Accounting and Society - Essay Example

Name: Tutor: Title: Accounting and Society Institution: Date: Introduction Australia mining sector has played an important role in development of the nation. The sector has longstanding stability to political influences and taxation impacts. It is expected that the sector will continue to develop and increase benefits to the nation. To achieve this, government proposed new taxation arrangements by introducing Mineral Resource Rent Tax (MRRT). Mineral Resource Rent Tax is a resource tax which taxes profits from mining operations for selected commodities. These commodities include coal, iron ore and certain derivatives of these commodities. MRRT basically applies to all entities that have mining projects. The tax will come to effect from 1st July, 2012 and it will always be calculated for each financial year starting from 1st July every year. Positive Accounting Theory is being applied by companies in order to come up the estimates of liability and tax. Positive accounting theory is used by the mining companies as they seek to explain and predict the effects of MRRT their total income and performance of mining business. Positive accounting theory have been used by the government and mining entities to predict and explain the impact of MRRT in the mining industry and how the tax will be used for development of the nation and mining sector (Deegan, 2009). Liability is calculated by multiplying the mining profit less MRRT allowances using the rate of 30%. An extraction allowance reduces the effective tax rate to 22.5% (Ernst & Young, 2011B). A measure was designed to ensure that small businesses are not burdened and it dictates that a company will have to pay the tax only if its annual profits add up to $75 million. MRRT was formed to replace the Resource Super Profit Tax (RSPT) which had been announced as the initial response to the Australia’s Future Tax System review that is the Henry Tax review. MRRT is similar to Petroleum Resource Rent Tax in concept but it is different in operations. MRRT was supported by the Prime Minister Julia Gillard who made its implementation her first priority (Ernst & Young, 2011B). This paper will evaluate on the impact of MRRT on the accounting policy of mining companies affected by the tax and how the mining entities apply the Positive Accounting Theory in their financial estimates for purpose of determining the amount of tax they should pay. Impact before implementation of MRRT Before implementation of MRRT, the affected tax payers have to perform a number of key measures to ensure that they are ready for MRRT. These measures include; use of PAT to conduct evaluations, modeling to determine and explain impact of the tax on the financial results, examine the impact on financial statements such as profits, cash-flows and balance sheet in order to comply with financial reporting obligations. Tax payers are also to develop a policy for complying with the requirements of the tax and also be ready to verify default installment rates by October 2012 (Ernst & Young, 2011B).The affected tax payers should evaluate systems and processes for capturing, analyzing data and filling profits. Tax payers are to form a lawful and corporate governance appraisal to guarantee that positions taken are invulnerable and companies are able to fund the payments required under tax payment and funding agreements. All these strategies are necessary for identifying the timeliness in which these proceedings need to be undertaken when the key milestones arise. This will ensure that the companies are prepared for the MRRT and its impacts on the accounting policy of the company as it can affect financial statements easily (Ernst & Young, 2011A). Understanding MRRT impact on the financial statements is an important issue to all the affected businesses because it has new issues different from the usual income tax. These key issues include determining the accounting impacts of MRRT that is the tax payers should understand whether MRRT is an income tax pursuant to AASB112 income taxes. The scope of AASB 112 includes MRRT as a tax based on taxable profit (AASB, 2009). The tax payers must also understand that the Australian Accounting Standards Board issued an explanation on 1003 Australian Petroleum Resource Rent Tax in 2007 which confirmed that Australian PRRT is an income tax within the scope of AASB 112 (Ernst & Young, 2011B). The tax payers should therefore understand that interpretation of 1003’s scope is for submission to Australian PRRT and MRRT. This is because the proposed MRRT regimen is modeled on the PRRT regiment and they have important similarities. The MRRT is based on a mining profit that is a net amount rather than a gross amount and thus mining companies should regard it as an income tax pursuant to AASB 112 (AASB, 2009). Starting base The initial impact will be reflected through income tax expense. The companies are also to consider their continuous disclosure obligations that is, whether financial impact should be disclosed to the market. There are many practical tax accounting issues that will affect financial reporting both on transition and ongoing basis. Such