inamerrata

My previous post apparently didn’t do the economics for the resource rent analysis quite right — it seems that the idea is a cleverer company would be able to use the resource rent tax to find cheaper sources of funding, which changes things…

The idea then would be that you start your mining project seeking 60% in risky funding (they get whatever profits you make and the totality of the loss), and 40% in risk-free funding (they get the same return as they would if they invested in government bonds, whether the project succeeds or fails). That’s as opposed to the current approach of seeking 100% in risky funding.

So say you’ve raised $5B. You spend your $5B doing surveys, setting up your mine, etc. Failure here means you declare bankruptcy and the government gives you enough money to pay back the $2B of risk-free investment, plus interest, presuming the Greens don’t have their way. On the other hand, your mine might be a success, and you might, eg, start getting $1.5B in revenue, against $500M in expenses. At this point you first have to pay your “super profit” tax, which is, apparently 40% of:

• gross receipts: $1.5B
• less depreciation: assuming 20 year expected life, 5% of 5B = $250M
• less running expenses: $500M
• less “normal return” on debt/equity: 6% of $5B = $300M
• totalling: $450M

So $180M on resource rents. You then pay corporate income tax of 30% (eventually 28%) of:

• gross receipts: $1.5B
• less depreciation: assuming 20 year expected life, 5% of 5B = $250M
• less running expenses: $500M
• less resource rent: $180M
• totalling: $570M

So $171M ($159.6M at 28% in 2014 or so).

You then pay the risk-free return to your risk-free investors, which is 6% of $2B or $120M. (Actually, this might be tax deductible too)

So after paying expenses ($500M), resource rents ($180M), income tax ($171M) and the risk-free dividend ($120M), your $1.5B of earnings is down to $529M. Issuing all that to your risky investors, gives an annual return of 17.63%, fully-franked.

That compares to doing things the current way as follows: you raise $5B of risky investment; your mine succeeds and makes $1.5B in revenue, against $500M in expenses. You just pay company tax at 30% after expenses and depreciation, so that’s 30% of $750M, or $225M. That leaves you $775M to pay in dividends, which is an annual return of 15.5%, fully-franked.

That, obviously, is an entirely convincing investment. It relies on the government refunding the $2B of “risk-free” investment in the event that the mine falls apart, though — which, as I understand it, is the part of the plan the Greens oppose. But otherwise, the above’s fairly plausible.

The difference in those sums — profit rising from 15.5% to 17.63% is due to the level of depreciation in the above sums. If those formulas for calculating the rent and company taxes are correct, then your return on investment increases by two-thirds of your annual depreciation compared to the initial investment and decreases by a fifth of the risk-free rate. In the above case, annual depreciation was 5% of the entirety of the initial investment, and the risk-free rate was 6%, which implies an improvement of 2/3*5%-6%/5 which is the 2.13% we saw.

In reality, you’d probably need to offer a higher return to your “risk-free” investors — because if you didn’t, they’d probably just by bonds directly from the government in the first place. And if I’m not mistaken you still need to repay the principle for your risk-free investors over the life of your mind. So hopefully that simply evens out in the end.

There’s not a lot of difference in that scenario to having the government borrow enough to maintain 40% ownership in every mining operation in Australia. They’ll then receive 40% of the after-tax profits, and have to pay interest on their borrowings at the long term bond rate, which would mean (in the above example) getting $225M in company tax, then $310M in franked dividends, then paying out $120M in interest costs for a total of $415M extra per-annum. That’s more than the total of $351M in receipts in the above example, I think due to the depreciation deduction in the resource rent tax calculation.

Mechanically, there’s a few differences: the company has to gain two sorts of investment (risky shares and risk-free bonds, for instance), if it fails it has to go to a lot more trouble to pay back the risk-free investors (getting the tax office to issue a refund in cash), and the government gets to keep it mostly off its books (doesn’t have to raise funds directly, investment losses turn into tax refunds).

In any event, that should make it easier for mining companies to raise funds — they only need to raise 60% of the amount at the risky level, for the same return they previously offered.

I don’t see anything stopping you from being tricky and doing a two stage capital raising: raising $3B of risky funds to do exploration; and if that fails repaying your investors 40% ($1.2B) of their capital — then doing the risk-free fund raising to get enough cash to start production. The initial fund raising then has a chance at a 17% ongoing return, or a 60% loss — compared to currently having a chance at a 15% return or a 100% loss. Again, that should make it easier to raise funds for new projects.

On the other hand, I also still don’t see anything stopping you from transferring your profits. Say you’re a public investment company. You’ve got plenty of money from offering superannuation products or what not, and you want to get into mining because you hear it gives a high return for your investors. So you allocate a few billion to start a mining company, which does some prospecting and opens a mine. That works out, and it starts making super profits. You decide you want to reduce your tax, and get more dividends. So instead of having one privately held subsidiary mining company, whose balance sheet looks like:

• Revenue: $1500M
• Expenses: $500M
• Resource rent tax: $180M
• Company tax: $171M
• Dividends: $649M

you decide to invest in a transport company as well. Hopefully one that’s already making a decent profit, but paying a bit more than market value works too. You then have them make an agreement that the mine will exclusively use your transport company for the next 10 or 20 years, for whatever excuse satisfies appropriate laws. Then have the transport company seriously jack up the price. Your balance sheets should then look like:

And voila, your resource rent tax has been reallocated to your dividends (except for the 30% that goes to company tax, of course). It doesn’t have to be a transport company, either — any private company that you can buy outright, that isn’t hit by the resource tax, and that you can find some excuse to make your exclusive supplier of a necessary product/service will do fine. And even better, as far as I can see, even when you get rid of all the resource rent proceeds the government was hoping for from your mine, they’ve still covered 40% of your initial risk…