain poses conceptual and practical difficulties.

4.84 One approach to the problem would be to construct a hypothetical separate and independent entity fitting the circumstances of the downstream operations (being the downstream mining operations, transformative operations and resource marketing operations).

4.85 On this approach the downstream operations would be considered in the context of the miner's overall operations and certain dealings between the hypothetical entity and the miner may be hypothesised. For example, it may be hypothesised that the downstream entity provides services to the miner.

4.86 Once a separate entity has been hypothesised it becomes simpler to apply standard arm's length methods. Those methods can be applied to all of the notional entity's activities, including its dealings with other entities and its hypothesised dealings with the miner.

4.87 This is broadly the approach adopted by the OECD for attributing profits to a 'permanent establishment' of a non-resident enterprise: the profits to be attributed to the permanent establishment are the profits that the permanent establishment would have earned at arm's length if it were a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions. Treating the permanent establishment as a separate entity focuses attention on the economically significant activities performed by the permanent establishment and the way it interacts with the broader enterprise.

•

PARA>4.88 Having allocated the functions, assets and risks between the upstream and downstream, the most appropriate and reliable method should be chosen. The choice should be informed by the functional analysis and, amongst other things, by reference to:

•

the characteristics of the resource at the point of supply or equivalent;

•

the terms and conditions of arrangements entered into by the miner;

•

the degree of comparability that exists between controlled and uncontrolled dealings or between entities undertaking the dealings, including all the circumstances in which the dealings took place and whether adjustments can and should be made;

•

the nature and extent of any assumptions that must be made; and

•

the availability of reliable information needed to apply the selected method.

[Subsection 30-25(3)]

Statutory assumptions

4.89 The MRRT law includes certain assumptions which must be used to the extent to which they are relevant to the application of a particular method. [Subsection 30-25(4)]

4.90 The statutory assumptions are that:

•

a distinct and separate entity (the notional downstream entity) does all the things (including using all the assets) that the miner actually does in carrying on the downstream operations;

•

the downstream entity does not acquire any interest in the taxable resource; and

•

the downstream entity and the miner deal wholly independently with one another under competitive market conditions.

[Subsection 30-25(4)]

4.91 These assumptions are assumptions about the nature of the downstream operations and the functions performed, the assets employed and the risks assumed in those operations. As such, it would be expected that the assumptions would be relevant to any method that requires (or takes into account, expressly or implicitly) a valuation of the downstream operations (for example, where a deductive method is used to netback from the revenue amount).

4.92 Such assumptions would not, however, be relevant in applying methods that do not rely on things that happen in the downstream operations. For example, where there is a comparable uncontrolled price for the taxable resource at the valuation point.

Distinct and separate independent entity assumption

4.93 As discussed above, the assumption that the things done by the miner downstream of the valuation point are done by a distinct and separate entity dealing wholly at arm's length with the miner establishes a basis for the use of arm's length methods to determine an appropriate price or value for those things. [Paragraphs 30-25(4)(a) and 30-25(4)(c)]

4.94 Specifically, arm's length methods may assist in working out what the miner would have paid a separate entity to do those things.

4.95 The separate entity assumption only applies to the things done by the miner in carrying on its downstream mining, transformative and resource marketing operations. It does not apply to things done by separate entities from whom the miner has procured services.

Example 4.22: Miner procures another entity to provide downstream operations

X Resources Pty Ltd contracts Y Mining Services Pty Ltd to crush and screen the iron ore it extracts from its iron ore mine. X Resources pays Y Mining Services $15 million for these services. While the crushing and screening activities constitute mining operations for X Resources' mining project interest, and the service fee represents expenditure incurred by X Resources in carrying on those operations, the things done by Y Mining Services are not things that are taken to have been done by X Resources.

The separate entity assumption only applies to the things done by X Resources in procuring the mining services from Y Mining Services Pty Ltd.

Resource assumption

4.96 The MRRT law is a resource rent tax. The underlying principle is that risks relating to the value of the taxable resource are borne upstream of the valuation point ^[2] .

4.97 Consistent with this, an arm's length method cannot be used if it relies on an assumption that the notional downstream entity has acquired an interest in the resource. [Paragraph 30-25(4)(b)]

4.98 A hypothesis that the notional downstream entity acquired the resource would produce an unreliable measure of the profits attributable to the taxable resources and could result in resource rents arising from price changes occurring after the resource passes the valuation point, but before the revenue event, being attributed downstream.

