27/07/2011 - 10:28

Miners ignore the MRRT at their peril

27/07/2011 - 10:28

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Iron ore and coal mining companies shouldn’t treat the MRRT lightly – the ATO will be looking to collect every dollar it’s entitled to.

Miners ignore the MRRT at their peril

I HAVE been surprised by some mining companies’ preparation, or lack thereof, for the proposed Minerals Resource Rent Tax.

While some of the big miners would appear to be well prepared, others are sticking their heads in the sand, saying they won’t be doing anything until the legislation is passed. That’s a risky strategy.

Politically speaking, the stakes around this tax are much higher than a company tax return. The ATO has been taking advice on the MRRT from industry and professional groups, and because of that it will be well placed to apply a high level of scrutiny to the methodologies adopted by taxpayers when it comes to implementing this tax and collecting revenue.

To achieve defensible valuations for their projects and to calculate MRRT liabilities, mining companies will have to calculate their starting base value as of May 1 2010.  

If miners don’t have a solid and credible set of source data they’re not going to be able to defend the assessed value of their projects. 

There are four main mine project phases that have varying levels of information and risk/uncertainty – exploration properties, mineral resource properties, development properties, and production properties. These require different approaches when assessing the market value starting base, and experience in undertaking valuations within each of these different project phases is required.

With this in mind, many companies will need to have market valuation undertaken.

Companies have to make an irrevocable decision from the start of the tax about whether to use market value or book value of their projects assets. 

An analysis of six iron ore producers, five coal producers and one coal and iron ore producer by our company compared their book value to market value. What we found was that for producing companies, all had a substantial differential between the book value and market value which ranged from 1.4 to 30 times, and for the exploration and development companies between zero and 55 times. 

There is obviously a great deal of benefit for these particular companies. In addition, if they work with a simplified book value of their projects assets they will lose all of the benefits of the government’s uplift parameters.

In addition, the location of that taxing point at the run of mine (ROM) pad means that valuation professionals need to be able to implement appropriate transfer pricing methodologies to account for the value of downstream activities. It is invaluable to understand the various transfer pricing methods and the limitations of some for MRRT purposes.

One transfer pricing method accepted by the ATO is the ‘net-back’ method. While high net-back amounts reduce MRRT revenues, pushing project value into downstream assets reduces the market value starting base of depreciating assets at the taxing point.

Valuers need to give careful thought to the way they implement transfer-pricing metrics. 

It wouldn’t be the first time that the ATO has made a taxpayer accountable for inappropriate transfer pricing practices.  While the new tax will only apply to iron ore and coal mining companies once their profit exceeds $50 million in a particular year, any company that thinks it might hit that benchmark within the next five years should consider having their project professionally valued.

Such companies should be prudent and ‘time capsule’ some vital information, given that the valuation date is May 1 2010 and more than a year has passed since that date. 

In particular, the following information should be archived:

• mineral resource and ore reserve statements as at May 1 2010 and all supporting information;

• base-case life of mine plan with reference to price and cost parameters at May 1 2010;

• base-case life-of-mine (LOM) schedule including all assumptions and supporting information;

• asset register including all upstream and downstream assets as at April 30 2010;

• three years of management reports up to April 30 2010 that provide a breakdown of costs by activity and cost code;

• the closing accounting balance sheet (including inventory physicals), and the tax base of depreciating assets as at April 30 2010; and

• relevant executive and board reports that discuss development options under consideration as at April 30 2010.

Mike Warren is a corporate consultant, project evaluations, at SRK Consulting.

 

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