Mineral Resource Rent Tax - Literature review Example

Mineral Resource Rent Tax Name Institution Mineral Resource Rent Tax Introduction Mineral resource rent tax (MRRT), is a proposed tax that will be imposed on mineral extracting companies in Australia from July 2012. It is intended to tax super normal profits for companies that record profit margins of above $ 50million. This paper evaluated the effects likely to occur in the accounting policies of Australia when the tax is introduced. He paper reviews literature on the nature of accounting policies and the likely changes prior to introduction of MRRT and after its introduction. Further, the paper reviews provisions stated in the act of parliament about the tax and the likely changes in the Australian accounting standards. In addition, critical review of this information is described, in view of likely changes in policies. Literature Review The Australian government through an act of parliament proposed the mineral resource rent tax. Its object is to provide returns to the community for valuable non-renewable mineral resources from which, mineral companies make heavy profits (Minerals Resource Rent Tax Act, 2012). The tax is charged on profits for mineral companies making above $50 million per annum (press office, 2010). It is intended to increase superannuation for employees hence increasing retirement savings and improve infrastructure such as roads and bridges especially in the mining areas. It will also provide a tax break for small businesses (press office, 2011). Minerals Resource Rent Tax (MRRT) replaced the proposed Resource Super Profits Tax (RSPT). Mining industry in Western Australia accounts for 24% of Gross State Product, contributing to 7% of employment in Australia. Mineral industry supports the national economy of Australia. The proposed tax will be calculated on the profits of the industries. The profit margin is calculated by deducting expenditure from revenue. MRRT is calculated on this result on an annual basis. Where the difference is zero or negative, MMRT is zero. This is from taxable resources obtained from a project area. In addition, the mining company is entitled to an MRRT offset if profits for the year are below $100 million. If profit goes to $50 million or below no MRRT is charged for the year. MRRT liability is reduced by the amount paid as royalty to the commonwealth, state and territories. Royalty allowances are calculated by grossing- up loyalty using MRRT rate. Royalty credits can be uplifted to be used in later years or in other mining projects (Treasury, 2011). While selecting the accounting policies to use, there are guidelines that govern this selection. The policies should comply with Australian Accounting Standards. Where absent, or in case of deviation from these standards, accounting policies should be relevant in making decisions and relevant. Relevance means they should faithfully reflect financial position of an entity, are unbiased, reflects the economic substance of an entity and are complete (Australian Accounting Standards Board, 2011). Changes in the standards occur if the board requires it or if the changes results to better quality of financial statements reflecting financial position, cash flow or performance (Australian Accounting Standards Board, 2011). The government gives grants to companies to carry out activities, which it would not have carried out. Such grants are regarded as profits or losses over a period which the entity regards as equal to the expense the grant covered for. Government grants are accounted for in two methods. As capital grants, they are considered outside profit and loss while as income grants, they are included in profit and loss (Australian Accounting Standards Board, 2011). Either grants, which are not attached to future costs, granted to compensate for a loss or financial support is included in profit and losses for the period they are received. While presenting government grants in financial statements, they are either treated as differed income recognized as profit or loss or on systematic basis over the lifetime of an asset. The grant may also be calculated on depreciation of an asset and included in profit and loss (Australian Accounting Standards Board, 2011). A repayable government grant is accounted for as a change in estimates. As an asset, the carrying amount is increased or the repayable amount reduced on the differed income balance (Australian Accounting Standards Board, 2011). In financial statements, grants and the method of presentation are disclosed. Imposing this extra tax on mineral companies’ profit margins will affect choice of accounting policies. Accounting policies are the rules or principle applied in developing financial statements. Different accounting policies give different information leading to different conclusions on capital market and development. Accounting policies used in are in accordance with requirements stated in Australian accounting standards (International Actuarial Association, 2005). Information of a company is disclosed using financial statements, internet sites, management discussions, foot notes, financial analysts and financial press among others. Demand for disclosure arises from demand by outside investors. Information problem arises when there is