Australia’s ‘super’ mining tax

Part 2 Company Tax Calculation:

Looking at the above example you may be wondering how this Tax on Super profits got its name and whether this tax is applicable to just highly profitable mining companies. The government, in its infinite wisdom, has decided a super profit equates to anything over and above the risk free rate of return on Australian long term bonds (presently 5.7 per cent). Note the capital allowance in our example above which allows a deduction of 5.7 per cent of the investment in the gold mine ($200 million) or $11 million. Let me put this miserly rate of return into context for you.

Having spent the best part of the last 10 years of my working life focused on investing in gold mining companies, you learn that this business is very risky (very often the hard way!). I have witnessed what seems like a countless number of mining companies fail to realise their feasibility study predictions due to any number of unforeseen circumstances. To arrive at a 5.7 per cent risk free rate of return as a reasonable profit to make on a mining venture fails miserably to adequately compensate for this risk. Mining companies need to be rewarded for the gamble they take on developing a project, otherwise what would be the point.

They face risks associated with fluctuating metal prices, geological anomalies, weather related events not to mention human error. If a mining company is not making at least a 5.7 per cent return on its investment before financing costs, I think it is pretty safe to assume the company is in some trouble.

I can assure you that when a bank lends money to a mining company, it takes these risks into account. If we use our example above, you can see that the government’s deductible capital allowance of $11 million fails to even cover the company’s financing costs of $12 million, which are conveniently disallowed as a deduction in calculating the pre-super tax profit. In other words, if the government considers $11 million to be a reasonable rate of return on Gold Mining Ltd’s assets before financing costs, they would consider a loss making position for the company reasonable for the purposes of calculating this super tax. Regardless of the repayment of the debt over time, this is laughable and demonstrates the ignorance involved in formulating this tax. Let us now consider the effect this tax might have on the valuation of mining companies with projects in Australia.

Gold Miner Ltd Profit after Tax under each scenario:

Example 1: $86m (Australia’s existing tax structure)

Example 2: $90m (Canada’s highest taxed province Nova Scotia)

Example 3: $59m (Australia’s proposed mining tax on super profits)

Assuming Gold Miner Ltd is valued on the basis of on an undiscounted after tax earnings multiple of 9 (reflecting the remaining life of the mine) you could get a very rough back of the envelope valuation of the following:

Example 1: $774m