Could Australia end up with little to show for its mining boom — as an echo of what happened to Nauru once its considerable phosphate wealth was exhausted?

Close examination of the proposed Minerals Resource Rent Tax (MRRT) reveals serious flaws that could leave the federal government well short of the forecast revenue. It is conceivable that some large and highly profitable mining companies could reorganise their affairs to pay little or none of the tax at all.

The first and most obvious shortcoming of the MRRT, in terms of its revenue potential, is that it applies only to coal and iron ore. All other minerals are exempt.

But it is the design of the tax as it applies to coal and iron ore miners that could leave the government facing an unanticipated multibillion-dollar shortfall.

The main problem is that the tax is based, not on an objective measure such as tonnes of material mined, but on ‘‘super-profit’’ (mining profit less allowances). Profit, at the best of times, is a highly flexible concept that can allow accountants to apply creative techniques to minimise a company’s tax obligations.

In the case of the MRRT, the incentives and opportunities for creative avoidance appear even greater than those applying to company tax.

The Australian Taxation Office has already released five early guidance papers on the tax, but the legislation is complex. Its 232 pages will no doubt exercise the minds of the nation’s best and brightest managers and tax accountants as they seek to find means of reducing tax.

The minerals tax is not based on audited company profits from their statutory accounts, but on a narrow portion of profits from particular mining activities. It requires the taxpayers (that is, the mining companies) to determine the amount of proceeds and costs that relate to these activities.

This reliance on the miners themselves to determine the appropriate proceeds and costs creates a significant incentive to estimate profit from taxable activities in the most tax-efficient manner. For example, the MRRT requires the miners to split revenue between the taxable value earned to the point of producing a stock of coal or iron ore from revenue earned after that point. Transfers within the company also need to be valued. Losses can be offset between operations.

At numerous points opportunities exist to reduce revenue estimates and increase costs so as to minimise the taxable profit reported. Volatility in commodity prices could also allow strategic timing of the recognition of revenue and expenses.

All these factors, combined with any decline in the underlying commodity price from the record levels seen when the tax was first envisaged, could greatly reduce the expected proceeds to government coffers.

So, too, could the generous and sometimes unconventional allowances built into the tax. There are more than 50 pages of allowances that can be used to reduce a firm’s tax liability. While most allowances have their foundation in generally accepted accounting principles (e.g. royalties paid to state governments or pre-mining exploration expenditure), other are less conventional.

For example, under division 75, miners can choose between the ‘‘book value’’ or ‘‘market value’’ of an asset, which will be allocated against revenue over the productive life of a mine in order to calculate MRRT liability. Depreciating assets based on market valuation is not generally accepted accounting practice, yet it is allowed in the legislation.

In simple terms, a mining asset that cost $100 million to bring to production might today be worth $350 million if sold on the open market. A miner could use this higher valuation to calculate depreciation which would reduce the profit subject to the tax.

Business transactions can be complex, and legislation must therefore contain a range of provisions that require subjective interpretation. The mining tax legislation adds a further layer of complexity, which at times defies conventional accounting and can be used to aggressively minimise the amount of tax payable.

A key argument in support of a tax on super profits, rather than on the simpler and more readily verifiable measure of tonnage, is the need to avoid sending unprofitable miners bankrupt. A low-profit offset would ensure, however, that if the total profits of a mining company are low, the miner has no liability for MRRT and unprofitable operations do not go bankrupt because of a tonnage-based tax.

Even at this late stage in the process, key improvements might be made if there were full transparency in the revised revenue estimates, the underlying assumptions, and in particular the ability of the tax office to monitor and collect the minerals tax. It is not surprising that critics have begun to question Treasury’s revenue estimates which are based on private information supplied by the mining companies which is not on the public record.

Mining companies are entitled to make a profit, but if the nation decides it is also entitled to a return on the exploitation of national resources then it is important to design a tax that is effective. Once the resources are gone, they are gone for good. By the time Nauru became independent in 1968, most of its phosphate had been mined and the vast bulk of the profits retained by the British Phosphate Commission. Little was left for the new nation. It would be a pity were a similar story to be played out today in Australia.