conflict of interest in between investors and entrepreneurs. However, this conflict is solved by contracts between the two parties and the management to disclose private information. A second arising from information disclosure is agency problem. It arises because investors are not active in the business. Decisions on how to use investments are left to the entrepreneur. The problem is more pronounced in high risk investments. Solutions to agency problem include signing compensatory contracts and aligning the interests of all parties involved. In addition, a board of directors monitors activities of the management and intermediaries who monitor private information of the management to ensure they do not misappropriate funds. Success of these measures is tagged to ability to write comprehensive contracts and nature of corporate control market (Healy, 2000). A regulating body in every country governs disclosure of financial information. Potential investors free of charge use this information. Accounting policies regulating presentation of accounting information are intended to be cost effective, communicating information that can be understood by both the investors and the managers. Regulating accounting standards provide relevant information to investors. This information however should not just be what investors already know but should reflect other relevant developments. Accounting standards should also be accommodative of information relevant to both the stakeholders and the investors. Harley (2000) concurs that there are no international standards set for presentation of financial information. While examining the effect economic consequences and shareholder wealth has on accounting policies, it was found out that, some accounting methods impact heavily on stock prices. The latter however does not affect accounting policies. Additionally, changes in accounting methods are not related to stock returns at the time of change. Though accounting methods do not affect stock prices, this is contrary to oil and gas industry, where significant changes in stock prices are experienced with change in accounting policies. Changes in accounting policies take a long time to fully be effected and thus it is difficult to determine their effect on stock market. In addition, it is not easy to tell when inventors know about the changes (Healy, 2000). Changes in financial policies may also be affected by globalization. Investments are currently global with the best performing companies being targeted by investors worldwide. As international investors set in, policies may be required to change to accommodate them. Accounting standards therefore have to change to accommodate modern changes in the investment sector (Healy, 2000). Audit firms and financial analysts are fast changing form being independent to consulting with managers. This change may lead to changes in accounting policies but do not affect credibility of reports. Accounting policies are also challenged for failure to accommodate complexities experienced by interrelated industries. An example is Coca-Cola and the bottling companies. In addition, Accounting policies are behind technology. They do not reflect economic implications of internet, technology and computers in financial statements. Use of wireless communication, the internet makes communication between investors and intermediaries easy. Conference calls reveal company information to finance analysts. Information about the company may be update on the internet at regular basis keeping the concerned parties at par with the company (Healy, 2000). With the internet, most financial information of a company is revealed, for example the stock market, press release and performance reviews. This in turn reduces demand for voluntary disclosures. Creative Accounting Creative accounting is a process of presentation of accounting records to reflect expected results rather than actual records. This is done by manipulating results, misrepresenting information and deceit (Amat, 1999). Creative accounting involves choosing the accounting policy that gives a colorful image of a company. Policies may allow companies to select between accounting policies, for example writing off development expenditure (Amat, 1999). In addition, provisions such as depreciation rates are estimations made within the business. There are no standards defining such estimation levels. They can there be used as opportunities to produce optimistic reports without violating Accounts standards rules and regulations. Where an outside estimator is higher to make such estimates, the estimator may be advised accordingly or chosen depending on how known they are in making such estimates (Amat, 1999). Manipulating the balance sheet is also possible with creative accounting. This is possible if a company enters into artificial transactions with a bank, where they “sell a property to a bank, then lease it back. The lease figure can be set at a figure deemed to produce desired financial statements. Creative accounting is also possible by timing genuine transactions. To control creative accounting, measures out to be taken to minimize accounting options. For example, reduce choices of accounting methods and attaching conditions to available choices may regulate the extent to which companies