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Economics References Committee
Development and operation of the minerals resource rent tax

BENNISON, Mr Simon, Chief Executive Officer, Association of Mining and Exploration Companies

HUGHES, Mr Marcus, Group Manager, Taxation, Fortescue Metals Group

PEARCE, Mr Stephen, Chief Financial Officer, Fortescue Metals Group

SHORT, Mr Graham, National Policy Manager, Association of Mining and Exploration Companies

Committee met at 08:59

CHAIR ( Senator Bushby ): I declare open the second hearing of the Senate Economics References Committee's inquiry into the development and operation of the minerals resource rent tax. The inquiry was referred to the committee by the Senate 26 February 2013 for report by 6 May 2013. To date the committee has received 15 submissions, which are available on the committee's website.

These are public proceedings although the committee may determine or agree to a request to have evidence heard in camera. I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to a committee. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken and the committee will determine whether it will insist on an answer having regard to the ground which is claimed. If the committee determines to insist on an answer, a witness may request that the answer be given in camera. Such a request may also be made at any other time.

I remind members of the committee that the Senate has resolved that departmental officers shall not be asked to give opinions on matters of policy and shall be given reasonable opportunity to refer questions to superior officers or to a minister. This resolution prohibits only asking for opinions on matters of policy and does not preclude questions asking for explanations of policies or factual questions about when and how policies were adopted.

Mr Bennison : We have Fortescue Metals as part of our presentation this morning. I will make a brief opening statement before handing over to Mr Stephen Pearce for a couple of comments. I thank the committee for the opportunity to appear today. AMEC itself is the peak body for mineral exploration and mining companies in Australia with a membership of over 360 explorers, miners and the companies servicing them, many of which have a direct interest in iron ore and coal.

AMEC and many of its members have a direct interest in the debate surrounding the resource super profits tax and obviously now the minerals resource rent tax. AMEC publicly opposed the original RSPT when it was announced in May 2010 primarily in the view of the potential detrimental effect the tax would have on Australia's international competitiveness and the attractiveness as a place in which to invest. AMEC has also continued to oppose the replacement MRRT that was announced by the government in July 2010 as it was an ill conceived, unfair, discriminatory, complex and not long-term strategic tax reform. These concerns remain.

The MRRT was clearly ill conceived as it was a direct result of a private and secret consultation process with three large multinational companies. AMEC was not consulted in any way during this private negotiation process. It should be acknowledged that these companies had no mandate to act on behalf of hundreds of mining and exploration companies with Australian projects or interests in iron ore and coal. They did not have any mandate to act in any way on behalf of AMEC or its wide membership base.

In AMEC's view the tax is unfair and discriminatory to small emerging mining companies, which generally have higher risk profiles, have limited access to working capital, have a lower economies of scale and consequently a higher unit cost production in comparison to large mature miners. This will make it more difficult for them to compete with large mature miners in domestic and global markets. The design of the proposed MRRT or the actual implemented MRRT provides mature miners with significant tax shields through the starting base allowance and additional financial advantages to large mature multinational conglomerates that are not available to emerging miners in the same proportion. Such a situation ultimately distorts the unit cost of production and investment decisions.

AMEC has previously drawn attention to expert independent modelling by the University of WA which highlights the unfair and discriminatory nature of the MRRT regime and shows that there will be at least a four per cent differential in the level of effective total taxation between the project that was in existence force 2 May 2010 and that applying to less advanced or new developments taking place post 1 July 2012.

The modelling shows that under the MRRT regime a small emerging miner could be paying an additional effective tax rate of 60 per cent compared to large mature miner, who could be paying an extra two per cent. This differential is caused by the large tax shield provided to mature miners who are able to claim a significant deduction for the market value of their starting base assets, and it allows them to reduce the MRRT liability for the remaining life of the mine or 25 years, whichever is less. Small emerging miners are not able to claim such extensive tax shields and therefore the unit cost of production and ultimate effective tax rate are detrimentally affected. This is a significant issue with respect to competitive neutrality and equality, and it is fundamental to AMEC'S continued opposition to the design of the MRRT.

In the longer term, the smaller miners will start to reach the MRRT proper threshold. This would be extremely unfair and discriminatory. The government has attempted to provide some concessions for smaller miners. However, these are of no value and do not address the discrimination factor. AMEC has also consistently expressed concern that there will be inefficient and higher levels of administration and compliance costs to industry and government associated with the new regime. Late last year AMEC conservatively estimated that the minimum accumulated total set-up cost for all small iron ore and coal miners and junior exploration companies, excluding the large miners, is estimated to be over $25 million in the first year and the ongoing annual administration and compliance costs will be in excess of around $2 million to $3 million.

In conclusion, AMEC notes that the mining sector has been a world leader and has been successful in a growing and competitive environment. It is therefore crucial to the Australian economy now and into the future. There are however a number of warning signs and published information on the current status of the industry which indicate that Australia cannot simply rely on the return to favourable market conditions and China and India saving us in the future. The ongoing threat of the expansion in commodities covered by the MRRT, such as gold, nickel and uranium, and other possible detrimental tax reforms, has created considerable uncertainty and angst amongst investors, financiers and other boards. This uncertainty and lack of predictability point to the fact that Australia's reputation and credibility as a safe place in which to invest have been put in doubt. Action should be taken to reverse those trends by promoting investment, growth and productivity in the industry, not by penalising it.

Thank you for allowing me to provide that opening statement. I will now hand over to Mr Stephen Pearce.

Mr Pearce : It is my pleasure to appear before you today, and in particular in support of AMEC's presentation to the committee. Fortescue has consistently stated that it remains opposed to the MRRT, that the design of the tax is fundamentally flawed and believes that the tax should be repealed.