Competitive market assumption

4.99 The assumption of a competitive market for the provision of the downstream operations, transformative operations and resource marketing operations carried on by the notional downstream entity ensures that resource rents cannot be attributed downstream as a result of the assumed exercise of market power by the separate entity.

4.100 In a competitive market the notional downstream entity would be expected to make a return sufficient to induce an entity to enter the market to do the things the entity is taken to have done. The return would be commensurate with the non-diversifiable risks borne in doing those things and would be no more or less than would be sufficient to justify the continued commitment of that capital. [Paragraph 30-25(4)(d)]

4.101 A non-diversifiable risk is a systematic or market risk that cannot be diversified away. For example, the risk that an asset could become stranded may be non-diversifiable to the extent that the stranding results from market wide events such as a reduction in demand associated with changes in movements in interest rates or changes in commodity prices. Such risks (including any non-diversifiable risks associated with the resource) should be compensated for in the returns that the notional downstream entity would make.

4.102 Characteristics of a competitive market that are relevant in determining the amounts that a miner would pay a separate entity to provide downstream operations are freedom of entry and the presence of many potential service providers, none of whom individually can affect price. Freedom of entry implies that costs can be recovered, if it were otherwise this would increase the risk for new entrants and so deter entry.

4.103 A comparable uncontrolled price for the provision of downstream operations is unlikely to be appropriate where the price reflects the exercise of market power by the provider.

Possible methods

4.104 As discussed above, there are different methods that may, depending on the miner's circumstances, alone or in combination, provide an appropriate and reliable method for working out the miner's mining revenue. The method that is used should be the method that is the most appropriate and reliable method. [Subsection 30-25(3)]

4.105 Although the attribution methodology requires a reasonable attribution to be made of a revenue amount, this does not mandate a 'net back' from the revenue amount although this is likely to be the most reliable method in many cases.

4.106 Arm's length methodologies that may be relevant include the comparable uncontrolled price method, the cost-plus method, the resale price method, the transactions net margin method and profit-split methods. There may be others.

4.107 For example, to the extent to which there are comparable transfers of taxable resources in the form the resources were in when they were at their valuation point, between unrelated parties in comparable markets, then a comparable uncontrolled price, as at the time of the mining revenue event, and adjusted for any material differences, would be an appropriate and reliable method.

Example 4.23 : Comparable uncontrolled price at the valuation point

An independent enterprise sells iron ore of a similar type, quality and quantity at the same time and the same stage of the production chain as those produced by the taxpayer. Assuming no other material differences, the price received by the independent iron ore producer, as at the time of the mining revenue event, would be considered a comparable uncontrolled price.

4.108 In many cases, however, a netback from the mining revenue event to the valuation point is likely to be the most appropriate and reliable method.

4.109 In a netback, the revenue amount would be reduced for the arm's length value of the downstream operations that reasonably relates to the resources (or the things produced from taxable resources). The residual amount would be the mining revenue.

4.110 Applying a netback approach would support neutrality in the application of the MRRT law to miners who 'buy in' their downstream operations and those who provide them 'in-house'.

4.111 To the extent to which the miner carries on its downstream operations in-house, a net back could be undertaken by reference to the price that a hypothetical service provider would seek to recover for providing those operations to the miner on an arm's length basis.

4.112 A miner that adopts this approach should value the downstream operations using the most appropriate and reliable method. This could be using a comparable uncontrolled price for equivalent downstream operations or worked out by reference to the miner's actual operating and capital costs (for example, by applying an arm's length cost-plus or transactional net margin method).

Example 4.24 : What a miner would pay a distinct and separate entity - comparable uncontrolled price

Daly Resources Pty Ltd performs all of the crushing, processing and transporting of the ore it extracts from its iron ore mine before it is exported. These are the only downstream activities undertaken before the ore is sold.

Daly Resources observes that there are other iron ore miners in the same region that procure comparable crushing, processing and transporting services from independent service providers. The market for the services is a competitive market.

Having regard to the prices charged by those service providers, Daly Resources determines that it would need to pay $18 million to procure the same crushing, processing and transporting activities as it directly carries out itself. The $18 million is a comparable uncontrolled price being a price arrived at having regard to the comparable activities performed by parties dealing independently with one another under materially the same circumstances.

