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October 2012

CRU Intern Sophie Maltabarow discusses the likelihood of success of the challenge by Fortescue Metals to the Minerals Resource Rent Tax:

Andrew Forrest and the beleaguered Fortescue Metals Group had a victory in the High Court last week against the corporate watchdog. A unanimous judgment held that Mr Forrest’s statements on binding agreements with State-owned Chinese entities back in 2004 were not false or misleading. This decision would have come as a personal relief for Mr Forrest, as the High Court found that he had not breached his Directors duties to exercise the level of degree of care and diligence required by s 180(1) of the Corporations Act 2001 (Cth). Fortescue Deputy Chairman Herb Elliott stated that ‘ASIC's allegations have been an expensive distraction. We can now focus our full attention to ensuring the continued success of Fortescue Metals Group for many years to come.’ Fortescue Metals was also successful in an appeal against the decision of the Australian Competition Tribunal in September. But Mr Forrest has another legal proceeding underway: Fortescue Metals filed a statement of claim in the High Court on 22 June 2012, challenging the constitutionality of the Minerals Resource Rent Tax (MRRT) which came into effect 1 July 2012.

The MRRT taxes profits made by companies mining iron ore and coal. In working out a mining corporation’s profit, the amount paid by it in State royalties is first deducted. This ‘loophole’ equalizes the effect of different State royalties on the overall burden of the tax on miners. It means that the higher a state royalty, the lower the MRRT paid and the lower the revenue received by the Commonwealth. Greens leader Christine Milne has introduced a private member’s bill in the Senate to close this loophole in the MRRT. The Minerals Resource Rent Tax Amendment (Protecting Revenue) Bill 2012 provides that any increases in State or Territory royalties after 1 July 2011 should be disregarded when calculating royalty credits for the MRRT.

Big Mining has spoken out against any amendment to the MRRT. If it has to accept the tax, it wants to keep the loophole.

It is no surprise that the Greens are taking on Big Mining in an attempt to protect tax revenue. Nor is it a surprise that mining companies want to preserve their current protection from any rise in State royalties. The credibility problem here for Big Mining is that the Fortescue Metals Group has also sought to challenge the constitutional validity of the tax in the High Court and it relies on the argument that this very loophole causes the MRRT to be unconstitutional.
Fortescue’s challenge is most likely based on an assumption that by the time the High Court decides the case there will be a change in government. The tactical benefit to the constitutional litigation is that if the MRRT is struck down by the High Court, a future coalition government would not have to get its repeal of the tax through the Senate. If the Gillard Government together with the Greens removes the loophole, however, the constitutional challenge would be destroyed.

Mitch Hooke, chief executive of the Minerals Council of Australia, has reportedly said that any change to the MRRT would ‘simply add to the instability and uncertainty of Australia's taxation regime’ and negatively impact on mining investment in Australia. Surely a constitutional challenge, if Fortescue Metals believes that it has any chance of having the MRRT struck down, also adds to the uncertainty? The line from Fortescue Metals is that by challenging the tax, it is being a ‘good corporate citizen’. It seems clear, however, that both these approaches to the MRRT are motivated by self-interest. The miners complain that the loophole makes the MRRT unconstitutional because it is discriminatory, but at the same time they are lobbying to keep it because it benefits them.

In fact it was Big Mining that negotiated the loophole in the first place. After the federal government abandoned the ‘Resource Super Profits Tax', a renegotiation deal was done behind closed doors. Three of the largest mining companies in Australia - BHP Billiton, Rio Tinto and Xstrata – negotiated with the federal government for the MRRT in its present form. The States and smaller mining companies were not party to these discussions. The large mining companies successfully negotiated the deduction of State royalties from mining profits before the tax applies and removed a clause which would have capped the amount that could be deducted. The miners are not going to let their loophole go without a fight, even though Fortescue Metals is challenging its constitutional validity.
All the grounds of purported constitutional invalidity raised by Fortescue Metals rely on the MRRT liability being reduced by State royalties. First, Fortescue Metals argues that the MRRT is in contravention of s 51(ii) of the Constitution, the taxation power, because it discriminates between States. Fortescue Metals argues that, all other things being equal, whether a miner will have to pay either more or less of the MRRT in a particular State will depend on the royalty rates in that State. Further, as State governments have the power to raise, reduce or grant exemptions from royalty rates, the MRRT liability may be subject to variation. And therefore this variation amounts to discrimination between the States. Success in this argument will depend upon the High Court taking a highly literal interpretation of the Constitution and the meaning of ‘discrimination’, as the effect of the loophole is to ensure that the overall liability to pay State royalties and the MRRT is equalised for all miners regardless of the State in which they are operating mining projects.