Today I want to make a couple of quick points, specifically about the cost of compliance with the MRRT. It has taken us as a company close to two years to be prepared for the introduction of the MRRT and it has cost us some $3 million to $5 million. There has been a large amount of consulting cost and use of internal resources to be prepared for the tax. It should be noted that that amount of money is many times what it costs us to meet our obligations with respect to the primary taxes: income tax and royalties. This year, Fortescue will pay in excess of $1 billion in income tax and state government royalties. We do not expect to pay any MRRT for this financial year or for the years ahead.

We estimate that the amount of corporate income tax and royalties that we pay will grow rapidly following the end of this financial year as we complete our expansions and ramp up to 155 million tonnes of production. We expect to pay possibly $1½ billion dollars for the next financial year, rising to close to $2 billion in corporate income tax and state government royalties in the years ahead. Thank you.

CHAIR: Thank you, Mr Pearce.

Senator CORMANN: I have some questions for Fortescue Metals Group and then also for AMEC. Just to put that income tax figure into context, when did FMG first start operation? Sorry—when was it first established as a company?

Mr Pearce : It was first established as a company in 2003.

Senator CORMANN: About 10 years ago.

Mr Pearce : Yes, approximately 10 years ago this July, and we first went into production in May of 2008.

Senator CORMANN: And you are now in a position where you will be paying $2 billion of income tax a year?

Mr Pearce : And state government royalties—correct.

Senator CORMANN: Okay. You said that so far you have not paid any MRRT and you do not think that you will be paying any MRRT in the years ahead. But, when you say 'years ahead', are we talking about one? Two? Three? Four?

Mr Pearce : Probably at least up to five years.

Senator CORMANN: For at least up to five years, you do not expect to pay any MRRT?

Mr Pearce : That is correct.

Senator CORMANN: Is this the result of what you expect to happen to commodity prices, or is that as a result of some of the features in the MRRT heads of agreement that was negotiated by the Prime Minister and the Treasurer?

Mr Pearce : I would say it is both. The design of the tax itself obviously, as has been well documented, provides significant capital shelter. We are in the very fortunate position of being an existing miner and an existing project at the time that the tax was introduced, unlike many of the smaller exploration companies that Mr Bennison and AMEC represent. We have run, if you like, the MRRT across models that we had from when Fortescue was first established, and we do not believe Fortescue would exist today if the tax had been in existence at the time the company first was trying to get the project up and funded.

Senator CORMANN: So, if in 2003 we had had a tax like the MRRT, we would not today have a company that would be paying $2 billion in income tax and state royalties a year moving forward.

Mr Pearce : Yes, that is very much our belief.

Senator CORMANN: How many people do you employ at Fortescue?

Mr Pearce : Directly about 4,000 and indirectly, through contractors and other suppliers, probably at least that again. So close to 10,000 people.

Senator CORMANN: Presumably there would be some companies today that would be trying to do what you did 10 years ago. As a result of the MRRT it would be harder for them to be, dare I say it, a success story 10 years from now, employing people and paying tax—is that what you—

Mr Pearce : We could not make that point more strongly to the committee. It is very much what we believe, and it really goes to the heart of the argument in terms of the structure of the tax.

Senator CORMANN: Can you, in some quick sentences, talk us through how the market value based depreciation arrangements and the netback arrangements operate for you? The reason I am asking is that Treasury are telling us that, in their mining tax revenue forecasts, they could not take those variables into account because they could not see how they would operate. I am just interested in your perspective on that.

Mr Pearce : I am not surprised they could not see it. It has been very hard for us to see, and we are in charge of our own detail. Both calculations and the principles embedded in both the netback and the starting base are incredibly complex. It has taken us, as I say, the better part of two years to work through our own circumstances with the assistance of outside experts and consultants to help us firm up the opinions, the facts and the database that will support our positions opposite the tax office. So I am not surprised at all that Treasury have not been able to work their way through the detail, because we did not know the outcome of that process in detail until we went live last July.

Senator CORMANN: But then you did not sit around the table negotiating the tax, whereas some of your competitors sat around the table and negotiated the tax.

Mr Pearce : Correct. It has been—

Senator CORMANN: And the government sat around the table and negotiated the tax. Isn't it a bit surprising that they would not know how it operated?

Mr Pearce : It is very hard for me to comment. I suppose I can comment on my own circumstances. We were not at that table. I suppose we were very frustrated with the outcome that that secret negotiation went on. We were in discussions with the government prior to the introduction of the MRRT, but our position was that we would never agree an outcome with the government. Rather we would be prepared to agree some principles that would then be discussed with the industry, and we believed that was a better consultation process.

Senator CORMANN: Did Fortescue report a deferred MRRT tax asset in its half-yearly report recently?

Mr Pearce : No. We have disclosed the amount of the deferred tax asset that we have not booked. We have not booked any deferred tax asset in the accounts to date.

Senator CORMANN: Why is that?

Mr Pearce : The reason that we have not done so is that we do not believe we will pay any MRRT in the near term and, under the tax and accounting rules, you are only allowed to book that deferred tax asset if you believe there is a degree of certainty about realising some of that benefit.

Senator CORMANN: So what you are saying here is that, because you do not have any tax liability against which you can deduct that particular credit, you are not booking it in your account.

Mr Pearce : That is correct.

Senator CORMANN: So how much is the deferred tax asset which you did not book?

Mr Pearce : It is approximately $3½ billion.

Senator CORMANN: That is just for FMG for the half year?

Mr Pearce : No, that is our view of the deferred tax asset that we have as we look forward across the life of the MRRT.

Senator CORMANN: So, if in six or seven years time you did end up with an MRRT liability, would that deferred tax asset become live again?

Mr Pearce : Yes, it would. We would carry that forward, and it would be inflated because we would be carrying forward some of the allowances, particularly the royalties et cetera, that would get inflated over time as part of the structure of the MRRT.

Senator CORMANN: Which then would essentially push back any time that you would pay any tax even further.

Mr Pearce : That is correct.

Senator CORMANN: Okay. You say you are now approaching $2 billion in income tax and royalties. How much do you pay in royalties alone per year?

