Making sense of the Resources Super Profits Tax

Late US President Ronald Reagan nicely summed up government views on tax; 'if it moves, tax it'. The awakening of the Australian resources sector has not gone unnoticed and, this week, the government proposed introducing a new Resources Super Profits Tax (RSPT) from 2012. The tax will be levied at 40% and will apply to all commodity groups that generate profits from assets in Australia.

Companies that fail to make a profit will have 40% of their loss refunded, so the government acts like a 40% partner on all projects, sharing in profits and losses. Losses will also be transferrable within a corporate group, so if Rio Tinto's bauxite division made a large loss, for example, it could be used to offset bumper profits from the iron ore division.

Importantly, as franking credits won't be issued for the new tax, companies may be tempted to cut their dividends. Miners aren't traditionally income stocks but in recent years BHP Billiton, Rio Tinto and Santos have paid steady or rising dividends. Whether that will continue now carries greater doubt.

Existing state royalties will be refunded, but only to the extent they are charged now; future increases will have to be paid for by mining firms. Companies will also be able to deduct exploration expenditure and depreciation charges. In addition, the RSPT will allow a rate of return equal to the long term bond yield to be earned without penalty.

But the combined taxation rate on mining firms, including the RSPT, GST and income tax, will effectively rise to 58% - amongst the highest in the world.

What's mine is yours

The outcry from the mining industry has been predictable and noisy. Many have claimed that investment dollars will flee, mines will close and investors will lose.

There is little doubt about investors losing, as cash that previously went to shareholders will now be directed to the government. But not all companies will suffer equally. The exploration and depreciation allowances mean there will be some big discrepancies in how different miners fare.

Those with foreign operating assets, such as Oil Search, Kingsgate Consolidated and Andean Resources will not be affected at all. Because their assets become relatively more attractive, they may well benefit from the changes. The share price of Oil Search, for example, has increased since the RSPT was announced. Diversified groups with some overseas assets such as BHP and Rio Tinto will have some protection from the tax as well.

Companies with new assets that incur high rates of depreciation, as well as companies with heavy exploration expenditures should likewise be insulated. So the effect on the likes of Silver Lake Resources and Oz Minerals will be muted.

Early stage producers and developers may well find they benefit from the new regime because 40% of their inevitable early losses are refunded in cash. This assumes that their projects are able to pass the higher investment hurdle.

The biggest losers from the new tax will be older established companies with mature assets and high margins. The bulk miners – iron ore and coal companies in particular – will fare worst of all. They typically have little in the way of depreciation or exploration offsets. The other losers will be firms with takeover premiums embedded into their price, for example, Fortescue Metals and many coal companies. Their assets suddenly look a lot less attractive to foreign predators.

The effect on the new coal seam gas (CSG) producers in Queensland is most uncertain. They operate with high margins but should have some protection from depreciation and capital expenditure charges. The market has savaged the share prices of Santos and others in the industry, but we feel the outcome for them may not be as bad as some fear.

A consensus is emerging that, on average, about 10% of the net present value of the local resources industry is at risk. Markets have moved quickly to largely factor this into prices. But some, including Kerr Neilson of Platinum Asset Management, have stated that the RSPT will have a larger impact than what markets are factoring in.

Tax changes

This view makes two assumptions; that capital spending planned before the announcement of the RSPT will not be made following it, and that the RSPT ends up being implemented in its current form. We think both assumptions could be wrong.

Miners that change investment decisions are assuming that other countries will also not change their tax regimes. But the UK recently increased its petroleum tax, and plenty of others have threatened higher resource taxes as well. Australia's move is only the latest in a series of tax increases around the world.

It should be remembered that Australia's great advantage is not just its mineral wealth; it has strong rule of law and civil society. It could be argued that these desirable traits should attract a price premium; if mining companies were customers purchasing exemplary Australian standards of law and order, shouldn't they pay a premium?

The RSPT will be modelled on the existing Petroleum Resource Rent Tax (PRRT), which has applied to offshore oil producers for years. BHP, Woodside Petroleum, Hess Corporation and Chevron have all approved projects whilst paying the PRRT.

It should also be remembered that the RSPT won't be running until 2012. That's two years in which the mining industry's considerable might could be harnessed to alter the outcome. We think there is a high chance that the RSPT will be watered down before it's introduced in two years. What is being presented now is the worst case scenario.