TAX NEWS - JUNE 2010

Australia Tax: Future Fund chairman David Murray talks

Future Fund chairman David Murray tells Business Spectator's Alan Kohler and Stephen Bartholomeusz:

- The proposed resource rent tax needs to be amended or abandoned
- The tax needs to find a balance between recurrent spending and long-term wealth creation
- With sovereign risk back in the picture the tax couldn't have come a worst time
- The acrimonious debate between government and the miners gives foreign investors a bad impression
- Telstra and the government need to resolve their differences on the NBN, to provide shareholders with a modicum of certainty.


Alan Kohler: Well David, perhaps we can start by asking you your view of the RSPT, the resource super profits tax?

David Murray: You're probably aware that I made an address at the Australian Papua New Guinea (PNG) Conference in Townsville recently because PNG is going through the process of designing a wealth fund to deal with its oil and gas dividends, taxes and royalties and trying to determine how much should be spent today, essentially, and how much put aside for tomorrow. And you know going through that issue in the context of PNG really makes one consider the pros and cons of this tax regime in Australia. I think the discussion has to be divided into two parts. One is the application of the tax to existing projects and the sovereign risk concerns that the tax brings for Australia, and secondly the design of the tax around the Australian Constitution and the source and flow of funds, whether they're used for long- term purposes or short-term purposes.

Stephen Bartholomeusz: David, there's a presumption there that there should be a super tax on mining profits.

DM: No, not necessarily. You've got to remember in Australia that states own their land, the resources under the land and have the right to collect royalties on those resources. The Commonwealth has the taxing power and has ownership of its territories and resources outside the coastline. But the Commonwealth has already imposed royalties and the Petroleum Resource Rent Tax (PRRT). The issue here is that the states are not in a very good position to set aside their royalties for longer-term purposes. If the Commonwealth wants to impose a super profits tax on resources activity, then the Commonwealth has to think about when and how that's used. But that's why I divide the whole issue into retrospectivity or application to existing projects, on one hand, and the design on the other.

AK: Isn't there possibly a third element, which is the way that the proposed tax reduces the net present value of future projects because all of the mining companies are now saying that they're not going to go ahead, or they're putting future projects on hold, or that there'll be fewer projects and they'll be looking at other countries instead of Australia?

DM: Well, the consequence of additional tax is magnified across returns and, you know, that's what they say is technically correct. But the design of this tax has had to be customised to a particular application because of the constitutional position and, in doing that, there are several significant flaws. My view is that the tax has to be changed or abandoned.

AK: Which would you prefer, the change or the abandonment?

DM: Well, it's conditional. If there's a change, there has to be some process of putting aside returns from resources depletion for the longer term – and that doesn't happen in the states and it's not really happening at the Commonwealth level – and unless we do that, we'll be directing resource taxes of one sort or another to recurrent spending of government, which will actually cause significant problems later because all resources go through waves of strong returns and weak returns and you've got to have a sensible collection of taxes and royalties when returns are strong, but you can't apply these retrospectively because you won't get investment.

SB: So, David, what you're saying is if you're going to have this kind of tax, the revenue should go into the future fund or a fund like it.

DM: Well, you can do it in a couple of ways.You can dedicate a part of royalties to go into long-term wealth funds, intergenerational funds, or you can direct budget surpluses when the terms of trade are strong and the budget is strong. But in Australia's case, you've got to give some consideration to what happens in the states. If states collect royalties, there should be some incentive to put some of that aside and the reason for that is that it can't happen as easily elsewhere. For example, the states should not be penalised on their grants from the Commonwealth if they collect significant mining royalties.

AK: Well, the reality is that this sort of revenue will go at least to some extent into recurrent expenditures, so in that case are you saying that this proposal ought to just be abandoned?

DM: Well, if we can't achieve a design that does not penalise the existing projects – that's a sovereign risk issue and a design that does not discriminate between recurrent spending and long-term intergenerational wealth creation; if those things can't be done, the tax should be abandoned.

AK: Right. So, just to be clear on it, you're saying that it should not apply to existing projects, only future projects and that all the revenue should go into a fund for the future.

DM: No, not all the revenue, but there should be some sensible calculation and debate about what portion of compensation for resource depletion goes into recurrent spending in Australia in total and goes into intergenerational wealth creation.