Mr Pearce : For this financial year we paid approximately $400 million to the state governments.

Senator CORMANN: So $400 million in royalties this year. For simplicity, you said that for the next five or six years you do not expect to pay any MRRT, so $400 million times five is $2 billion.

Mr Pearce : We are also about to double our production again.

Senator CORMANN: So it will be more than that.

Mr Pearce : It will probably be close to double that number.

Senator CORMANN: So over the next five years roughly how much do you expect to pay in royalties.

Mr Pearce : Probably close to $4 billion over the next five years.

Senator CORMANN: You are presumably accumulating royalty credits.

Mr Pearce : Yes, we are.

Senator CORMANN: So those royalty credits, according to the MRRT heads of agreement, attract compound interest of more than 10 per cent, don't they?

Mr Pearce : Is it that high?

Senator CORMANN: It is the long-term bond rate plus seven per cent. The long-term bond rate was 3.3 per cent when I last saw. So that is 10.3 per cent, and any unclaimed royalty credits—presumably for the next five years your royalty credits will be unclaimed—attract 10.3 per cent interest in terms of uplifting the value of the future deduction. That is right, isn't it?

Mr Pearce : That is correct.

Senator CORMANN: And, for as long as you have not claimed that credit against any future mining tax, it continues to be uplifted by the unclaimed amount plus compound interest, right?

Mr Pearce : It is one of the design features of the MRRT that certain unclaimed allowable deductions or offsets gets inflated and carried forward.

Senator CORMANN: So even just for your company alone—this is just FMG; we are not even talking BHP, Rio, Xstrata or any of the others—the value of that credit over the next five years will be well in excess of $4 billion.

Mr Pearce : It is a significant amount of money.

Senator CORMANN: So that would again delay any prospect of you paying any tax even further.

Mr Pearce : That is another design feature of the MRRT.

Senator CORMANN: So here we are. You will not be paying any of this tax for the next decade and beyond. How much are you paying to comply with this tax again?

Mr Pearce : It cost us $3 million to $5 million to put all of the systems in and get all of the opinions and starting base calculations et cetera in place. It will not cost us that much in ongoing annual compliance, but it would still be in the hundreds of thousands of dollars.

Senator CORMANN: For a tax that you do not foresee you will pay for a very long period.

Mr Pearce : Correct. Again I would emphasise your point that we are just one company. There are a lot of other companies, particularly exploration companies, that are years, if ever, away from paying the tax and have to keep very detailed records that support the MRRT basis of the ground and the exploration projects that they hold.

Senator CORMANN: Can you give us a bit of the flavour of some of the compliance processes that you have had to go through to prove that you do not have to pay any MRRT?

Mr Pearce : Fairly simply, if you look at the MRRT calculation, obviously the MRRT revenue less your allowances and deductions gives you your MRRT income, but each of those three lines is incredibly complex. There is no natural measuring point for what MRRT revenue is. You have to start with the sole product and work backwards. You referred earlier to the calculations. You have to take the sole price of a tonne of iron ore in our case and deduct the shipping or transport costs to get it from the mine to rail and port. Then you take back the processing costs right back to the point where you extracted the ore from the ground. There is no natural reference point for that calculation, so as a taxpayer you need to be very certain of the positions that you are taking through every step of that process because you know the tax office will come and look at the books in due course. That is just one element.

Then there is the capital allowance starting basis. Again, remembering the structure of the MRRT, you have to take the starting base on 2 May 2010 and you are not allowed to use knowledge since that time for to for the evaluation basis. So, again, it is a very, very complex process to work out the value that you are allowed to deduct as a starting base.

Senator CORMANN: Are you surprised that the MRRT has not raised any meaningful revenue so far?

Mr Pearce : Not at all. We had been saying for years—often, with AMEC, as a fairly lonely voice in the wilderness—that our belief was that the tax as designed would not raise any income for the government.

Senator CORMANN: As you said, you were lucky because you were an existing project and that triggered certain features of the mining tax deal for yourself. But you were a reasonably recent existing project. Obviously some of the companies that negotiated the mining tax have had existing projects for much longer. Would you expect their experience to be fundamentally different from your experience around the operation of market value based depreciation, state royalty credits and so on?

Mr Pearce : Because we were a reasonably recent company, it was more likely that our accounting values were closer to the market values. Because other companies have been around for a lot longer and would have written down the accounting values of their infrastructure and mine operations, it is likely that there would have been a greater gap between the accounting values and the market value.

Senator CORMANN: So what you are saying is that there is that tax shelter that, significant as it is for you, would be even more significant for them because the gap between book value and market value is so much larger for them than what it is for you?

Mr Pearce : There is an element—

Senator CORMANN: Yes or no?

Mr Pearce : Yes, that is correct.

Senator CORMANN: So there is an element of it—

Mr Pearce : The tax does need to realise some degree of treatment for capital that has been expended in the past. That was always one of the contentious points in the design of the RSPT and then the MRRT—how do you do that? How do you give someone credit for money that they have spent in the past? Is it book value? Obviously I was surprised that market value was the outcome. But you do need to give people some recognition of past expenditure.

Senator CORMANN: Sure, but there are two different questions here, aren't there? One is whether it is desirable to recognise and how to recognise past expenditure. But, once a judgement call on recognising it in a particular way had been made, the government in our view should have costed that properly. On the face of it, they did not.

Mr Pearce : That is exactly the point that we would also like to make for the smaller emerging companies—that they do not enjoy that historic shelter factor. So it will be very difficult for some of those projects to get up in the current environment.

Senator CORMANN: Mr Bennison, that is a good segue to you. How is the MRRT impacting on the smaller emerging miners?

Mr Bennison : From the point of view of where prices are currently, the trend obviously is that a lot of these companies will not be liable for tax in the short term. But, again, they recognise, as Mr Pearce just said, that because they are recent producers they do not have the shielding that the larger companies do. Therefore, when they reach the $75 million threshold, their capacity and their deductions will not be of the extent that will mean they avoid paying the MRRT liability above that $75 million threshold.

