Petroleum Resource Rent Tax In Australia – Accounting And Ethical Issues

Approach to the Research Project

Discuss about the Petroleum Resource Rent Tax In Australia.

There has been a tax sink hole as the gas multinational fuel companies that exploit LNG in Australia have claimed fifty billion dollars more in relief in one year (Aston, 2017).  By building up an additional $51 billion in tax in credits, these MNCs have further delayed any reasonable royalty payment from the enormous export industry in Australia. This means that these energy giants evade payment of their share of tax unethically. This is because the Australian Tax Office submitted a review of the PRRT to Treasurer Scott Morrison that demonstrated that the combined tax credits/carry forward expenditure of the LNG industry surged to $238 billion in the trading period 2015-16, having shot up by $51 billion from $187 billion the past year. This was equivalent to $138 million per day increase over twelve months.

The MNCs have taken a relief in the industry’s war chest of the tax credits thereby unethically shielding themselves (Chevron, and Shell) from any meaningful PRRT’s contribution in its lifetime. This is quite shocking since PRRT is the solely royalty-kind payment that the big LNG projects  such as Chevron-, Shell- and Exxon-owned Gorgon must pay in exchange of the billions of dollars in Australian gas extracted and exported to Asia by these MNCs. Thus, evading this tax unethically by failing to disclose information as required is indeed shocking and deprives Australia of the huge dollars in terms of royalty that in fact rightfully belongs to its economy (Smith, 2013).

The LNG MNCs solely declared taxable profits of 2.10 billion dollars in the trading year 2015-16. The PRRT stood at forty percent of the taxable profit subsequent to deductible capital alongside exploration expenditure written off against the assessable receipts. Due to the high “uplift rates” for the deductions compounding over life of projects, certain gas projects might never pay PRRT. There is a need for future projects to evade “extremely high uplift rates” for carrying forward such deductions into the future years where profits are stronger since currently, these rates are as high as long-term bond rate in addition to 15% points (Aston, 2017).  It is against this backdrop that this paper seeks to probe and present a detailed critical evaluation of the accounting and ethical issues referred to in the Aston (2017) article based on two perspective in relation to Petroleum Rent Tax (PRRT). The evaluation undertakes a comprehensive comparison of the insights from each theory (perspective) and outlines the different impacts on the preparers, users, regulators and the public.

Analysis and Theoretical/Conceptual Application

To critically evaluate and submit a comprehensive evaluation report on the accounting and ethical issues referred to by Heath (2007), this paper uses two theories (progressive income tax theory and regressive income tax theory) with respect to PRRT. The evaluation is anchored on a detailed comparison of the insights from each of above income tax theories and highlighting the different impacts of such insights on the financial statement preparers, users, regulators and the public (Mintz & Chen, 2012). The paper undertakes a systematic critical review of the articles relating to the above two opposing income tax theories and the AASB 112 Income Taxes to understand the interpretation of the Australian PRRT. This follows the appreciation that the RRRT can only be interpreted within the scope of Accounting Standards AASB 112 Income Taxes.

The interpretation 1003 of the Australian PRRT will help in understanding both accounting and ethical issues highlighted by Heath (2007). Both Accounting Standard AASB 112 Income Taxes and Accounting Standard AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors will form key references in this evaluation. The PRRT Assessment Act 1987 will also help in understanding the calculations of the taxable profits. Thus, Australian PRRT will be interpreted in this report as an income tax within AASB 112 scope and hence the MNCs must recognize, measure and present it in accordance with AASB 112. This interpretation will thus apply to: each firm which is required to prepare financial reports in accordance with Part 2M.3 of the Corporation Act 2001 and which is a reporting entry. It will also be applicable to the general purpose financial statement of each other reporting firm; and applies to all financial statement which are, or are held out to be, general purpose financial statements.       