issues include measurement of the starting tax base using an appropriate valuation method for MRRT (Ernst & Young, 2011A). The AASB112 requires companies to have determined the tax base of their assets and liabilities at or before reporting date by applying PAT to come up with the estimates (AASB, 2009). This will force the companies to choose a methodology they will adopt for the valuation of the starting base. Once they chose the methodology, they are also required to calculate the starting base in order to be able to measure the transitional deferred tax balances. This is required after substantive enactment. For instance under the MRRT, a company is required to lodge a starting base return to evidence their choice by the first day of the sixth month following the end of their first MRRT year (Ernst & Young, 2011A). If the company has not set a formal starting base, they have to take the appropriate approach method like PAT in determining their transitional MRRT deferred tax balances for reporting purposes. The companies in this case will be required to make an estimate and provide disclosure of their estimates and assumptions depending on the risk of a material adjustment later (Ernst & Young, 2011A). If the bill will be passed immediately, the companies will not have enough time to undertake and finish the work of determining the effect of MRRT and as such the standards require that the companies make the appropriate estimates and disclose any key assumptions but changes on estimates may be made on reporting dates. If the market value starting base methodology is used, the companies should indicate market valuations or other evidence to support an appropriate estimate of value. This is necessary for supporting the starting base and the resultant deferred tax balances at the time of preparing financial statements (KPMG, 2011). Impact on financial accounting policy post MRRT Deferred tax balances When the bill will be passed by both houses of the parliament, the deferred tax accounting for MRRT is expected to be reflected on the companies’ financial statements immediately. They are required to recognize and measure it in their financial statements for that reporting period that is their opening MRRT/PRRT deferred tax asset or deferred tax liability. Transition to MRRT may lead to deferred tax asset if the starting value of the project assets is greater than the accounting carrying value (KPMG, 2011). This can mainly occur if the company chooses to adopt a market value methodology when determining starting base of the project. In such an instance, the company has to consider the general AASB 112 recognition of deferred tax assets after substantive enactment and periodically during reporting dates (AASB, 2009). The company must then put up and maintain comprehensive MRRT models that support their forecasts of the use of the starting base deductions. The company will therefore be forced to use the probability of use of the starting base deductions based on the built MRRT model. The company will further be required to use assumptions in estimating future MRRT taxable income in order to assess the probability of recoupment of the MRRT deferred tax asset as it applies to AASB 136 impairment testing. The MRRT will be considered as an income tax and as a result it would impact on the effective tax rates reported in financial statements and requiring deferred tax accounting (Ernst & Young, 2011B). Volatility of future tax expense On transitions into MRRT, there can be an immediate material impact on tax expense. It is expected that there will also be an increased volatility of tax expense in future years due to the effect of introduction of the MRRT. This can occur if the introduction of MRRT creates a large deferred tax asset (Ernst & Young, 2011B). Therefore changes in estimates of taxable income would require a reassessment of the probability of recovery of recognized and unrecognized deferred tax assets with changes in the deferred tax assets being recognized in the current period’s income tax expense. For instance, assumptions made in the MRRT model such as commodity price and foreign exchange rates may change over time leading to significant volatility in the tax expense of the company (Ernst & Young, 2011A). A change in the underlying assumptions may lead to different deductions leading to future recognition or de-recognition of all or part of MRRT deferred tax asset. Carried forward expenditures and non deductible expenditure for MRRT can also lead to a volatile tax expense. It is therefore important for the companies to develop strategies that can detect and manage volatility of tax and appropriately explain these to their board, audit committee and market. This calls for continuous monitoring and modeling future effective tax rates as well as educating both internal and external stakeholders (IAS, 2011). Treatment of state royalties Currently, state royalties are treated as an operating cost and not an income tax for accounting purposes. Under the proposed MRRT, the tax liability of an entity will be reduced for state royalties and other resource taxes paid. This creates an issue of how such payments