Senator CORMANN: As commodity prices go up and smaller miners become more profitable they would be paying MRRT much more quickly than the larger miners who have these multibillion dollar tax shelters courtesy of the market value based depreciation arrangements and so on. Is that what you are saying?

Mr Bennison : Correct, and, as a consequence, they will also do it at a higher effective tax rate, which the University of WA's research has demonstrated.

Senator CORMANN: So the MRRT provides significant shelter for the big miners and makes it comparatively harder for smaller miners—who are trying to become the economic success stories of tomorrow—to get off the ground?

Mr Bennison : That is right, and that is why it discriminates against a number of the companies within the industry.

Senator CORMANN: That is completely contrary, though, to the policy objective that was advanced by the Henry tax review for introducing a resource rent tax, isn't it? It was supposedly there to help the smaller miners get up more easily.

Mr Bennison : You are quite correct. Unfortunately, that is the collateral damage that has come out of the design of this tax.

Senator CORMANN: You have written a letter to Treasury where you say that the cost of compliance for smaller miners and junior explorers was $20 million in the first year and that there will be an annual cost, ongoing, in excess of $2 million. Can you just explain to us the size of the industry we are talking about there? Who are the players that you are capturing in this and how did you come up with those figures of $20 million and $2 million ongoing?

Mr Bennison : We have actually surveyed our membership who are in the iron ore and coal space, and that includes a number of the junior companies that are not in full production but are having to track their costs as they relate to the MRRT and its design. They have given us a mixture of both actual costs and estimates for putting in accounting systems and preparing to track the necessary expenditures relating to the MRRT. We have pulled that together and aggregated data from the various companies, many of which did not want to be identified individually, and that is where the $20 million was derived. We have discussed that with Treasury. They are fully aware of the numbers.

Mr Short : Part of the feedback that we got—again picking up on what Mr Pearce has been indicating—was that the significant costs for setting up revolved around the valuation of the project, developing charts of account, bearing in mind they had to revise the charts of account so they could classify the data in accordance with the way the tax is designed. There is also forms design. There are policy and procedure manuals. There are IT systems. They had to rejig their accounting processes. There is staff training. That in itself is a major issue. There are individual staff costs. There is audit, professional advice, consultants—legal, accounting—to make sure that they are complying, so that when the ATO comes and knocks on their door they have got all the information that is required. Then, on an ongoing basis, IT continues to be an issue, and staffing, in terms of data collection—the input, the reconciliations, the appropriate reporting. Even if they have nil returns, they still have to fill in the return on a quarterly basis.

Senator CORMANN: So smaller miners and junior explorers have to do all of that work while not actually paying any tax?

Mr Short : That is correct.

Senator CORMANN: And the bigger miners are doing all this work and not actually paying any tax.

Mr Bennison : That is right.

Senator CORMANN: So why have a tax which does not raise any meaningful revenue and is costly to administer?

Mr Bennison : I guess we are all asking the same question, of both those who signed off on the heads of agreement and those that sit in the relevant agencies that are responsible for the administration of the tax.

Senator CORMANN: Can you tell us what you have observed in terms of impact on investment as a result of the way the MRRT has been implemented—the impact on investment in the smaller miner and junior explorer space?

Mr Bennison : For us, a lot of this is about death by a thousand cuts, of which the MRRT is a very significant cut. Independent research, like that of the Fraser Institute, clearly demonstrates that Australia as an investment destination in the mining and exploration sector is clearly out of favour. We have dropped down the list dramatically. I think it is indicative of the lack of investment in IPOs in recent years. Probably in 2013 and 2014 we will see one of the lowest level of IPO listings on record. I think that is further indication of how the policy environment, particularly in the tax area, has been seen as a massive risk in Australia. The government also went through an exercise, fortunately with extensive industry consultation through the Business Tax Working Group, which again highlighted the vulnerability of the industry to ad hoc decisions on the taxation framework as it impacts on the industry. Certain deductions and exploration right across the board could have been impacted. We have been vigorously defending the cost structure as best as we can do it in the industry, but now we have seen recently published data by Xstrata in thermal coal that in 2007 it was $61 to produce a tonne of thermal coal and last year, 2012, $176 to produce a tonne of thermal coal. The international benchmark is $106 to produce a tonne of thermal coal. When you got that uncompetitive international situation that Australia is suffering at the moment, it clearly makes Australia a no-go zone for exploration in mining as it stands at the moment. All the independent research is clearly backing this up. So we are trying to get the government to seriously look at the total cost structure and the cost of production of doing business in Australia and outcomes at all state and territory levels as well as the federal level. But we cannot endure these sort of taxes and this sort of ad hoc policy arrangement, particularly on the smaller producing and emerging companies and also obviously in the exploration sector, where risk is a significant issue.

Senator CORMANN: Essentially you are saying that the cost of business is going up because we keep putting more lead into our saddlebags. One of the more significant pieces of additional lead is the mining tax but there was a whole range of others like the carbon tax and so on. So we are now in a situation where we are essentially no longer internationally as competitive as we have been in the past. Is that your basic proposition?

Mr Bennison : Absolutely.

Senator LUDLAM: Mr Bennison, I think you might have addressed this committee at the time the bills were scheduled for passage through parliament. I do not remember, Mr Short, whether you were here as well. You have done very well in not just coming out today and saying, 'I told you so.' That must be a little bit on your mind this morning.

Mr Bennison : It is. I guess the ultimate consequence of this is seeing the delivery within Treasury and the ATO. There were people who really did an enormous amount of work, and one in particular what John Murray, who did some work for Fortescue that clearly spelt out the implications of the design of this tax on the tax take. We certainly would not take the credit for the sort of research that they did in some detail that clearly spelt out the implications on the tax take with this design.