use creating accounting. In addition, accounting methods, which are realistic, should be provided for use. Consistency in the method used may provide more realistic results as one method may produce optimistic result s in one period and fail in another (Amat, 1999). Controlling estimates of for example depreciation rates can be controlled by regulating estimations, or ensuring consistency in estimation used. Auditing provisions should also accommodate identification of faulty estimates. To curb plastic transactions, the economic substance value may be used instead of the legal form. In addition, timing of genuine transactions may be dealt with by demanding regular reports. For example, producing financial reports within a stipulated time if the year. Transactions may not always be favored by the time selected (Amat, 1999). Creative accounting is preferred by companies so as to produce consistent results. Instead of reporting fluctuations in profit and losses, the method in used as a regulator of these fluctuations. In case of high profit margins, investors may gain false hope in the company, which may later be diluted by low profit margins. It reduces short-term judgment of a company’s performance. Where a company is making losses, the method can be used to increases the losses so that future years give a better reflection (Amat, 1999). Those against this method argue that investors have a right to know about instability in a company. In addition, the method may hide profit trends in the long-term. Income smoothing is used to match profit forecasts with the reality. High profits in one year are used to cover up for possible slips in the following years. It also boosts share price for a company be reducing levels of borrowing and maintaining a smooth trend. Creative accounting can easily be noted by auditors and is at times translated to a weakness of the company (Amat, 1999). Analysis From the interpretation of available information on the tax, MRRT may be classified as income tax or royalty. Royalty arises from the company being allowed to use valuable non-renewable natural resources. Royalty is considered as a production cost. As an income tax, MRRT may trigger tax deferment accounting which makes tax deductibility a complex process. The minimum taxable profit of $50 million may trigger changes in accounting methods so that a company that do not necessarily make huge profits remains with profit margins below the stipulated amounts. However, as loyalty, this threshold may not affect accounting policies of a company. As an income tax, MMRT may not be obtained throughout a mine’s lifetime. This is because; existing projects use market value to transit to MRRT. In addition, there may be carried forward MMRT losses and timing of revenues and costs. This tax is imposed to “supper high profits” and is dependent on the current market prices, operating costs and capital among others. This may in some situations lead to either no payable MRRT or inconsistency in the annual amount payable. Profit margins are not annually guaranteed. The tax is calculated on net profit and not accounting profits. It is therefore not directly related to accounting profits. The current Australian accounting standards do not have an enactment policy. The enactment bill has not been tabled in parliament; hence, affected entities are not liable to account for impacts of MMRT. Therefore, before MMRT takes root, the parliament has to pass an enactment bill. Introduction of MMRT, affects the accounting policies. For example, it is recognized as a “change in tax status”, it would affect market value uplift and it recognized by the government as a grant or tax holiday, would affect normal accounting. Changes would have to occur in the current Australian accounting standards to accommodate and define MMRT. other changes in accounting policies will define whether loyalty offsets against MMRT liabilities are a government grant or not and whether it should be accounted for as part of income tax or not. Questions of how to treat unclaimed tax loyalties and impacts of loyalties should be addressed in the policies. Changes in uplift allowances are also expected to occur. Uplifts based on CPI or over a margin interest rates occur on items carried forward. Whether or not such uplifts are considered on differed tax accounting, affect the tax rate or are government grants in case MRRT is a tax on profits should be addressed. AASB requires disclosure of information regarding future expectations of liabilities and assets. If this requirement applies to MMRT, information on how is has been accounted for in financial records should be disclosed. In view of presentation of financial information, the current standards will revamp to accommodate the new tax. Testing of financial reports accommodating this new tax should be done to derive the best means of presentation. The accounting standards will be review so that provisions for MRRT are inclusive. In addition, communication of the changes to the affected stakeholders will take place. Policies used by intermediaries for example auditors will change to accommodate the new changes. There may be need for training programs to the auditors. Change in accounting policies that may be introduced due to MRRT, are not expected to change the price