Rio Tinto, Mongolia and the Mining Super Profits tax


Anyone who hankers after the original mining super profits tax (MSPT) should take a look at Mongolia. Stephen Batholomeusz has a nice piece outlining the details. Bloomberg have a more recent piece here.

The MSPT would have made the federal government a ‘silent partner’ in all mining projects. It would have been like an equity investor with no votes but a share of the profits and a liability for the loses.

In Mongolia, the government is an actual equity investor. It has a 34% stake in the mine. It now wants to renegotiate the contract that it has with Rio. Sovereign risk? Perhaps. But at the heart of the dispute is an argument about profits.

The Mongolian government is worried about cost blow outs in the project that will reduce the profits. These cost blow outs directly affect the Mongolian government’s ‘revenue take’ from the mine. Rio argue that the expenditures were necessary. But Rio also appears to have a direct conflict of interest. As noted:

Rio as the recipient of cost-based management fees might benefit from increased capital costs …

I agree with the statement that such fees are likely to be swamped by dividend and profit reductions to Rio, but they highlight the key point. A MSPT only works if the government has a robust measure of ‘profit’. And that can be hard. As someone who spends a non-trivial part of my day trying to regulate profit (or ‘returns’) on various utility industries, I know the difficulty of measuring profit in a robust way.

One issue – that has come up before in Australia – are ‘management fees’ charged by a subsidiary of the main company. In accounting terms these are a cost to the project (so profit falls) but are actually just a transfer between one part of the business and another part. The part with the MSPT would make less profit but part of the company not subject to the MSPT makes more profit.

More generally, profit depends on costs and a real risk of a MSPT is that the relevant companies have an incentive to shift every possible cost to Australia and take every possible revenue overseas. These games can be made hard by things like regulated transfer prices (i.e. transfers that re paid when the firm ‘sells’ or ‘buys’ internally between Australian and overseas parts) but they end up in a quagmire of regulation  The lawyers get rich – but they are about the only ones.

In contrast, simple resource rent taxes, levied, for example, on output, are much more enforceable.

This is not a new issue in taxation – but it is one that can be easily forgotten by economists after a ‘first best solution’, who forget real world issues of implementation.

So next time someone reminisces about the mining super profit tax – tell them to go to Mongolia!

4 Responses to "Rio Tinto, Mongolia and the Mining Super Profits tax"
  1. I would hope that most of us would want to leave the design of any “Mining Super Profits Tax” to experts in the Treasury. And to then properly test and model their recommendations prior to any implementation. Seems to be far too many traps for young and inexperienced players – particularly over-eager politicians.

    But the main issue is that we need a “fair share” of mining profits to be kept for the nation. What is a “fair share”? I don’t know – but it is a hell of a lot more than zero.

    So how about a debate about what is a “fair share”? And that ought be guided by expert advice. But in the end the people ought to decide. To date, the debate has been conducted in secret behind closed doors – without the input of the people and that’s the main reason why it has been a spectacular failure.

  2. I like this argument but some empirical feel for how easy it is to increase the scale of such things as transfer pricing when a tax is imposed would be useful. Maybe some accountants can tell you. It is obviously a tradeoff since there are inefficiencies in output-based duties and economists do have info on this. If management fees are small relative to profits then a little shifting doesn’t matter much. What is nastier is, as you suggest, if firms modify their capital investments to increase the management fees to avoid tax.

    BTW this sort of argument applies to almost every tax – there are increased incentives to evade income taxes at higher tax levels – indeed this has recently occurred in France.

    I’d encourage you to write this up as a technical piece for a local economic journal. I was a bit involved in the Henry Review and I didn’t see them raised there. There were of course other objections.

  3. Wasn’t the tax suggested in the original Henry review just a straight rent tax? I never understood why they went after super profits over this.

  4. I have not heard that this is a major issue for the petroleum version of the tax. Is there something different about that tax that makes it less susceptible to this sort of transfer pricing?

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