Senator LUDLAM: Having gone back and look at your evidence from last year, you were not too far wrong, were you, in terms of how you thought the industry would respond to taxation in this form. You are not completely off target, were you?

Mr Bennison : We thought our statements were pretty accurate at the time.

Senator LUDLAM: That seems to be the case in retrospect.

Senator CORMANN: We believed it at the time too.

Senator LUDLAM: I was part of drawing that evidence out. That is the reason I am getting you on the record and you have been very polite in not saying I told you so but actually you did. Now we have seen the outcome that I think you more or less accurately predicted, not just in terms of the revenue but in terms of how the tax would be dodged and how it would be gamed. I will bring us back to first principles, though. There is a gentleman giving evidence shortly who talks about the different forms of taxation. I want to bring us right back to first principles because you did address the issue of principles earlier without spelling out particularly what AMEC's position is, the idea that a mining company will pay royalties for access to a public resource under Australian law, the crown resource. You pay company tax once you are generating a profit, as all other entities in the economy do. Once you have covered your wages and your cost of capitals is reimbursed, do you agree with the principle that, if a big economic rent opens up above and beyond that, the public has a claim on some of that rent—once everything else is paid for?

Mr Bennison : Our approach to this has been that the royalty represents the community's return on the resource in the ground. As we all know, in 1976, through the Commonwealth Grants Commission, the whole concept of horizontal fiscal equalisation was established, whereby that asset of the royalty take would be offset, against things like GST ultimately, to make sure that there was a redistribution of the wealth around this country. If you got more royalties, or even if you did not get the tax take you were meant to have received as a state, you would be penalised in the revenue that would be returned back to the state. We have always seen that as being the major fundamental underpinning redistribution of the resource wealth generated around this country.

Senator LUDLAM: I think you might have answered a slightly different question to the one I asked. I understand that offset with the GST. My question is—and maybe you have answered it: in AMEC's view, the royalties is all that is really accruing. Apart from the company tax, the royalties is it, even though that is a flat measure. It does not go up and down according to commodity prices; it only moves according to—

Mr Bennison : Yes, it does.

Senator LUDLAM: Hold on. It only moves according to volume.

Mr Bennison : No. Royalties are what they call ad valorem. My colleagues here, who pay a fair share of them, can vouch for me.

Senator LUDLAM: That is all right; I have been through this before.

Mr Bennison : And I will hand over to Messrs Pearce and Hughes shortly. Certainly as price goes up the royalty take increases and as the volume goes up that royalty take increases. That is the attachment of the value of the royalty to both price and volume.

Senator CORMANN: The royalties are a percentage of the—

Mr Bennison : Sale price.

Mr Short : It is the invoice price. The invoice price is reflective of the commodity prices.

CHAIR: So it reflects both volume and price.

Mr Bennison : That is right.

Senator LUDLAM: Would it be AMEC's view, then, that the superprofits argument as it was first formulated under the Rudd government is already taken care of by your royalty receipts? Nothing else needs to accrue?

Mr Bennison : Correct.

Mr Pearce : We pay significant royalties, but it is volume times price times a percentage. The percentage is fixed by the state government, but the amount we pay goes up and down with price and, obviously, volume. But we also pay one other tax that goes up and down with the amount of money that we pay, and that is called corporate income tax. Both of those two things move with the amount of money that we make, which is driven via the commodity price.

Senator LUDLAM: I might come to you now, Mr Pearce, if you like. You spoke of complexity. You guys gave evidence—I do not know whether you appeared with AMEC—last February.

Mr Pearce : We might have appeared separately; I cannot recall.

Senator LUDLAM: Regarding the complexity that you were trying to talk us through before and the extraordinary compliance costs that you have had to cop as a result of this instrument being landed, how much of that complexity is due to the design of the tax, which was effectively written by the three majors in order to advantage their own tax position?

Mr Pearce : I am not sure that I can actually answer that question. What I can say is that the complexity of the implementation is driven by the complexity of the tax.

Senator LUDLAM: But why is it so complex?

Mr Pearce : Because they are incredibly complex principles that you are trying to overlay to artificially create taxing points. Companies are not opposed to change; what we are opposed to is complexity and compliance costs in trying to do business. The best tax design will normally try to adopt simple principles. But to try to artificially calculate a revenue point that does not actually exist and to artificially allow deductions that do not naturally exist and have to be calculated is a very, very complex thing. How much of that is because of the influence the companies have in the design versus the design itself I cannot really answer specifically.

Senator LUDLAM: Fortescue had gone to former Prime Minister Rudd just before everything fell over with an alternative model. Would you sketch for us what the alternative model that your company proposed would have been.

Mr Pearce : It is going back quite some time. Again, we always remained opposed to the introduction of the tax but we were asked by the Prime Minister to try to work with his office to come up with some other solutions to allow the circumstances to move forward.

Senator LUDLAM: Have other companies had that same invitation extended to them or have any of your members, Mr Bennison, that you are aware of had a call from the PM's office asking to help them redesign the tax?

Mr Bennison : No, we were not offered that.

Senator LUDLAM: So what was the proposition that you put to him?

Mr Pearce : The framework that we were given—and there were only so many variables again that we were allowed to try to play with—went to the heart of: how do you sensibly and simply recognise the past expenditure that companies will have made; and how do you appropriately protect companies that are trying to get established? It was trying to balance those two key principles within a framework that we fundamentally objected to that we tried to come up with, again, an imperfect solution, I would have to admit. It was not perfect. It was probably slightly simpler than what we have ended up with but it was still complex because what was trying to be introduced was incredibly complex in itself.