of the stock market of the affected industries. With the current changes of technology, information on MRRT is available in the internet sites. This information lacks completeness because the accounting standards do not stipulate changes to accommodate it in its policies. A change of these policies in internet sites is expected. Communication of the tax to relevant stakeholders is most likely to be done via internet. Therefore, changes in accounting records reflecting communication expenses are expected. Introduction of MRRT on mineral resource companies may lead to fluctuation of profit margins. Prior to effecting this tax, companies may engage in creating accounting, as an inside technique to cover up for expected fluctuation. In addition, this tax will be imposed on profits; creating accounting may be used as a method of smoothing up accounts due to changes caused by MRRT. The method may also be applied to control market share value for these companies, which will also be most likely affected. Application of creative accounting by these companies will give them an upper hand in maintaining share value stable. These companies have high investment potential which may be affected in case profit margins decline. In addition, policies within accounting standards are expected to change to accommodate for possible changes in accounting methods to either accommodate creative accounting or control its use. Imposing an extra tax on the profits is likely to affect wealth levels of shareholders to a small extent. Though this may not affect stock market immediately, it will be affected in the future. Stock market trends may stagnate or decrease depending on the effect of this tax. In addition, the annual system of taxation is likely to produce fluctuating figures of profits. Creative accounting may control these fluctuations. In addition, taxing on annual basis may be a disadvantage to companies that regulate their profit margins using creative accounting methods as multiple taxation will occur of profits reflected in future years. Therefore, a policy change in accounting systems is expected for such companies. To accommodate the changes within the affected systems, a lot of discussion and consultation between the government, companies and affected stakeholders in expected. Revamp in accounting policies is expected to take place to that all provisions are accommodated. These negotiations and changes are expected to take a longer period, thus may not directly impact heavily on the stock exchange value of shares. Conclusions Introducing MRRT tax to ore producing companies comes along wit changes in accounting policies. There is need to define the kind of tax and taxation formula for it. That is, is it an income tax or royalty tax? In addition, the government will be required to work on the enactment bill so that all provisions for this tax are clearly stipulated. Disclosure of information regarding MRRT is sensitive regarding to the conclusions likely to be derived. Thus there is need to control information reflected on financial statements regarding profit margins of the company. Changes in accounting policies are also deemed to occur to control expected fluctuations. These fluctuations are most likely to emerge from the annual taxation basis. Therefore, a method that may smooth out these fluctuations may be used. One of these methods is creative accounting. Where this method is already in use, policies within a company may change to avoid situations where profits are charged for multiple times. In addition, companies whose profit margin is close to $50 million, are expected to change their accounting policies to that profits remain below threshold. Failure to this, these companies may be affected by the extra tax heavily. With introduction of an extra tax, changes are deemed to occur both within company polices and accounting standard to accommodate the changes. Stipulated changes will be as a result of negotiations and agreement between the government and affected parties. REFERENCES Minerals Resource Rent Tax Act 2012 No. 13, 2012 An Act about a minerals resource rent tax, and for related purposes Press office, 2 July 2010 Breakthrough Agreement with Industry on Improvements to Resources Taxation, retrieved on 2nd may 2012 from http://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2011/065.htm&pageID=003&min=wms&Year=&DocType= Press office, 2nd November 2011, Locking in the Benefits of the Mining Boom retrieved on 2nd may 2012 from http://www.treasurer.gov.au/DisplayDocs.aspx?doc=pressreleases/2011/134.htm&pageID=003&min=wms&Year=&DocType= International Actuarial Association Published 16 June 2005Changes in Accounting Policies under International Financial Reporting Standards IFRS [2005] Ottawa, Ontario Canada (Treasury), 2011 Minerals Resource Rent Tax Bill 2011 No.      , 2011 Australian Accounting Standards Board,(2011).Accounting Policies, Changes in Accounting Estimates and Errors, 2011 Australian government Healy Paul et al,2000 Information asymmetry, corporate disclosure, and the capital markets: a review of the empirical disclosure literature Journal of Accounting and Economics 31 (2001) 405–440 Amat Oriol (1999), The Ethics of Creative Accounting Economics Working Paper Journal of Economic Literature classification: M41 Read More