From the Heath (2017), following accounting and ethical issues come out clear. First, in determining the Australian PPRT taxable profit, it is clear that the MNCS did not adhere to the AASB 112 requirements that dictate that PRRT be assessed based on petroleum projects, and subsequently levied at the rate of forty percent on “taxable profit” of the project. The MNCs did not calculate the taxable profit for the PRRT purposes as the excess of assessable receipts over sum of; (a) the eligible spending incurred, (b) un-deducted/carried forward spending which are compounded yearly at the uplift rate constituting the long-run bond rate plus fifteen percent for exploration spending or in addition to five percent for project operating and development expenditure; and (c) un-deducted exploration spending which is compounded at uplift rate which is transferred from other projects the taxpayer is involved in or, where the taxpayer is a company in a wholly-possessed group, from additional projects within group.

Theoretical/Conceptual Application

The MNCs did not adhere to the provision that requires such non-deductible expenditures as private override royalty payments and income tax. Also, the MNCs did not adhere to the requirements that PRRT be paid in quarterly installments. The requirements for the PRRT payments as deductibles were not adhered to during the determination of taxable income within the confinement of Income Tax Assessment Act 1997. The MNCs unethically failed to apply all the requirements of the AASB 112 that are all applicable to Australian PRRT including such requirements linked to definition, recognition, measurement, presentation, as well as disclosure of the current alongside deferred tax associated with Australian PRRT (Kraal, 2016). This is why the MNCs also reported a mere 2.1 billion dollars as the taxable profit in the disguise of information asymmetry between them and the government, public, users and regulators to deprive the country payment of the correct royalty.

PRRT is the profit-oriented tax levied on petroleum project and has been subsequently applied from 2012, 1 July to include all Australian onshore as well as offshore oil alongside gas projects including the oil shale and coal seam gas projects of the North West Shelf. The PRRT history is traced from the enabling legislation, the PRRT Assessment Act 1987. The parliament passed the Act and became effective on January 15, 1988. PRRT applied to all offshore areas with exemption of Bass Strait and North West Shelf at that time. PRRT has gone through various amendment since introduction starting 1991 through July 1, 2012 when it was extended to onshore oil as well as gas projects including oil shale projects, coal seam gas projects of North West Shelf came into effect. 

From the above two opposing theories of income tax, it is clear that Australian is using a regressive tax approach that does not effectively capture the income tax (PRRT) as would otherwise be captured by progressive taxation. The resource rent is classically defined as the excess of total project lifetime value emerging from a deposit exploitation over sum of all costs of exploiting the resource including compensation of all factor inputs.

The principle underlying the PRRT is to solely tax the rent and leave alone the investor’s required return to carry out the investment. In principle, however, this should never distort the decisions of investment, in so far as it need not change the pre-tax merits of the investment. In this regard, PRRT remains a neutral tax that can only be captured by progressive taxation. Based on the resource rent definition, a decline in risk linked to investor’s investment would, ipso facto, decrease the investor’s minimum required return to carry out the investment hence surging the potential of resource rent of the deposit.

The resource rent taxation remains very topical and has enormously featured in deliberations of the resource tax policy in the 1970s. The renewed interest in resource rent taxation is the discourse over how best to share the spoils of recent extractive industries boom as the regressive taxation theorists have failed miserably in term of PRRT capture.  Sharing of such spoils remains often marred with brinkmanship between the host economies and the industry, leading to a skyrocketed uncertainty and feasible limitations on investments in these resources in the longer run. The challenge that has to be addressed by the fiscal policy relates to the optimization of revenue from such heterogeneous resource endowment amidst the economic uncertainty without resorting to brinkmanship which always result from regressive income tax theory application to PRRT due to its fiscal rigidities.

The fiscal flexibilities and employment of progressive taxes, avail a more orderly as well as predictable footing for effective-re-allocation of benefits between the host economy and the industry when economic conditions alter. The progressive taxations targeting resource rent must maximize the revenue from the resource by optimizing resource exploitation in general as well as optimizing rent available from each resource project.  Various taxes have already been designed targeting resource rent capture with a range of extent of accuracy. The PRRT takes the case of a more accurate progressive taxes in relation to resource rent capture.