Mr Bennison : We have been sitting on an ATO liaison that was established towards the end of 2010 that has the sole purpose of looking at the detail and design aspects of the tax and trying to work out administrative procedures that will lessen the impact, the costs and ease the whole process of the administration of the tax. That group is still meeting. It has got a whole suite of working groups that sit within it, and we are still working with that group today. It is coming up to three years that we have been operating with that liaison group and the working groups associated with it. I do not know how many taxes get introduced that need a liaison group from the ATO that needs to operate for an ongoing period for about three years with a whole subsequent bunch of working groups to try and work through the administration of a tax. I have never experienced that before but I think it is indicative of the complexity of this tax that we all struggle with getting our heads around the administration of it—and the cost of it. The number of people that come together in that whole process over the last three years we have not even factored in is enormous.

Senator LUDLAM: Can we come back to the principle? If the tax was a lot simpler and the compliance costs were much lower, most of AMEC's members are just never going to pay it. If AMEC's members ever do pay it, again, with a much simpler model—notwithstanding you having said you do not support this form of taxation at all—and reasonable compliance costs, it is never going to hit the junior is it, until you are making so-called superprofits?

Mr Bennison : It comes back to what you define as a superprofit and that is the problem we have at the moment that the threshold for a superprofit set at $75 million is totally inadequate for us. When you look at the risk and investment of some of these emerging miners they have got to make for a $3 billion capital investment—

Mr Short : $75 million represents 2.5 per cent return but that is far from being a superprofit.

Senator LUDLAM: The tax is not going to apply. Senator Cormann has just established that the tax is not going to apply until that capital has been—

Mr Short : The other point that we raised in our first submission is: if there is going to be threshold, which we did not agree with anyway, that that threshold should also be indexed, otherwise you will have bracket creep. So over a period of time, let's say commodity prices fluctuate but also production gets ramped up, ultimately, there is a reasonable expectation that the smaller emerging miners who do not have the same significant starting base allowance will at some point in the future be paying a tax. When it comes to their own individual circumstances and their business case, which is developed not just today but looking into the future, the investors, the bankers, the financiers and the boards are asking the question: what does the future hold? Again, it raises uncertainty in terms of the business case and the future viability, so therefore funding also becomes an issue.

Senator LUDLAM: Again, is it not the case, and I want to bring this back to first principles, that the tax will not apply as in perfect a shambles as this particular design is—and you will get no disagreement from me on that—and that it is designed in theory not to kick in until you are doing pretty well?

We could argue about whether $75 million is too low. As FMG; you guys are never going to pay it. I think you are nicely hedged, apart from the fact that it costs you five million bucks to sort the arrangements out. Well done. Back to the theory, once your $3 billion—or whatever your investment is—is paid off and you are in the black, if you are significantly in the black, then the tax cuts in. How does that risk anything at all?

Mr Bennison : I am not looking so much at the risk as at the cost. You have to look at the cost structure of these companies. A lot of their growth is going to come out of that profit being reinvested into developing the mine. That is part of the problem. You cannot just come in and say, 'Right. Look, there's a bit of profit there and we're going to take all of that.' In the whole capital cycle of financing an operation like this—and my colleagues here can really typify it for me—all that capital becomes working capital that they want to put back into expanding an operation. These operations are extraordinarily thirsty.

Our argument is: do not just look at this. Do not look too simplistically and say, 'I can see a profit there above and beyond a certain threshold that we think the community should enjoy.' You have to look at the whole business model in the resource sector of the hungry nature that these projects are for working capital. We like to see at least the opportunity for these companies to reinvest that into their operations. Quite frankly, until we see the design of a revamped whatever tax it might be I would not like to speculate on when and how a company has a capacity to pay.

Much of that depends on where those assets are brought into the equation. Remember, there is a cut-off of 10 May, so a lot of these companies that have massive capital assets sitting there do not get the ability to put in at market value and to appreciate like a lot of these other companies do. So there is still a divide there between what can be put into the books and what cannot. It is not that everyone has all this capital sitting there that they have spent that can start depreciating against their tax liability.

Senator LUDLAM: You do make it sound a little though as if the industry is some kind of not-for-profit public service that is reinvesting all of its profits back into continued expansion. Somewhere along the line profits are coming out of the industry—a lot of them are flowing overseas—to shareholders. Are you saying that it is just the tax component that the public should be accruing that needs to be invested, because the industry is making extraordinary profits at the moment? They are not all being reinvested in expansion.

Mr Bennison : If you look at some of the mid-tier iron ore and coal producers right now, they would argue that statement about making decent profits at the moment.

Senator LUDLAM: But they are not going to make decent profits until—this is not some kind of socialist enterprise.

Mr Bennison : I am being quite frank and honest with you. It would be worthwhile as an exercise to go out there and ask those companies, right now, how they forecast their profitability over the next three or four years. The pricing structure at the moment, particularly in the coal industry, is seriously questionable. That example I gave of Xstrata is real. I would be very curious to see where you would sit a number of these thresholds in a superprofits tax context to where the cost structure of the businesses are today and will be in about three to four years time. A lot of people would be in for a rude shock.

Mr Pearce : You would find that most junior- to mid-size iron ore companies—and there are only maybe 10 of them in the state, particularly through this financial year—have had a very close to near-death experience through the price decline of iron ore through the September-October-November period.

Senator LUDLAM: You are looking at that near-death experience against future profit obligations though, are you not?

Mr Pearce : It goes to the heart of this concept that iron ore companies are out there making endless sums of money—

Senator CORMANN: With no risk.

Mr Pearce : with no risk.

Senator LUDLAM: I am not defending the specific design of the tax, as I hope you have gathered by now, but the government would argue that the design of the tax incorporates that risk. You can brook all sorts of hedges and kinks and quirks against future superprofits.

Mr Pearce : But it goes to the heart of the concept that the industry is in fact making super profits at the moment—

Senator LUDLAM: So you just deny that they are there at all?

Mr Pearce : At the moment, no they are not.

Senator LUDLAM: At the moment. But they were there and they will be there again.

Mr Pearce : Well, again, the selective timing of the introduction and the policy response back in 2010—yes, iron ore prices were incredibly high at that point in time, but they are not now—

Senator LUDLAM: And royalties were not cutting in, in terms of benefits to the public, and neither were company taxes. And that is really the government's argument.

