Australia's Future Tax System

Architecture of Australia's tax and transfer system

8.5 The treatment of natural resource assets

The Australian natural resources sector is made up of two components — the mining and petroleum sector and other natural resources such as forestry and fisheries.

These natural resources are owned by all Australians, with legal ownership vested through governments' rights over these assets. Governments often assign exploration, utilisation and production rights to the private sector in return for certain payments. These payments include company income tax, royalties, excises and licenses. Such payments can enable governments to collect a return from the extraction or use of the community's natural resources but can also impact on the level of investment, both by Australian and overseas investors.

There are challenges in valuing many of Australia's natural resources. A market price may not always exist and, where it does, it may not reflect the full value that the community ascribes to the asset — for example, the value of an old growth forest. There are a range of factors that can affect the price of these resources, including government ownership and regulation. In many cases, the prices (implicit or explicit) charged by government for access to the community's natural resources are non‑transparent, or at least very difficult to compute.

The Australian mining and petroleum resources sector

Australia has significant non‑renewable resource endowments relative to other countries. In 2000, the OECD calculated that Australia's natural resources (excluding agriculture), as a percentage of total capital, ranked fourth in the OECD behind Norway, Canada and New Zealand (Boulhol et al 2008). Table 8.2 shows Australia's share and ranking in selected world proven mineral resources as at 2004.

Table 8.2: Australia's share and ranking in selected world mineral resources(a)

Metalic Minerals Share (%) Ranking   Oil and gas Share (%) Ranking
Gold 12 2   Oil 0.3 28
Iron ore 9 5   Natural gas 1.4 14
Copper 9 2   Coal  
Lead 26 1   Black coal 5 6
Zinc 18 1   Brown coal 24 1
Nickel 37 1   Non metallic minerals (diamonds)
Silver 15 2   Industrial diamonds 10 4
Uranium 40 1   Gem/near gem quality - High
Bauxite - 2   Mineral sands  
Tantalum 95 1   Ilmenite 20 2
Manganese 11 4   Rutile 39 1
Tin - 10   Zircon 41 1
  1. Based on economic demonstrated resources, as at December 2004.

Source: Hogan (2007).

The mining and petroleum sector accounts for 7.1 per cent of GDP, and generates 14.2 per cent of economy‑wide profits (gross operating surplus and gross mixed income). Exports of mineral resources from Australia were valued at $91 billion in 2005‑06, accounting for 46 per cent of total exports of goods and services. Reflecting the rapid increase in commodity prices, mining exports are forecast to grow to $176 billion in 2008‑09.

Mining and petroleum revenue collection methods

Australia has a complex array of tax and non‑tax revenue raising instruments that it applies to the mining industry. Different resource taxes, royalties and payment arrangements are imposed across different resources, and on the same type of resource depending on its location. In relation to petroleum, these include PRRT, crude oil excise, a series of different royalties applied by the Australian government (the offshore petroleum royalty, the internal waters royalty and the resource rent royalty) and different oil and gas royalties applied by the States. Further, mineral resources are subject to different royalty arrangements across the States including ad valorem royalties, specific royalties, profit royalties or a combination of these types of royalties. The details of these arrangements are provided in Section 2.

Each of the revenue collection methods (and those used in other countries), can result in different effective tax or revenue outcomes, depending on the resource's price and the rate of return to the private sector. Chart 8.11 shows how the combined rate of tax on the profits of a resource project changes as resource prices, and consequently profits, change.

Chart 8.11: Illustrative combined rates of tax on profits
of different resource revenue arrangements

Chart 8.11: Illustrative combined rates of tax on profits of different resource revenue arrangements

Note: The combined tax rate for each type of tax includes company income tax and the respective royalty as a proportion of pre‑tax profits.

Source: Australian Treasury estimates.

Company income tax is a significant part of the effective tax rates shown in Chart 8.11. It applies to both the normal return and any additional profit. Nearly 50 per cent of all revenues from the mining sector come from company tax. As a tax on non‑residents, company income tax is particularly important in the mining sector, with around 50 per cent of mining assets owned by non‑residents.

The combined tax rate on profits arising from an ad valorem royalty decreases with a higher resource price, while the combined tax rate of a profit based royalty remains constant. These royalties can discourage high risk investments (for example, in the case of an ad valorem royalty, revenue can be collected even when net losses are being made).

A resource rent tax does not apply until a firm has earned above normal profits. Once this occurs, the combined tax rate on the total return increases as the resource price increases. The Australian Government's PRRT is Australia's only form of resource rent tax. A royalty on a price above a certain threshold has some similarity with a resource rent tax but the similarity depends on the price threshold.

International comparisons

Countries in the OECD that have comparable natural resources to Australia include Norway and Canada and, while not in the OECD, Russia has similar natural resources to Australia. Table 8.3 provides a brief generalised description of natural resources taxes in Norway, Canada and Russia.

Table 8.3: International natural resource revenue methods

  Norway Canada Russia

Natural resource taxation

50 per cent 'special tax' in addition to company tax.

An additional deduction equivalent to 7.5 per cent of investment costs available in the first four years from when investments made.

