Final verdict – RSPT a deeply flawed tax
Posted on 05 May 2010
After a couple of days ruminating on the new Resource Super Profits Tax (here and here), I’ve come to the conclusion that it is a deeply flawed structure. It is simply too complex in the implementation. Does the world really need another legion of tax accountants?
The strange thing is that the same economic result could be achieved through revamping the existing royalty system. I’m beginning to suspect that this is the Commonwealth government’s end-game.
The story so far
Yesterday we had a quick look at how the RSPT would apply to an existing mining operation. The conclusions were:
- It is complicated to implement – so much more so than a royalty on sales. It will create a whole industry around ‘optimising’ the actual RSPT paid.
- Using ‘undepreciated tangible tangible capital expenditure’ as the effective price that the government ‘pays’ for its ’40% equity stake’ leads to highly inconsistent results. This cost base will vary depending on how old the mine is etc and has little relationship with a ’40% stake’ – even if that stake is intended to be calculated off the cost base and not the prevailing market value. The net result is that the impact of the RSPT is likely to be very different across individual mines.
- Investing in Australian mining companies is suddenly a whole lot less attractive – the government has taken the sword to the upside, while the price discovery process to determine the perceived fair value for existing assets has some way to run.
The RSPT and new mines
Today going to have a look at a hypothetical new mine. Let’s assume that you’ve got a copper deposit that will require $100m in capex to start mining and has a projected 10 yr life over which the initial investment will fully depreciate. How are you going to fund it?
1) A banking syndicate puts up $40m – that will fully amortise over the mine life. Broadly plausible.
2) You issue $20m in subordinated debt – paying a coupon of say ~3% (equivalent to the dividend yield on mining stocks) that is also indexed to the price of copper. For simplicity assume that it matures at the end of the mine life – paid out of a reserve that is built up over the term.
3) You raise $40m in equity.
Without trying to over-engineer the example, the point I’m trying to make is that the risk/return in the capital structure has been skewed by the RSPT.
Think about it – the government has guaranteed tax credits to 40% of the capital cost of the project (ie. $40m). These tax credits are ultimately redeemable against the government’s balance sheet. Equity investors are effectively investing in a government bond – with some upside to earnings.
The hybrid equity investors on the other hand, have the protection of this $40m first loss piece – fantastic. And, taking into account the need to structure within debt and equity rules, can effectively share in commodity price appreciation. The earnings on which the miner pays the RSPT are reduced when commodity prices are high.
Ultimately, it’s the same issue that pokes its head up with existing mines – the ‘undepreciated tangible capital expenditure’ is not the same thing as the equity invested.
Finally
I’ve spent a couple of days on this RSPT simply because mining is so important to our equity markets. In the end, the RSPT comes across as a half baked tax. If the government is wedded to the idea of extracting additional tax from the mining industry when times are good, then it would be a whole lot simpler to revamp the royalty system – centralise the administration and implement a scaled royalty rate that tracks higher (or lower) depending upon the prevailing commodity price. But again this may have been the government’s goal all along.
5 responses to Final verdict – RSPT a deeply flawed tax
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Another interesting post. If the intention of the government is to move toward some sort of a centralised royalty/levy/tax or whatever, they may have misjudged the reaction to their tactics.
Certainly the markets are sending the government a message they may have trouble ignoring. I’m starting to see quite a few online comments etc from various sources (predominately comments on news websites etc) saying something along the lines of “what’s the point of increasing my superannuation by 2% when I probably own shares in BHP and Rio through super and they have fallen by 10 or 15%?”. Which is a valid point I guess.
I think politically the government may have overstepped the mark here, believing that the resources industry wouldn’t get much support from your average Joe, who was effectively being bought off with increased superannuation and a few small other tidbits. Given how widespread share ownership is in this country, I just don’t think it will fly. Going after Telstra is one thing (most people have to deal with Telstra and find it painful), but going after the mining industry which doesn’t engender any unfavourable feelings among the electorate is another.
I suspect we will see a revision in the next few days, something along the lines of a timeline for phasing in an increased tax level over a very long timeframe, or something along those lines. I think it was unfortunate (for the government) that their plan was released just as markets began to really be concerned about the Europe situation. Another couple of bad days on the ASX and we may start to see some pretty snappy back-peddaling….
Agree Justin. It all comes across as a little naive commercially which – as you point out given share ownership – amounts to politically as well.
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The RSPT reduces the risk of the entire operation faced by the firm. Accordingly, the syndicated loan and subordinated debt should attract lower rates of interest.
It follows that the debt-equity structure of mining companies will need to be altered to deal with the RSPT.
You cannot assume that the debt-equity structures that are currently used will apply in future.
Mining companies will be able to reduce their equity, and increase debt, to return the same level of equity risk (ie upside and downside potential) as before the RSPT.
Agreed. That is the point I’m (perhaps clumsily) trying to make – and it is at the heart of the problem. You are absolutely right that the debt-equity structure of mining companies will change to take advantage of the RSPT. My example was intended to show that the govt’s funding could become a first loss piece – and that the risk/return on equity can actually be improved. As a taxpayer, I’m not all that enthused by the idea.
If it was intended as a tax that would not impact on the economics of a mining operation (as it says it is), then how can it make marginal producers less so?