During the same year Daly Resources obtains $40 million from selling the iron ore. It would be reasonable to include $22 million in Daly Resource's mining revenue ($40m - $18m).

4.113 Where the miner procures its mining operations from a third party then, assuming those operations are procured on an arm's length basis, the amounts paid for the mining services would form the basis for the net back. Allowance would also be made for the functions performed by the hypothetical separate entity in procuring and administering the service contracts.

Example 4.25 : Miner procures another entity to provide downstream operations

X Resources Pty Ltd contracts Y Mining Services Pty Ltd to perform all downstream mining operations leading to the export of the ore it extracts from its iron ore mine. During the MRRT year starting on 1 July 2012, X Resources pays $15 million to Y Mining Services to conduct the downstream mining activities. X Resources deals with Y Mining Services on an arm's length basis.

X Resources also incurs costs in managing its contract with Y Mining Services. During the same year, X Resources derives consideration of $35 million from exporting the iron ore. The revenue that is reasonably attributable to the ore as at the valuation point for the year is $35 million less the $15 million paid to Y Mining Service and an arm's length charge for the procurement functions actually performed by the miner in its downstream operations.

4.114 If the miner procures services from a third party on a non-arm's length basis then, unadjusted, the amounts paid for the mining services would not form the basis of an appropriate or reliable net back method (note, also, the potential application of the anti-profit shifting rules in Division 205).

4.115 A full net back from the revenue amount may not be the most appropriate and reliable method for a vertically integrated transformative operation (for example, the production of electricity or steel). However, a netback from the point at which the mining operations end and the transformative operations commence may be appropriate and reliable if there are comparable uncontrolled prices for the sale of the resources in the form they are in when they are first applied to the transformative operations.

Example 4.26 : Separate entity providing transformative operations - comparable uncontrolled price

E Energy Pty Ltd owns and operates a coal fired power station. It supplies the power station with coal from its own coal mine. It also acquires coal, of similar quality and in similar quantities, on an arm's length basis, from other miners who have mines near E Energy's mine.

Assuming no other material differences, the price that E Energy pays for the coal from the other miners would be a comparable uncontrolled price for the coal it has mined itself.

E Energy also finds a way of working out the arm's length value of its processing and transporting operations. For example, it may be able to find a comparable uncontrolled price for those services. Alternatively, a cost-plus or transactional net margin method may provide an appropriate and reliable method for pricing those services.

In these circumstances, it would be reasonable for E Energy to work out its mining revenue by taking the comparable uncontrolled price for its own coal (adjusted to the date that the coal is stockpiled at the power station) and reducing it by the arm's length value of its own downstream processing and transporting operations (being those operations that are downstream of the valuation point but which end when the coal arrives at the power station).

The residue would be an amount that is reasonably attributable to the coal when it was at the valuation point (to the extent it does not exceed the revenue amount).

4.116 Another possible method is a profit-split method. A profit-split method, is a method that takes a combined profit and splits it on an economically valid basis that approximates the division of profits that would have been anticipated between independent enterprises. This economically valid basis may be supported by independent market date (for example, uncontrolled joint-venture agreements) or by internal data.

4.117 Profit-split methods are only available to be used if they are the most appropriate and reliable measure of the revenue amount to be attributed to the taxable resource at its valuation point.

4.118 When the supply chain is not highly integrated, the importance of the mining rights and the upstream mining operations relative to the downstream would tend to favour the use of other methods over a profit-split method.

4.119 However, the position may be different in the case of a highly integrated operation, such as a transformative coal to electricity generation.

4.120 In applying a profit-split method in the context of the MRRT law, it would be expected that the mining rights, and the capital contributed in the upstream and downstream, would provide a more appropriate bases for analysing a split of profits as compared to other bases, such as operating costs. That is because of the capital intensive nature of the mining industry and the significant value attributable to mining rights.

4.121 Although capital contributed would be reasonably observable, the value of mining rights increase and decrease with variations in commodity prices.

Example 4.27 : Profit split ratio

A profit-split calculation, for attributing revenue amounts, could be based on the ratio: mining right value plus upstream capital asset values/mining right value plus upstream and downstream capital asset values

Safe-harbour method

4.122 To improve certainty and reduce compliance costs, the MRRT law provides a safe-harbour method for working out how much of the revenue amount is attributable to the taxable resource at the valuation point. If the method is chosen by a miner, it is taken to be the most appropriate and reliable method. [Subsection 30-25(5)]

4.123 There may be circumstances in which the safe-harbour method would be the most appropriate and reliable method in any event (that is, without recourse to the safe-harbour provision).