Mr Pearce : But the government, I think, underestimated the amounts of company tax and royalties that were about to flow through the system. At that stage the industry was going through significant investment—and you know these things take years to get in place, particularly in iron ore, because the barrier to entry is multibillion dollar infrastructure and it takes high-risk, high-cost capital to get these products to market. The wall of volume that we are now seeing flow through is, in fact, translating to significant sums of royalties and significant sums of corporate income tax. That is what those two taxes are designed for.

Senator LUDLAM: Okay. Just to finish up: one of the government's arguments as to why the tax has collected so little revenue is that it is anything but the design—that is, it is anything but the deal that was cooked up behind closed doors; it is a whole range of factors. One that we are addressing now is the iron ore prices. Are you able to give us a sense of the degree to which that statement might be true? How much of it is about iron ore prices and how much of it is about structural problems with the design of the tax itself? If the iron ore price shot through the roof again—and there are some indications that it may—will the revenues start flowing? Or is this thing just irretrievably broken?

Mr Pearce : I would say that at current iron ore prices I cannot see any scenario where the MRRT will collect any significant income tax for the government.

Senator LUDLAM: Will it be collecting anything from you guys?

Senator CORMANN: What is the current price?

Mr Pearce : It is around $130 a tonne.

Senator LUDLAM: Okay.

Senator CORMANN: Which is still pretty high.

Senator LUDLAM: By historical precedent.

Mr Pearce : It is slightly above what we would consider the norm. Our view at the moment is that around $120 is probably a normal price; $130 is not that much higher than $120. So it is not that significant.

Senator LUDLAM: Okay. If it stays at roughly that level, around the $120 to $130 range, will Fortescue ever pay this tax at all? Or are you fairly comfortable that your offsets will look after you?

Mr Pearce : I don't believe that we would pay MRRT under that pricing scenario for the foreseeable future.

Senator LUDLAM: And is that a reasonable forecast for iron ore prices? I am not asking you—well, maybe I am!—to look into a crystal ball.

Mr Pearce : I wish I had a crystal ball. But it is a difficult thing. I suppose we have our corporate view, that around the $110 to $130 mark for the next couple of years is a reasonable estimate. Most industry forecasters are predicting significantly lower iron ore prices on that.

Senator LUDLAM: Okay. And does FMG mainly sell on the spot market? How much of your contracts are forward sell?

Mr Pearce : We sell to customers. Every time we put iron ore onto a ship, we sell to a specific customer in China. So none of it is really on the spot market.

Senator LUDLAM: All right. Thank you. I will come back with more questions if there is time.

Senator EGGLESTON: I am interested in the long-term impacts of this sort of thing on the future of the Australian mining industry, which of course underlies and underpins our economy and has done for many years. In your submission, you comment that cost competitiveness and attractiveness as a place for mining investment in Australia is in decline and, also as part of your submission, that: 'Contrary to public perceptions, Australia is currently faced with a serious problem due to insufficient exploration investment to discover and develop the mines of tomorrow.' You refer to research by the University of Western Australia released in 2012 which states that 'about half of Australia's non-bulk commodities mines would be exhausted in between seven and 18 years'. Your submission says that it takes a long time to convert a discovery into an operating mine, and you also refer to the fact that the ASX has reported that 'over 50 per cent of the funds being raised through IPOs in Australia over the past few years has been for overseas projects, such as Africa and Canada'. You also refer to comments by the Fraser Institute about 'various global jurisdictions and their individual attractiveness as a place in which to invest in exploration', and you note that Australia has dropped in ranking from 8th out of 45 jurisdictions to 30th out of 96 jurisdictions. So it seems to me—and I would ask whether or not you agree—that there is quite a significant threat to the Australian economy, which as I said at the beginning depends heavily on mining, posed by this taxation proposal, or procedure, which the government has put up. In the short time that we have left, would you like to comment on those general issues?

Mr Bennison : I think you have summarised it very well. There is a litany of issues out there at the moment which are impacting particularly on the exploration end of town. We have commissioned various aspects of research and the University of Western Australia minds of tomorrow is probably one of the most significant, where two of the most eminent people in this space have put together the international data to clearly indicate that we are going to be in strife in 15 to 20 years time because of a lack of new discoveries—and I am talking about serious mines. As a consequence, we are working as diligently as we can to make governments aware that they must look at how they can put programs together to encourage investment in the exploration sector for the sake of long-term revenues for this country. Taxes of all nature, including royalties, are really going to be at risk for the next generation. It is a sad indictment on our political system that we cannot get enough people who have the vision to pick up that university research and apply it in the context of policy in this country. We are really going to hit a wall down the track. Unfortunately, when you are in a three- or four-year political cycle, a lot of people do not see out far enough to put in place the necessary policies for this country to have the revenue streams it so much relies on today.

So yes, we do have a serious predicament. I speak to a lot of CEOs of companies and their technical people, and to the service industries which are members of our organisation and, sadly, they are heading offshore because that is where business will be. Sure we will have a lot of the established minds which we have today continuing on but they have a life of mine and the investment being raised today on the stock exchange and privately is heading offshore. When we speak to CEOs they say they have had enough of Australia. I can give you their names. They would be more than willing to speak to you to explain exactly why they do not think Australia is a destination. They are even going to places like the Congo, which they rate higher than Australia despite what the Fraser Institute research finds.

Senator EGGLESTON: That is a really significant threat to the future of our economy, one could say. Have you had any indication from government spokesman that they have any comprehension of this as a problem which needs to be faced and dealt with?

