SA Mines and Energy Journal : October - November 2013
OCTOBER/NOVEMBER 2013 SA MINES & ENERGY JOURNAL 37 BUSINESS Thin edge of the wedge Changes to rules around thin capitalisation and exploration deductions mean companies have to dramatically increase the equity they contribute to new Australian investment projects. Michael Churchill and Kalem Sammut discuss. Major changes affecting foreign investment in Australia and the future of mining investment were largely overlooked in the Federal Budget earlier this year as the public focused on the size of the government deficit. Reduced allowances for mining exploration deductions announced in the 2013/14 Budget have forced mining companies to be more focused on correctly allocating value amongst production and exploration assets. The removal of Capital Gains Tax exemptions for foreign investors means more attention must be given to acquisition valuations to achieve a fair value for the assets considering the cash required to pay tax liabilities. Previously, mining companies that acquired exploration assets -- including mining rights and information -- could claim an immediate tax deduction. This concession has been amended and exploration assets must now be written off over 15 years or the life of the mine (depending which is shorter). This change is in effect now. This means a company takeover resulting in a $100 million tax value allocated to exploration tenements and information would previously have made an immediate tax saving of $30 million. Under the new laws, this $30 million benefit would be spread over a maximum 15-year period, with a present value closer to $10 million (assuming a discount rate of 8 percent). Deal metrics are instantly less attractive to acquiring companies and lower prices may end up being paid in acquisitions. It is important for miners to consider the potential deductions they are eligible for under the new laws, as they are estimated to cost the mining industry $1.1 billion over the next four financial years. To date, the majority of miners use historical cost as the value of their rights and information. This method is neither accurate nor ideal and is potentially exposing the company to unnecessary stamp duty under the landholder regime -- triggering tax liabilities under the Taxable Australian Real Property (TARP) regime and exposing the company to an unnecessarily excessive tax liability under the new mining rights and information regime. It is important that mining investors accurately allocate value between exploration and production assets in order to minimise their tax liability. Foreign investors who dispose of mining entities where the value of non-TARP assets exceeds 50 percent of total assets are exempt from paying Capital Gains Tax. Previously, mining information was classified as a non-TARP asset, increasing the ratio of non-TARP to TARP. This is especially relevant for early stage miners who hold high levels of information and lack income producing assets. Mining information and goodwill must now be valued and included together with the mining rights. For early stage miners, this effectively lumps all assets into the TARP 'bucket' and gives rise to a tax liability upon disposal. Also, under the stamp duty regime, mining information is still classified as a non-land asset. Therefore, correctly valuing mining information is still important if miners wish to minimise their potential tax payment. Ignoring this valuation issue can lead to an excessive stamp duty tax liability. In addition, from 1 July 2016, a 10 percent non-final withholding tax will apply to the disposal of all TARP assets by any foreign investor. The purchaser is obliged to withhold and remit to the Australian Taxation Office 10 percent of the total purchase price. Foreign investors should place their valuation method in the spotlight to ensure acquisition bids are competitive without the new tax requirement harming future operations or creating excessive liquidity constraints. Together, these changes will cost foreign investors $219 million over the next four financial years. Foreign investment could suffer as more cash generated by asset sales finds its way into the government coffers rather than reinvested into other projects. The 'safe harbour' debt limit for general entities has also been reduced from a debt to value ratio of 75 to 60 percent, in effect from 1 July 2014. The change is costing foreign investors $1.5 billion over the next four financial years and will likely slow cross- border investment activity. The change will mean that unless asset values have risen 25 percent, companies will be forced to either inject equity and/or reduce debt. Companies should consider the likely effect this change will have on the appropriate debt valuation method; current financial model assumptions which incorporate the old safe harbour limit; optimal capital structure; returns to investors (especially in structures which support high levels of debt, such as infrastructure); and cost of capital.
August - September 2013
December - January 2013-14