The host country, Australia in the present case, has to balance such advantages against the fiscal risks linked with various kinds of taxes and resources required to guarantee effective PRRT administrations. Experience indicates that pure regressive PRRT could impose an unacceptable degree of fiscal risk on Australia-at best PRRT has been merged with other promising progressive tax instruments. The emerging issues in PRRT application that cannot be effectively addressed by regressive taxation theorists include; can the required rate of return by the investor be arrived at reliably; what proportion of PRRT should be taxed; how should the government set the tax threshold and tax rates; will PRRT be creditable?

PRRT further has a reputation for administrative complexities that could weigh against it when regressive taxation is used. A progressive PRRT is one amongst many available instruments for capturing resource rent. The effectiveness of PRRT relies on the revenue potential, fiscal risk as well as administrative costs linked to PRRT use. The advantage that progressive PRRT has over regressive as well as unsustainable fiscal regimes remains the ability to evade damaging brinkmanship.

Discussion and Conclusions

The experience of several host government with inclusion of Australian government in the latest periods has been that as MNCs earnings have substantially and dramatically grown, the Australian own revenue from these extractive MNCs industries has lagged well behind as well as declined as a percentage of general profitability (a declined fiscal “take”). The reason behind this, at least partially, is the Common features of such fiscal regimes designed during the 1980s and 1990s that were mainly regressive tax-based. Such Common features of fiscal regimes had included the low royalties as well as flat rate income taxation merged with generous allowances-investment uplifts and accelerated depreciation (Kraal, 2016). These governments have as well as offered tax holidays in depths of depression in mining sector, supported by agreements stabilization. In oil industry, volume prevalence instead of profit-oriented production sharing together with generous provision for cost recovery to entice investors, encompassed restrained government sharing in any escalation in price.

These agreements have remained unsuitable to the altered economic conditions of the contemporary Australia. Australian government is aware that windfall taxes are currently on political agenda and hence their introduction would capture profits otherwise, an outcome which would be particularly difficult to accept. Given this backdrop, several host economies have been attempting to regressively tax windfalls of incumbents and imposing stringent entry terms for the new entrants. This has, however, been coupled with rising nationalization and deprival of direct access by private sector to valuable petroleum deposits. The Australian government and extractive MNCs or extractive industries must re-allocate benefits between them in absence of brinkmanship by adopting the progressive PRRT (Kraal, 2013). After all, variable rent potential alongside commodity price volatility have been known phenomena for a number years. What could the solutions be to this challenge?

One can argue that better foresight anchored on regressive taxation would be panacea so that fiscal terms might be better tailored to technical as well as economic circumstances which shall prevail in the course of lifetime of resource project. In essence, this is what the Australian government and MNCs investors have attempted in particular project negotiation over the fiscal terms. Nevertheless, experience suggests that any such attempts of forecasting the complete array of feasible economic outcomes over a project lifetime remain fallible (Siu, Picciotto, Mintz & Sawyerr, 2015). The Australia is often disadvantaged due to information asymmetry between the government and these MNCs in terms disclosure of taxable profits hence the outcome of dependence on forecasts is probably either in favor of MNCs or barring parties from arriving at a consensus.

The fiscal flexibility need to be built into design of the fiscal regime up front in order that financial benefits are re-allocated on the agreed footing if and when the economic conditions alter. This will be favorable for both host economy and the MNCs and would bar the accounting and the ethical issues that have been recognized above including failure by MNCs to fully disclose the useful financial information on their profits as well as intentional delays of royalty payments. The government of Australia can provide this fiscal flexibility via the progressive taxation upon which the share of overall benefits are re-allocated progressively in favor of Australia as the host economy as the general value of benefits surges.