SB: David, the tax, as it stands, one of its several design features is this 40 per cent credit. You were a banker for decades; if a miner came to you and said will you lend against this IOU from the government, would you do it?

DM: Well, I would be more concerned about that now because of what's happened with the announcement of this tax. When mining companies go to less developed countries with a poor track record of rule of law and taxation, they generally seek tax standstill arrangements, commitments from government and they also get an acknowledgement of those standstill arrangements from political parties not in government. Traditionally that's not been regarded as necessary in Australia and I think mining companies, and companies generally, understand that the general rate of company tax can move over time, but it's the specially structured designer taxes that give rise to additional sovereign risk.

Australia has a good track record on sovereign risk, but if I could just go on a fraction more, Steve, the issue here is that for investors globally, sovereign risk is coming back into the picture as a larger issue because of the massive issuance of sovereign debt around the world post crisis – not just post, but before the crisis and especially during and after. As a consequence of that, investors are becoming a little bit concerned whether governments will become more desperate and impose things that might… that they might not otherwise have done. So, for Australia to do this now is not good timing and if I was a mining company I'd be extremely concerned that tax is being taken off at the top of the cycle. The best thing for Australia to do is to take a component of its corporate taxes that can be attributed to resource depletion and set it aside.

AK: In fact you seem to be suggesting that to some extent the tax is self defeating in that it requires a level of sovereign trust from, in particular, financiers, but the way that it has been introduced actually destroys that trust.

DM: Well, yes, I think it does. And in addition to that, our starting point is a country that needs foreign investment and, notwithstanding all of our success, we still have a current account deficit, you know, and a chronic current account deficit, and that has to end at some time in our history. The worst thing that can happen is that the resources run down, we're still spending on welfare and we still have a current account deficit. That would be, for future generations, a seriously bad outcome.

AK: So, is the extra sovereign risk that has clearly been identified by other investors around the world, is that affecting or likely to affect the future fund's asset allocation. You've got quite a large allocation to international equities at the moment, in both developed and developing economies, but is that likely to increase at the expense of Australia, given this?

DM: Well, actually the large allocation is not offshore.The large allocation to equities is onshore if you consider the relative scale of Australia's economy to others, and the reason for that is partly because we have less exchange risk onshore, but partly because we see Australia as a proxy for Asia, including China and India, and their growth. If that proxy principle breaks down, then we would not see as much of a reason to be invested in Australia.

SB: David, if there has to be a tax, do you have a particular design in mind that would be reasonable?

DM: Well, we need a design for new projects starting from exploration up and the one that's understood is the PRRT. So, in my view, that would be a better structure, but it could not apply to any existing projects or any existing exploration. Bear in mind that the design of this tax makes the Australian taxpayer a mining joint venture and, as a taxpayer, if I am a joint venture in a mine, I'd really want my joint venture partner to be well-resourced enough financially and, in skill terms, to do a good job with the mine. If they are taxed on a basis that does not enable them to do that, then I carry all of the risk of the investment of my tax money and much less upside because if my joint venture partner is not incentivised, then I'm less likely to get the returns. So, I'm not sure if that answered your question directly, but you know when you have to make a designer tax partly for constitutional reasons and partly for current funding, then you get into all sorts of difficulties.

SB: Another design feature of the tax is that it cuts in before the financing costs. A lot of smaller mines in Australia have been project financed. What would be the implications of an RSPT be for project financing in this market?

DM: Well, as you pointed out before, you're absolutely dependent on the cash flowing from the government and it's not clear that that will always be the case, especially with the terms of trade and commodity prices. If that changes, then the Australian revenue has got a flow of commitments for existing projects and virtually none of the super profits tax. So the current account cycle would actually deteriorate.

AK: David, there's now a pretty fiery barney going on between the government and the mining industry. There's lots of name calling, the government's now launched a taxpayer-funded advertising campaign against them, how do you feel about that and are you concerned about the consequences of that?

DM: Yes I am. This should be the subject of sensible negotiation behind the scenes. One implication of this advertising war is that a lot of foreign investors see Australia as a place where common sense usually prevails and this sort of public brawl will reduce their confidence in those sorts of things happening. And the difference between us and a lot of countries, with resources, is that we had this reliability; we've had a solid rule of law and we've had a taxation regime which has been highly predictable.

