What impact will the Henry Review have on the Resources sector

The Australian Government has announced two key policy measures in response to Henry's Australia's Future Tax System that will have a profound impact on Australia's resource industry: The announced measures are the introduction of:

• A Resource Super Profits Tax (RSPT) at a rate of 40% on all petroleum and mining projects; and
• A refundable Resource Exploration Rebate (RER).

Whether a resource taxpayer is financially better or worse off under these announcements depends upon where they sit on the exploration, development or production spectrum. One inevitable position is the additional compliance burden the RSPT presents for the resources industry, but one that will be disproportionately borne by the small and medium resource entities.

The RSPT is a 40% tax slug on the profits of the resources industry. As a tax deductible tax slug, the net cost is 28%. It's been justified by the Government as a means of ensuring all Australian's share in the wealth generated from the extraction of our non-renewable resources.  Try explaining this to the working mum and dads that own shares in BHP. The RSPT is projected to raise $3 billion in 2012-13 and $9 billion in 2013-14. Over this 2 year time period $2.8 billion will be spent on company tax cuts, $1.4 billion on the State Infrastructure Fund, $2.4 billion on superannuation measures and $1.1 billion on the RER, while still leaving $3.2 billion of surplus revenue. The redistribution of wealth within the economy is significant but politically it shouldn’t be too difficult for the Government to sell. There are more winners than losers overall in the electorate from the Government’s range of measures announced yesterday.

It should not be forgotten that developing a resource project is a highly risky and long term venture. The risk verses reward balance needs to favour the reward side of the equation for Australia to attract its fair share of the exploration and project development budget from the large mining groups. Henry and the Australian Government are acutely aware that Australia will remain internationally competitive in attracting capital to invest in the development of our non-renewable resources, even with a RSPT.

The announced introduction of the RSPT will give board directors of resource entities with development projects in the pipeline some sleepless nights. Mine development plans and economic feasibility studies will need to be re-examined because the RSPT costs are likely to reduce the internal rate of return on the project. Marginal projects based on financial models developed last week could now be unattractive due to RSPT costs. Boards may prefer to defer any commit to the project development decision until after the operational uncertainty surrounding the RSPT has been worked through the industry consultation process.

There are broader considerations for the resources industry than merely the introduction of another tax. ASX disclosed JORC Code proved and probable reserves and petroleum P2 reserves will need to be examined given by definition they must be economically recoverable. The carrying value of capitalised exploration and development assets will need to be reviewed for impairment. Dividend yields paid by Australian resources companies would be expected to fall. Financial analysts will be revising their stock valuation models.

One of the key design principles Henry refers to for a tax and transfer system is simplicity. The RSPT fails the simplicity test. It introduces a new tax regime, it does not replace any existing taxes and it will be complex to transition into and comply with. There will be many examples where a taxpayer will be subjected to three different taxes in relation to a single mining project. Inevitably additional complexity and compliance means additional costs. As a leading tax adviser to the resources sector we should cynically be praising Wayne Swan and adding him to our firm's Christmas card list!

One of the Labor party's promises during the last Federal election was the introduction of a share flow-through scheme for small exploration company shareholders.  A similar system presently operates in Canada where the tax losses of exploration companies flow through to their shareholders. The Canadian structure benefits those investors on a higher marginal tax rate. The RER is a more equitable and fiscally responsible measure because it rebates the tax benefit of the exploration losses back to the exploration entity. The RER is a winner for small exploration companies doing green field or brown field exploration. Exploration entities typically fund their activities through the equity markets. Underwriters are not cheap. If 30% of a small exploration entity’s exploration expenditure is refunded by the Government, it can either raise less money at the outset (incurring less cost) or have more exploration dollars to play with. What is not explained in either Henry's paper or the Government’s response is exactly what a "small" exploration company is. With the Government having so much RSPT revenue fire power, lets hope the RER threshold is set high enough to make this a worthwhile policy announcement.