Apples and oranges: the tax is a matter of ROCE

The debate on the RSPT, to date, is not getting to the heart of the matter. For whatever reason, the wrong financial metrics are being used to assess whether “the 40% tax rate is too high” or “the 6% cut-in rate is too low”.

The main distraction is the “effective tax rate” (ETR) figure that mining companies are using to argue against the tax. It is a mistake to compare effective tax rates directly between industries because it does not tell us exactly how profitable the industry is overall, but only what slice of those indeterminate profits are paid as tax. The argument has been made many times that the high risk of mining projects demands a high return — but again, repeatedly pointing to the ETR for projects only tells us the slice paid in tax, not the level of earnings the company can retain to distribute as dividends or invest in other projects.

An alternative way to evaluate these questions is to look at profitability of mining projects as Return on Capital Employed (ROCE) — a percentage calculated by dividing the adjusted net profits before interest and tax by the value of the capital employed. A simple model can be built that does not require either a detailed knowledge of mining industry economics nor makes simplifying assumptions that can be challenged by either side of this debate. Put another way, ROCE cuts through the confusion and gets to the crux of the debate — whatever the average effective tax rate is within a sector, it is the average ROCE that shows whether or not super profits are being made.

One factor that has been widely overlooked in the RSPT debate is that the RSPT deducted before interest and tax, is not actually accounted for as a tax, but as a dividend to the government. That means that when corporate tax is finally applied to earnings, the RSPT amount already paid is not taxed again.

Moreover, as is widely known, the corporate tax rate is proposed to be reduced from the current 30 per cent to 28 per cent over two years.

Finally, then, using the ROCE method of assessing the tax leads to the following question (perhaps the most important question in the debate): by how much would a company’s after-tax earnings decrease under the RSPT? That is, how much less is available to distribute as dividends or reinvest in the business?

The calculation produces some surprising results as the table below shows.

It must be noted here that this example does not take account of a company’s gearing position. Miners typically fund their fixed capital costs with equity, and then fund working capital with debt. The more a company borrows, the less will be the amount of ROCE left to distribute to shareholders. This has been clearly shown in the case of Fortescue, which has seen its share price tumble since the RSPT announcement.

On the other hand, the figures above do not take account of accelerated depreciation in mining assets when calculating the corporate tax bill — which, of course, reduces the amount of corporate tax paid.

What the table does show is that the amount money to be distributed as dividends or reinvested, is nowhere near the 40% headline figure used to calculate the RSPT, and shows even more clearly how misleading the effective tax rate of 56.8% being promoted by the mining industry is. That figure is not wrong — but it gives a misleading impression of the true impact of the tax on the return investors make on their money.

*Munif Mohammed is presently GM finance projects for a major retailer in Sydney, and has worked as a CFO and finance professional in government, financial services, IT, FMCG and retailing for 25 years.