Unfortunately, Australian government is still using a regressive fiscal regime which has allowed the MNCs to tax credits or carry forwards which is hurting the populace since there is no royalty payment at the moment despite by MNCs despite the doubling in MNCs’ profits but halved revenue to the government since 2013 (Kraal, 2012). The progressive taxation must, in principle, maximize the PRRT potential both by surging the resource deposits quantity exploited and uplifting rent availability from each. To control the above accounting and ethical issues or loopholes used by MNCs by manipulating the PRRT and subsequently evading through carry forwards and tax credits, the Australian government should never employ a tax framework whereby the tax rates surges as the function of the price only. The progressive ad-volorem taxation can be integrated since it has been successfully used in Qatar to bar MNCs from manipulating the PRRT.    

The price-oriented royalty/windfall PRRT ensure that movements of prices remain normally linked to alterations in profitability (Clausing & Durst, 2015). This framework disregards the impacts of alterations in cost and output on profitability. There can be a surge in price, however, where unit costs have as well as surged, the generated profits on the pre-tax footing could have stood unchanged or declined and yet tax would still be payable at the hiked rate. Such an approach remains an inaccurate method of capturing resource rent that will culminate in distortion (Kraal & Yapa, 2012). The government of Australian should accurately capture this resource rent by making the tax rates a function of the actually achieved profitability but ensure that there is full disclosure on the part of the MNCs.

The Australian government need to use the most accurate method for capturing resource rent by directly linking tax rates to return on investment accomplished by the MNCs. In this regard, the government should adopts the Timo Leste’s Supplemental Petroleum Tax which is typical progressive resource rent tax. In this structure, the tax base denotes the resource project; the threshold rate of return on investment (16.5%) at which the PRRT would be applicable; and a specified rate (22.5%) is applicable to net profits.  

Preparers: the use of ineffective regressive taxation theory by Australian government on PRRT has enabled them to manipulate PRRT through failure to disclose useful financial information on taxable profits and hence benefit their MNCs employers through failing to pay royalties via carry forwards and tax credits. Users; the users of financial information from these MNC have been shortchanged due to failure by the MNCs to disclose the useful financial information on their taxable profits by failing to comply with the AASB 112. Regulators: The regulators have been dealt a blow due to the information asymmetry between them and the MNCs leading to regulatory capture whereby the MNCs have captured the state through their PRRT manipulative actions like carry forwards and tax credits. Public:  The have been shortchanged due to failure by the MNCs to delay the payment of their royalties as they capture and manipulate the regulators.    

Conclusion

The identified accounting issues and ethical issues through the MNCs manipulation of the PRRT needs urgent attention. The government of Australia should change from regressive taxation to progressive taxation including the use of such alternative taxation as ad-volorem to help maximize the revenue while not hampering/distorting the investments by MNCs.

References

Aston, H. (February 13 2017). Tax sink hole: Gas multinationals claim $50 billion more in relief credits in a year . The Sydney Morning Herald, 1-2. https://www.smh.com.au/federal-politics/political-news/tax-sink-hole-gas-multinationals-claim-50-billion-more-in-relief-credits-in-a-year-20170213-gubmfv.html

Clausing, K. A., & Durst, M. C. (2015). A Price-Based Royalty Tax?.

Kraal, D. (2012). Australia’s Resource Rent Tax: The Multi-National Mining Industry Response.

Kraal, D. (2013). A grounded theory approach to the minerals resource rent tax. Austl. Tax F., 28, 841.

Kraal, D. (2016). Australia’s petroleum resource rent tax: Paul Keating, Peter Walsh and other game changers. Griffith Law Review, 25(4), 492-524.

Kraal, D. (2016). The Petroleum Resource Rent Tax: Overview of primary documents and literature leading to the 1987 legislation. Browser Download This Paper.

Kraal, D., & Yapa, P. S. (2012). Resource rent taxes: the politics of legislation.

Mintz, J., & Chen, D. (2012). Capturing economic rents from resources through royalties and taxes.

Siu, E. D., Picciotto, S., Mintz, J., & Sawyerr, A. (2015). Unitary Taxation in the Extractive Industry Sector.

Smith, J. L. (2013). Issues in extractive resource taxation: A review of research methods and models. Resources Policy, 38(3), 320-331.