Mr Bennison : We are spending an inordinate amount of time with senior bureaucrats in the relevant agencies—for example, Treasury—and also within political circles to get all political persuasions to understand the urgency of this situation. All we can do is use that research to highlight the need for investment in particular in the exploration sector. The economic period we are going into now is extraordinarily uncertain both globally from a European-United States context and also particularly with our main destination in China. There are still some very serious questions about the long-term security of the investment market within the exploration sector. People are just hanging on to cash and will do so indefinitely until they have more confidence to put the cash back into risk areas like exploration. At this stage it does not look as though it will be Australia; it will be South America, Africa or North America.

Mr Short : To make it absolutely clear, we are talking about greenfield minerals exploration; we are not talking about oil and gas, petroleum or energy. We are talking about greenfield minerals exploration, which is where the mines of tomorrow are going to come from.

Mr Bennison : The focus is really on the base metals rather than on the bulks. I think we all pretty much have an understanding of the iron ore and coal space in regards to this. For us it is getting strategic. A lot those base metals generate enormous royalties in this country and other revenue flows à la the taxes.

Senator EGGLESTON: Thank you very much.

Senator CORMANN: I have a quick follow-up on the question that Senator Ludlam asked before about the extent to which commodity price variations or design features are to blame for the changes in revenue. You would be a student of what Treasury says on these matters, I assume.

Mr Pearce : I follow it closely.

Senator CORMANN: As you would be aware, the original mining tax revenue forecast for 2012-13 was for it to rise to $4 billion, and that was progressively downgraded; in the most recent budget it went down to $3 billion and in the most recent Mid-Year Economic and Fiscal Outlook it was $2 billion. Treasury has said to us that they have been able to update their revenue forecast, and they downgraded their revenue forecast because of the changes in commodity prices, production volumes, exchange rates, even increases in state royalties, because these were all things they could see. They said that the only things they have not taken into account are the two things they could not see, which was the starting base value and the net-back arrangements. By September, commodity prices started to pick up again, if anything. Is it fair for me to assume that the lower commodity prices at some point over that cycle were already reflected and that the only thing we do not know at this point in time is the impact of the starting base, the market value based depreciation arrangements and net-back arrangements, and that as such the design features are overwhelmingly to blame for the revenue coming in at more than 90 per cent below the budget forecast?

Mr Pearce : I suppose, to answer that question as best I can, I agree with the sentiment. I think the design features will mean that we will collect minimal MRRT this financial year, and I think that is a real issue for the country. If they are still estimating billions of dollars in inflow, I just do not see that that is going to happen this financial year.

Senator CORMANN: And they have spent billions of dollars on the basis of what they have thought the mining tax would raise.

Mr Pearce : It is a dangerous thing to do to spend money based on a highly variable income stream.

CHAIR: I might wrap up with one final question. Both organisations today have outlined the consequences of the decision. FMG have made it clear that they would not exist in the form they do today if the MRRT had been in. AMEC have made comments about a disincentive on junior miners coming into the space. Given that those processes exist, one of the issues we are charged with looking at is the process of development of the MRRT. I am interested in your thoughts, if a government were keen to proceed to implement a Henry style resource rent tax, on what process should have been followed compared with the process that the government did follow in terms of consultation with the industry to try to ensure that all those sorts of things still happened.

Mr Bennison : Very briefly, obviously extensive industry consultation is a priority, and I think all governments have to be included in this process because the impact on the deductions—and royalty is crucial to this equation—needs to be taken into consideration, and perhaps also the significance through the whole Commonwealth Grants Commission. If that is the main vehicle for balancing the wealth distribution, then where is that going wrong in the context of the structure across this country in relation to taxes and resource rents? There are a lot of people that need to be involved in this process. This demonstrates that, unless taxes are kept simple, you have got a nightmare in front of you. For us, at the state level where the royalties have been the vehicle for collection of community revenue at the resource, we still see this as the main viable option. I think that if the federal government wants to somehow modify that process then this will be a long drawn-out exercise and it will not be an easy one.

CHAIR: So, the process the government took quite clearly excluded AMEC, particularly the MRRT, and excluded Fortescue and a lot of other players. Contrast that with the process that was taken for the PRRT—and I am not sure whether anyone here is aware of it—which I understand involved a long lead-in time, a lot of consultations and trying to work through the issues to see whether they could deliver something that would work. But the government, as I understand it, did not take that approach here. I would have thought that when looking at new taxes it is incumbent on the government of the day to make sure that it thoroughly examines and works with those who are affected to ensure that there are not unintended consequences.

Mr Pearce : Maybe I can answer that, with a slightly different approach. I agree with everything Mr Bennison said. Creating wealth is actually really hard work. Particularly in high-risk resource industries, it is both long in time and incredibly hard work—if you are lucky—and there are a lot of people who fall by the wayside in between. If you then try to impose a tax on that wealth that is created in an ill-thought-through, shambolic, non-consultative process, you end up with what you ask for—and I think that is exactly where—

CHAIR: It is counterproductive.

Mr Pearce : Correct.

Mr Bennison : Perhaps I could add one more thing. It has to be remembered that the petroleum industry is administered through the federal arrangements, whereas the mining and exploration sector, and minerals, is done through state arrangements. Therefore you have the added layers and reliance of the states on the royalty structures. No matter whether they are profit based or ad valorem, the fact remains that you have to take all the states and territories into consideration in relation to the impact you are going to have on their revenue base as well. And that just adds to the complexity.

CHAIR: It elevates the need for proper consultation and working through the issues compared with the PRRT.

Mr Bennison : Yes.

Mr Short : I might also add that even though we had the Henry tax review, the recommendations that came out of that obviously related to the RSPT. That particular announcement was made on a Sunday, on 2 May 2010. I recall it very well, because we were in the office waiting to see the report. We had not been given any indication at that point that the RSPT was on the table.

CHAIR: So, the announcement was made without any consultation?

Mr Short : Correct. Having said that, we did contribute to the Henry tax review in an overall sense. But then obviously discussions continued regarding the RSPT and then the amended MRRT. Again, we were not involved.

CHAIR: Thank you to AMEC and Fortescue for assisting us this morning.