Fortescue Metals is arguing that the effect is to prevent a State from using its power to adjust its royalties rates to encourage economic development, gain a competitive advantage or discourage mining where it is damaging to the environment. The High Court has given some sympathy to such a prima facie discrimination argument in a different context. In the 1988 decision of Bath v Alston Holdings, a majority held that a Victorian law, which would have removed the potential competitive advantage of inter-state tobacco wholesalers selling to Victorian retailers when they did not have to pay tax on tobacco in their home State, was discriminatory and protectionist and therefore contravened s 92 of the Constitution. The minority instead looked to the practical operation of the legislation and made the point that the ‘economic effect of the tax is the same’, regardless of whether the retailer purchases the tobacco from wholesalers within or outside of Victoria. If Fortescue’s challenge is heard by the High Court, it will be interesting to see whether the discrimination between States argument in s 92 can be applied in the context of s 51(ii).

Second, Fortescue Metals submits that the MRRT is unconstitutional because it impairs or curtails the capacity of a State to function as a government with control over the economic development of its natural resources. This is because it removes a State’s capacity to create a competitive advantage by varying its royalty rates. It would have the effect of ‘rendering illusory or inefficacious’ any attempt by a State to differentiate itself from other States or countries. The difficulty here will be showing that the capacity of States to vary royalty rates with economic impact amounts to a constitutional power of the State which is protected by the Constitution. It is unclear whether the Melbourne Corporation doctrine, which preserves the rights of the States to carry out essential governmental functions, would extend to protect control over the use of natural resources and to the capacity to promote the economic development of the State through royalty rates. Regardless of the chances of its success, this argument still relies on the effect of the loophole to challenge the MRRT’s validity.

Third, Fortescue Metals asserts that the MRRT gives preference to one State over another in contravention of s 99 of the Constitution. Again, this argument relies on the loophole. It argues that a State with higher royalties is, in effect, given preference by the MRRT, because it gains additional revenue without damaging its competitive position in the market.

Recent High Court authority suggests this argument will not be successful. In the 2004 case of Permanent Trustee Australia Ltd v Commissioner of State Revenue (Vic), the High Court upheld the validity of a mirror tax scheme. The Commonwealth Places (Mirror Taxes) Act 1998 (Cth) imposes taxes on Commonwealth places (such as airports) which are equivalent to the relevant state taxes, and then returns that tax revenue to the state. One of the arguments made against the scheme was that it contravened s 99 of the Constitution because it gave preference to one state over another. The High Court rejected this argument. It stated that while the tax scheme ‘may produce differences in revenue outcomes between States,’ this simply reflected the difference in taxation regimes from State to State, and that the differences were ‘appropriate and adapted to a proper objective’.

Finally, the MRRT is challenged on the basis of s 91 of the Constitution, which provides that ‘nothing in this Constitution prohibits a State from granting any aid to or bounty on mining for gold, silver, or other metals’. The assertion is that, because the MRRT has the effect of removing any competitive benefit for a State to have a lower royalty rate, it prevents a State from aiding the mining industry through a reduction in royalties. This argument may prove difficult, as the High Court has previously said in 1978 in Seamen’s Union of Australia v Utah Development Co that s 91 ‘neither grants power nor withholds it. It merely limits the scope of the prohibition in s 90,’ which gives the federal government exclusive power over customs, excise, and bounties. There is no positive right for the MRRT to impinge on.

It is also interesting to consider the States’ stance on the ‘loophole’ issue, keeping in mind that they were not included in the final negotiations on the MRRT. The loophole presents an obvious cash-raising opportunity for the States. The Sydney Morning Herald reported that the federal Treasurer Wayne Swan has written to States and territories, saying that he intends to penalise dollar-for-dollar any attempts by States to make a revenue-grab by increasing their royalty rates. NSW has already increased its royalty rates since the MRRT was passed by parliament, and Queensland has announced it intends to do the same. Interestingly, Queensland has also announced that it will join Fortescue Metals in its challenge to the MRRT’s constitutional validity. It may well find itself in a similarly logically-uncomfortable situation.

If Senator Milne’s bill passes through parliament before any challenge is decided by the High Court, miners will be left without their current protection from rises in State royalties and the grounds for Fortescue Metals’ constitutional challenge will be destroyed. Even if the challenge does make it to court, Fortescue Metals’ chances of success are not high. It may well be prudent for Mr Forrest to listen to the words of his Deputy Chairman in response to their win against ASIC and the end to ‘expensive distractions’.