SB: David, the revenues from this tax, if it were implemented, are designed to bring the budget back into balance three years ahead of the previous schedule. Is that a priority and does it validate the tax?

DM: I think it's more the implications of the tax. It doesn't validate it if the tax itself is going to cause you to collect less in the long run, and that's possible. So, I think that the budgetary issues have got more to do with whether we want loose or easy fiscal policy, in the context of what's happening with monetary policy, and particularly the household sector indebtedness in Australia. So it only takes very small doses of monetary policy to have a significant effect on consumption and so the budget should be framed in that light. So I think you've got to weigh those things up in framing the budget, Steve.

SB: But does it matter that much whether it's in surplus in three years or four years?

DM: Well, it depends on how you do it and the problem with this tax is it could cause more trouble. It's a long-term tax being applied to a short-term purpose, really, and that's where the problems arise.

AK: Just changing the subject, David, you're still a 10 per cent shareholder in Telstra, what's your current view of the NBN and the government's determination to press ahead with it, following the implementation study from McKinsey and KPMG?

DM: Well, I don't think it's appropriate for the NBN, as a carrier for everybody else, to compete directly with the other telcos and I think, if it is in the interests of the NBN and the interests of Telstra to do a deal, then a deal should be done. I'm not privy to any information about any deals but the market, given Telstra's price, is clearly uncertain at the moment and that needs to be clarified. And I think a deal with the NBN company would probably be a win-win, if it were carefully designed. But the shareholders of Telstra would need to vote in favour of the deal, so it would have to have proper value to Telstra. But Telstra's board has to weigh up the compensation for any deal against their alternatives and I'm sure they're capable of doing that. So I'm a little surprised nothing has been done, given all the talk, and I think it's important to put some certainty back into the market for Telstra shares.

SB: David, if there is no deal done, there will be competition between Telstra and the NBN. According to the implementation study the NBN will return, if everything goes well, 6 per cent in the long run. Is that fair competition when you've got an owner who wants basically the bottom rate competing against a private sector organisation?

DM: If you go back to the reason for the creation of government business enterprises, it was usually to do with the introduction of a new technology where the private sector didn't have the capacity, or the capital, to get something started. This generally happened with some banks, telcos, airlines, railroads and these sorts of things. The issue is the unlevel playing field on capital and return on capital, but ultimately government-owned enterprises come into conflict between the immediate needs of government and the longer-term needs of the organisation, and eventually they fade away for that reason, so the rate of return, I don't know if that's a blended rate of capital and debt, but generally it sets up an unlevel playing field of some sort. That's why the NBN might work if it's purely a common carrier and does not directly compete and, if it's to do that, if it can acquire assets from Telstra, could do it much more satisfactorily than by any other purpose. Also I don't think it would be smart to have an NBN that's going to be calling on so much capital from the government. If its payback period is very long, then we would create further budgetary distortions.

AK: Do you have in your mind what a deal between Telstra and the NBN should involve? I mean, do you have a number, or do you have a view that you may have expressed to the board?

DM: That's not something I can talk about here.The board has its views and we don't have any specific information or privileged information from the government or Telstra. We've formed our views. We've said a couple of years ago that we're a seller of our spot in Telstra. We've moved that part of the way and clearly to undertake that in some sort of orderly way given our mandate, we'd like to see more certainty around Telstra.

AK: And the other thing that's happened recently is your brief excursion into supporting the bid for Transurban and then terminating that support in March. Can you just give us a sense of what you were thinking of doing, and why you terminated, and how that might influence, or what it implies about what you'll do in infrastructure in future?

DM: Well, look, on Transurban the issue was that we can't tie ourselves up for indefinite periods. We've got very, very skilled people looking for good assets for the fund, both domestically and internationally. They can't be tied up with commitments that are indefinite and so we found it better to be able to make our own decisions. Alan, on infrastructure generally, we still see it as a good asset class. We see a lot of opportunity, given this sovereign indebtedness around the world, we see a lot of opportunity in Australia. Our only concern, again, is sovereign risk; whether the governments who are more and more indebted will find a way to get agreements or impose new taxes or do things that cause us to be more cautious about some of these infrastructure investments. But we are very keen on that area.

AK: We'll have to leave it there. Thanks very much, David.

DM: Thanks, guys.

SB: Thank you, David.

DM: Thank you.