4.124 The method takes the revenue amount and reduces it by an amount that, having regard to the required assumptions (including the arm's length dealings assumption, the resource assumption and the competitive market assumption), the miner's circumstances and the available information, is sufficient for the notional downstream entity to recover the costs of the operations it is taken to have carried on such as reasonably relate to the taxable resource (or things produced from the taxable resource).

4.125 The costs that the notional downstream entity can recover are:

•

its operating costs;

•

any depreciation of the assets used in those operations; and

•

a cost of capital sufficient to justify the continued commitment of the capital it employs in those operations.

[Paragraph 30-25(5)(a)]

4.126 This is a method that is commonly used to set prices for access to infrastructure and related services. It adopts a 'building block' approach. It excludes from mining revenue the amounts the service provider would need to recover, over the long run, to meet the costs of those investments (where the costs of an investment includes a return on capital that is commensurate with the ^[3] non-diversifiable risks).

4.127 Applied in the MRRT context, the method works out a competitive price for the operations taken to have been provided by the notional downstream entity. To the extent to which those operations reasonably relate to the production of taxable resources (or things produced from taxable resources), the revenue amount for those resources (or things) will be reduced accordingly.

4.128 There may be a number of different ways of working out the extent to which the downstream operations reasonably relate to taxable resources (or things produced from taxable resources) in relation to which there have been mining revenue events. For example, it may be reasonable to work out an average price, per tonne, for the iron ore produced and transported in a year. That price could be applied to each quantity of resource that is sold, exported or used in that year.

4.129 The mining revenue cannot be a negative amount.

4.130 The costs which the notional downstream entity should be able to recover can be expressed as follows:

downstream operating costs + depreciation + (downstream capital value x cost of capital)

4.131 The notional downstream entity's operating costs would be the non-capital, arm's length, costs of the downstream operations. These costs would generally include maintenance costs (although see further discussion below). [Subparagraph 30-25(5)(a)(i)]

4.132 Depreciation would be the amounts required to compensate the notional downstream entity for the consumption of the assets used in its operations due to physical or economic loss. It would be expected that the amount of depreciation would be worked out having regard to the economic life of the asset, which may, in turn, depend on the expected life of the mining operation. The amount of the depreciation will be a recovery of the capital value of the asset over its expected remaining operating life. [Subparagraph 30-25(5)(a)(ii)]

4.133 The choice of depreciation profile under this approach (for example, straight line or annuity) should be consistent with a reasonably stable path of service charges, consistent with what an independent service provider would set in a competitive market.

4.134 The cost of capital would be the opportunity cost of the capital used to finance the notional entity's downstream operations (that is, the return on capital required to attract the capital). It would be expected that the cost of capital would be worked out by applying a weighted average cost of capital to the assets used in the downstream operations, being a rate that is consistent with prevailing market conditions, adjusted for the non-diversifiable risks (also known as systematic risks) involved in those operations, and weighted by the proportions of equity and debt used to fund those operations. [Subparagraph 30-25(5)(a)(iii)]

4.135 In order to work out depreciation amounts and cost of capital amounts, a capital value for downstream assets is required. For new assets, the most appropriate value will be the cost of acquisition or installation. For existing assets, a market valuation based on an approach that is consistent with the method used to value starting base assets should be used (albeit subject to the operation of the competitive market assumption).

4.136 There are a number of different approaches for working out the capital value of assets. Methods commonly used include depreciated actual cost, depreciated optimised ^[4] replacement cost, optimised replacement cost or full replacement cost.

4.137 The question as to which is the most appropriate method for valuing assets in a particular case will depend on the circumstances of the assets, the notional entity, and the industry and on the other assumptions made.

4.138 The three integers - operating costs, depreciation and costs of capital - are interdependent. Their combined operation should ensure that the service provider is not over- or under-compensated, over time. Assumptions made in working out one integer will generally affect the other.

4.139 For example, the operating costs that could be recovered should be commensurate with the assumptions made in valuing the asset. That is, it would not be appropriate to recover the full costs of maintaining an old asset if the assets have been valued, as new, at full replacement cost. Nor would it be appropriate to recognise any capital expenditure on assets valued at full replacement cost other than where the expenditure expands or improves the functionality of the asset. That is because the expenditure would already be reflected in the replacement cost of the asset.