should be presented from start of the MRRT in the light of AASB 112. Recognition of royalties can be done by royalties remaining as an expense and included in determining profit before tax and they can also be recognized as an advance payment of MRRT. It is advisable that royalties be treated as an above profit before tax line expense in that, royalty amount has to be converted into a royalty credit in calculating MRRT tax payable (Betkowski & Hankey, 2011). The debate on royalties is being continued and a review panel is responsible for examining the incentives for state to reduce MRRT revenue through increasing state mineral royalties. The panel has so far recommended that MRRT is more efficient than state royalties. State royalties may lead to questioning of how the interaction of royalties and MRRT should be presented in the statement of comprehensive income (KPMG, 2011). Preparation of tax sharing and funding agreements Tax sharing and tax funding agreements specify how group members share and discharge their tax liabilities. Tax consolidated groups manage their tax obligations and liabilities through sharing and tax funding agreements. Many groups have a tax funding accounting policy that directs on how tax expense and tax liabilities are to be allocated for financial reporting purposes. Taxpayer groups subjected to the MRRT will be forced to modify these lawful agreements and the accounting policy in order to clarify how the documents apply to the MRRT liability and tax expense (Ernst & Young, 2011A). Pre-mining losses Mining companies are likely to incur a pre-mining loss if their pre-mining expenses are more than their pre-mining revenue. These losses are carried forward and applied as an allowance. The MRRT bill suggests that pre-mining expenses incurred by a company prior to the company obtaining an interest in an exploration license would not lead to a pre-mining loss. In the context of a deferred delegate arrangement, the current holder may be entitled to pre-mining losses for expenditure incurred by another party. The exploration expenditure will not affect the other entity but in the case of a subcontract, the other entity may as well share the pre-mining losses once they acquire an interest in the project (Novak & Moran, 2011). Starting base adjustments Companies holding mining project interests as from 1st May 2010 will benefit from starting base allowances. This will be calculated by the reference to the value of starting base assets at 1st May 2010 and will be sum of the declines in value of the starting base assets. A company will be able to choose to use either the market value approach or the book value approach for determining the value of the starting base assets. The starting base losses are not transferable (Novak & Moran, 2011). The MRRT bill states that where the market value approach is chosen, mining project interests, mining information, goodwill and improvements to land on the mining project interest are to be treated as single starting base asset. It also states that the value of improvements of land at 1st May, 2010 is to be included in the starting base of the single starting base asset even when they are destroyed before 1 July 2012 (Ernst & Young, 2011B). The mining company will also be required to complete a starting base return to make a valid starting base valuation approach. The MRRT bills clarifies that dealings in starting base assets or changes in the use of starting base assets other than in connection with the disposal of an interest in a mining project interest can result to adjustments to the starting base allowance and potentially mining revenue. Mining companies disagrees with this and question why other improvements such as benches, berms and batters are not treated separately that is, they question why any improvements to land should not be treated separately if the company is able and willing to value them (Novak & Moran, 2011). Anti-avoidance Before introduction of MRRT, companies were following anti-avoidance rules for income tax which required a sole or dominant purpose of obtaining a tax benefit. With the introduction of MRRT, the threshold for application of general integrity requires more than incidental purpose of obtaining an MRRT benefit. Unlike before the draft legislation now includes general integrity provisions which allow the commission to deny the MRRT benefits where a project is entered into for the purpose of obtaining these benefits. The anti-profit shifting rules ensure that companies MRRT liability is not smaller than what it would have been if the company and other stakeholders were dealing wholly independently with one another (Betkowski & Hankey, 2011). Derivation of mining revenue The MRRT draft legislation requires the use of an effective netback method to arrive at the amount of mining revenue at the taxing point. Mining revenue is calculated as the consideration received in relation to the mining revenue event minus the expenses paid for the provision of downstream operations (Novak & Moran, 2011). The legislation requires the company to compare the expenses that it would incur while it provide its own downstream services and