Taxes and/or royalties applied by individual provinces.

Levied on profits from mining and processing operations with a deduction allowable for processing to reflect the normal return on processing assets.

8.55 to 16 per cent.

Mineral resources extraction tax and export duties based on physical volumes and subject to adjustment according to the world energy prices.

Regarding oil, Mineral resources extraction tax applies but only where the price for the oil reaches a certain threshold. The same applies for export duties on oil.

Source: OECD (2007f), Natural Resources Canada (2008), OECD (2008b).

Recent developments in the non‑renewable resource sector

The recent increases in resource prices have led to an increase in operating profits of the mining sector.

Over the period since 2001‑02, there has been a significant increase in operating profits in the mining sector in response to increased resource prices (the impact of price movements on resource profits is illustrated in Box 8.9). Operating profits (before tax) in the total mining sector (excluding petroleum) have increased from $5.8 billion in 2001‑02 to $32.1 billion in 2006‑07 (Chart 8.12).

The revenue from resource charges has also increased significantly over this period, though not as fast as operating profits.

Chart 8.12: Mining royalty revenues and operating profits

Chart 8.12: Mining royalty revenues and operating profits

Source: ABS (2007e); ABS (2008f).

Box 8.9: Higher commodity prices increase resource profits

Assume initially the world price for the representative commodity is at pOLD, but then increases to pNEW. The long run industry supply curve, S, represents the long run marginal cost of exploration, development and production (including abandonment), and includes provision for the normal required rates of return to capital and an appropriate risk premium. Given this industry supply curve, and the starting world price, firms initially maximised their returns by producing at point A, with output given by qA. Even at this point there is resource rent, being the profit in excess of firms' costs and normal returns, as given by the area CpOLDA.

Chart 8.13: Increased resource rents

Chart 8.13: Increased resource rents

With an increase in world price to pNEW, previously marginal or uneconomic projects become viable, and production increases to qB. In addition, rents increase in respect of the initial output level qA. The extent to which these increased rents are shared by the community depends on the particular tax or royalty arrangements that apply (see Chart 8.11).

Source: Adapted from Hogan (2007).

Forestry

Of the approximately 10 million hectares of native forest that is available for wood production, about 7 million hectares is owned by state forest agencies (Productivity Commission, 2007). There are several possible methods for ensuring an appropriate recognition of the value of these native forests. Methods include options for charging for reductions in environmental amenity, regulatory controls on the extent or nature of forestry operations, and collecting royalties from the sale of trees on public land (state forests). This section focuses on royalties.

The conventional technique used to calculate a royalty on the stumpage, or log price from trees, is through a residual value pricing method. This method estimates a derived demand curve for native timber for a timber mill by subtracting 'reasonable' costs incurred by the sawmill from the prevailing market price, including an allowance for 'normal' profit.

As illustrated in Chart 8.14, this means that royalty collections increase as timber prices increase. However, the size of the royalty is also highly dependent on appropriate estimates of 'reasonable' costs and 'normal' profit. Estimating these latter two components is particularly problematic, in part because the market for timber may not be fully competitive. For example, the high cost of transporting timber may mean that in some regions there is only one log supplier, the state forest agency, and one (or very few) buyers, such as a large sawmill. State ownership of forestry resources, may also mean that usual market incentives to minimise costs and seek an appropriate market return for the timber are diminished.

Chart 8.14: Components of the market value of forestry
under the residual value pricing method

Chart 8.14: Components of the market value of forestry under the residual value pricing method

One basis for assessing the possibility of an underpricing of native forests is to examine the rates of return on assets for the various quasi‑government bodies (Forests NSW, VicForests, the Forest Products Commission of Western Australia, ForestrySA, Forestry Tasmania and Forestry Plantations Queensland). These entities reported a positive return on assets in recent years with a return on assets across the forestry sector of 2.3 per cent in 2005‑06 (Productivity Commission, 2007).

From the results in Table 8.4 it appears that most of these bodies are not achieving a risk‑free benchmark return on assets (the return on 10 year Australian Government bonds averaged around 5.5 per cent in the period 2005‑06 to 2006‑07). Making an allowance for items such as community service obligations has little impact on these results. This may reflect under‑pricing of the assets they are selling or the existence of high cost structures.

Table 8.4: Return on assets, per cent

Entity 2005‑06 2006‑07
Forestry Tasmania 2.27 2.42
Forests NSW 1.20 1.07
Forestry Products Commission (WA) 4.72 4.70
ForestrySA 4.30 3.90

The figures for Forestry Plantations Queensland are not available and VicForests did not publish the return on assets.

Source: Forestry Tasmania, ForestrySA, Forestry Products Commission (WA) and Forests NSW Annual Report 2006‑07.

The possibility of under pricing is consistent with a series of empirical studies in the last 20 years that have indicated that royalties for sawlogs in state forests have been anywhere between 20 and 70 per cent below market value (Commonwealth Competitive Neutrality Complaints Office 2001). An alternative to residual value pricing is the use of auction or tender arrangements. When VicForests trialled an auction system in 2006, it resulted in significant increases in prices (150 to 160 per cent over the existing price).