4.140 Replacement cost should not be used where it exceeds market value. If the cost of replacing an asset is more than the cost of a cheaper alternative, an owner would not replace it. For example if, say, a rail transport asset is underutilised and/or the mine it services has limited remaining economic life, a valuation based on the net present value of the cost of transporting the resource by road would be appropriate if this option is cheaper than replacing the existing rail asset.

4.141 In valuing downstream assets, discounted cash flow methods should generally not be used. That is because those methods require assumptions to be made about the service charges for the use of the assets. In effect, the service charge is the thing that the statutory method is trying to determine.

Example 4.28 : What a miner would pay a distinct and separate entity

Katherine Mining Pty Ltd installs an iron ore crusher ready for use from 1 July 2011 and commences crushing ore from the run-of-mine pad. Katherine Mining determines that its operating costs in performing this activity are $700,000 in 2012-13.

The cost of the crusher was $2 million and its effective life is 25 years, so in determining the capital costs the separate entity would incur, Katherine Mining determines an amount of $80,000 for depreciation of the crusher for that year. The return on capital invested in the crusher would be worked out having regard to the risks the separate entity would incur and the assumption that there is a competitive market for the provision of the crushing services to Katherine.

Katherine Mining determines that a pre-tax return on the capital invested in the crusher of 13 per cent would be sufficient for a separate entity to continue to employ its capital in that undertaking.

Katherine Mining determines the amount that it would pay a distinct and separate entity to provide ore crushing services in 2012-13 to comprise the operating costs, depreciation and the return on capital as determined above: a total of $1,029,600 ($700,000 operating costs plus $80,000 depreciation and $249,600 return on the depreciated cost of the crusher). The sum of this and the amounts Katherine Mining pays, or would pay, for other downstream operations, reduces the revenue amount for the sale of the iron ore that will be included in its mining revenue.

4.142 Any costs associated with a particular operation that relate to operations that are not taken into account in working out the revenue amount should be added back. [Paragraph 30-25(5)(b)]

Example 4.29 : Costs not reflected in the revenue amount for a supply

Assume there is a supply of taxable resources at a port in Australia but the miner incurs the costs of carriage and insurance. Further assume that the miner invoices the purchaser for these costs separately from the resources.

The miner would be required to add back any costs that relate to the things it did in delivering and insuring the resources.

Example 4.30 : Costs not reflected in the revenue amount for resources exported

Assume a miner exports coal to an offshore customer. Title to the resources passes on delivery and the miner bears the cost of carriage and insurance.

The revenue amount is the amount for which the miner would have sold the coal had it sold it at the time the coal was loaded for export. Assume the miner sells coal of the same quality (and in similar quantities) to other customers on free on board terms and uses the price of that coal to work out the revenue amount for the coal it has exported.

The miner would be required to add back any of its costs that relate to the things it did in delivering and insuring the resources.

Other mining revenue

4.143 Other forms of mining revenue include:

•

amounts that recoup or offset mining expenditure and payments that give rise to royalty credits [sections 30-40 and 30-45] ;

•

compensation for loss of taxable resources [section 30-50] ; and

•

amounts that do not relate to a particular taxable resource [section 30-55] .

Recoupments and offsets

4.144 Mining revenue includes amounts that recoup or offset mining expenditure of the mining project interest. It does not matter whether the recoupment was received or receivable by the miner who has the interest or by one of its associates. It also does not matter whether the expenditure recouped arose in the past or will arise in the future. This ensures that mining expenditure is only recognised to the extent that the miner actually bears the economic cost of that expenditure. Treating recoupments of future expenditure in the same way avoids the need to track each recoupment against a particular amount of expenditure. [Subsection 30-40(1)]

Example 4.31 : A subsidy recoups mining expenditure

Lawrie Longwall Mining (Lawrie) receives a government subsidy for expenditure it incurs in employing apprentices to work on its mining project interest. The cost of employing the apprentices is mining expenditure, so the recoupment by way of the subsidy is mining revenue.

Example 4.32 : Sale of emissions units recoups mining expenditure

O'Toole Coal purchased 5,000 emissions units sufficient to offset Co2 emissions attributable to upstream mining operations. It paid $125,000 ($25 per unit) for the units and included this amount in its mining expenditure in its 2017 MRRT year. However, it only needed to surrender 3,000 units to offset its 2017 carbon emissions. In 2018, O'Toole Co sold 2,000 units for $46,000 (at $23 per unit). The recoupment of this mining expenditure is mining revenue.