while it hires another company to provide the services making assumptions that the other company was a separate and distinct entity. The miner should also assume that the other entity was to provide the operations as a service and that there was a competitive market for those services. The miner should assume that cost of providing services was sufficient to meet the costs of that entity plus a profit on the actual investment and also compensation for the risks involved. MRRT rules that the miner and the other company should deal separately and at arm’s length in relation to the provision of those services. The problem is that the mining companies are likely to find that such provisions are too prescriptive and unnecessary when aligned with the concept of determining a true arm’s length value of the resource at the taxing point (Novak & Moran, 2011). MRRT installments The draft requires that the MRRT installments rate to be applied to the gross final sales revenue received that is, free on board price instead of mining revenue calculated at the earlier taxing point. Default installment rates are stated in the legislation to be 8% for the iron ore and 3% for core (Hooke, 2011). This is to be valid until the mining company chooses to vary the installment rate or a new installment rate is introduced by the commissioner. These rates are based on assumption that the mining company’s profit will be equal to 35.6% of the gross final sales revenue for iron ore and 13.3% for coal. Companies consider these assumptions to be high considering that this is after the deduction for grossed up royalties. Companies can however vary these rates but it is risky because an interest charge of 11.9% will be functional if the rate chosen is too low (Betkowski & Hankey, 2011). Impact on impairment of calculations The changes on income tax may have impacts on recoverable amount calculations and specifically MRRT may require adjustments to forecast cash, directly or through determining the pre-tax discount rate. The repayment of state royalties may impact cash flows as well as risk premiums and other market based factors may be impacted because of the proposed changes (IAS, 2011). MRRT tax laws are still undergoing changes and therefore it is important for mining companies to keep monitoring changes to ensure that the financial reporting are adequately considered. Continuous disclosure is also important for accounting approaches are varied. Investment allowance accounting is still unclear because investment tax credit is not included in the scope of AASB 112 income taxes (Hooke, 2011). Also there are different views on how to account for the impacts of benefit but the main approaches is to treat it as a tax benefit in income tax expense or treat it as a form of government grant that is matched against existing assets. The ongoing changes in legislation makes it difficult for accounting because some entities may have used principles of the new legislation in the past. Other companies may have applied other interpretations and this means that the financial reports needs prior adjustments in the income tax reconciliation as the variations may be reflected in the income tax expense once legislation is enacted. The proposed disclosure of tax positions by larger entities when preparing their tax returns may have financial reporting considerations (Betkowski & Hankey, 2011). Conclusion Mineral Resource Rent Tax is a resource tax which taxes profits from mining operations for selected commodities. These commodities include coal, iron ore and certain derivatives of these commodities. MRRT basically applies to all entities that have mining projects. Before implementation of MRRT, the affected tax payers have to perform a number of key measures to ensure that they are ready for MRRT. Understanding MRRT impact on the financial statements is an important issue to all the affected businesses because it has new issues different from the usual income tax. The government and mining entities have applied PAT in explain and predicting the effects of MRRT on the mining sector and nation. The tax payers should understand whether MRRT is an income tax pursuant to AASB112 income taxes. The changes on income tax may have impacts on recoverable amount calculations. The ongoing changes in legislation makes it difficult for accounting policy because some entities may have used principles of the new legislation in the past. Other companies may have applied other interpretations and this means that the financial reports needs prior adjustments in the income tax reconciliation as the variations may be reflected in the income tax expense once legislation is enacted. Bibliography Betkowski, F. & Hankey, D., 2011, Accounting alert 2011/04 - Financial reporting impacts of recent and proposed tax changes, retrieved on 11th April 2012 from http://www.deloitte.com/view/en_AU/au/services/assurance/accountingtechnical/accountingalerts/5d6592f842030310VgnVCM2000001b56f00aRCRD.htm. Novak, J. & Moran A., 2011, Submission to inquiry into the Mineral Resource Rent Tax Bill 2011 and related bills, Institute of public affairs. 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