4.145 A recoupment is not included in mining revenue if the amount gives rise to an adjustment. As the adjustment rules deal with such recoupments, this ensures the amount is not double counted. [Paragraph 30-40(1)(c)]

4.146 Where an amount is received that recoups an expenditure that is only partly deductible, the proportion of the recoupment included in mining revenue matches only the proportion of the expenditure that is deductible. [Subsection 30-40(2)]

Example 4.33 : Recoupment is only partly for upstream expenses

Continuing Example 4.18, if Lawrie's costs in employing apprentices were incurred 60 per cent for upstream mining operations and 40 per cent for downstream mining operations, only 60 per cent of the costs would be mining expenditure, so only 60 per cent of the subsidy would be mining revenue.

4.147 An amount received or receivable before the start of the MRRT that recoups or offsets mining expenditure is included in mining revenue. [Schedule 4 to the MRRT (CA & TP) Bill, item 3]

4.148 Amounts that recoup or offset a liability that gives rise to a royalty credit will normally reduce royalty credits [section 60-30] . However, if there are insufficient royalty credits to reduce, the excess recoupment, grossed-up by the MRRT rate, is included in mining revenue [section 30-45] .

Compensation for the loss of taxable resources

4.149 A miner who obtains, or whose associates obtain, an amount of insurance, compensation or indemnity relating to the loss, destruction or damage of an extracted taxable resource or something produced from it, must include mining revenue to the extent that, if the compensation had been consideration for a supply, it would have been included, as mining revenue. [Section 30-50]

4.150 This reflects the fact that, from the miner's perspective, compensation amounts for the loss, destruction or damage of resources is equivalent to consideration for supplying them.

4.151 Amounts included as mining revenue are limited to compensation for loss, destruction, or damage of resources after 1 July 2012 and before there has been a mining revenue event for the resources. Resources that were lost, destroyed or damaged before 1 July 2012 would not have generated mining revenue, so compensation for their loss or destruction would similarly not be mining revenue [Schedule 4 to the MRRT (CA & TP) Bill, item 4] . Resources lost, destroyed or damaged after their mining revenue event will already have generated an amount of mining revenue, so treating the compensation as mining revenue would be double counting. [Section 30-50]

Amounts that do not relate to a particular mining revenue event

4.152 Amounts received or receivable by a miner for the supply, or proposed supply, of taxable resources that do not reasonably relate to a mining revenue event for a particular quantity or quantities of taxable resources are treated as mining revenue. [Section 30-55]

4.153 Typically, this will occur where a purchaser makes a scheduled payment under a take or pay contract but does not take delivery of any resources.

Example 4.34 : Take or pay contract

X Energy Co entered into a long-term supply contract to pay for a fixed annual quantity of coal from New Resources Pty Ltd, whether or not X Energy takes delivery of that quantity of coal. For the year beginning 1 July 2012, X Energy pays the fixed annual amount, but, because of reduced demand for energy from its coal-fired power station, X Energy takes delivery of only 3/4 of the coal contracted for and it obtains a credit that can be applied to future coal deliveries.

New Resources treats 3/4 of the payment as a revenue amount that must be attributed to the coal that was supplied and the balance as an amount which must be included directly in mining revenue.

New Resources would not have to include any further amount in its mining revenue if it later has to supply the remaining 1/4 of the coal to X Energy (although there would be a change in the circumstances relating to the payment included directly in mining revenue such as may warrant an adjustment under Division 160).

Expenditure causing revenue to be received

4.154 An amount that would otherwise be included in mining revenue in respect of a mining project interest is reduced to the extent that the miner necessarily incurred the expenditure in enforcing the miner's entitlement to receive the amount, provided that the expenditure:

•

does not relate to any other amount;

•

was not mining expenditure for the mining project interest; and

•

was not excluded expenditure.

[Section 30-65]

4.155 This ensures that the mining profit for a mining project interest properly reflects the net mining revenue and mining expenditure for the interest.

4.156 For example, if litigation costs incurred in seeking compensation for damages to taxable resources are not mining expenditure, they would reduce the mining revenue for the mining project interest from which the resources were extracted.