Telegraph | 9 May 2010
Australian tax could breach treaty with China
Mining shares plunged last week after Kevin Rudd, Australia’s prime minister, proposed a 40pc tax on mining profits, arguing that Australia’s mining boom was benefiting shareholders based abroad – but there could be some light at the end of the tunnel for aggrieved mining investors.
By Garry White
Alex Baykitch, a partner in the Sydney office of Holman Fenwick Willan, a law firm advising on international commerce, says legal action to try to get compensation for the tax hit could be taken under various bilateral investment treaties signed with numerous countries, including China.
There are no such treaties with the UK, Mr Baykitch says, but companies such as Chinalco, which own 9pc of Rio Tinto, may be able to launch legal action under one of these treaties.
This raises the prospect that the Chinese government, which controls mining group Chinalco, could take legal action against the Australian government. UK pension funds are locked out of this process, unless they have funds incorporated in countries that have a bilateral investment treaty (BIT) with Australia.
The tax proposal "is a classic example of a potential breach of a host state’s obligations under a BIT", according to Mr Baykitch. "Broadly speaking, BITs establish clear rules on the scope of investment protection and the treatment that states must provide to foreign investment in their territories. In addition, they establish a framework for the resolution of investment disputes through arbitration between the foreign investor and the host state."
This means that a looming BIT claim by mining companies’ minority shareholders could play a part in the lobbying and opposition to the new mining tax.
BITs generally protect foreign investors of a signatory state from actions of the other signatory state which affect the value of their investments. Typical BITs include clauses protecting foreign investors from discrimination, expropriation and nationalisation. BITs generally provide for such disputes to be arbitrated.
"BHP is 40pc foreign owned, Rio Tinto is more than 70pc foreign owned. That means these massively increased profits, built on Australian resources, are mostly in fact going overseas," Mr Rudd told Australian radio. These comments about foreign ownership could add weight to the case that the mining tax breaches these rules, Mr Baykitch says.
Australia has entered into 22 BITs and 6 Free Trade Agreements (FTA). With one or two exceptions, Australia’s BITs and FTAs protect against unfair and inequitable treatment, as well as expropriation. In addition, they all provide for the security of investments. All kinds of investments are covered including real estate, capital projects and equity investments.
"Whilst Australia has been viewed as an attractive place to invest in the past, the proposed tax now raises the spectre of sovereign risk in the form of unfair and inequitable treatment of foreign investors and the possible expropriation of assets without adequate compensation," according to Mr Baykitch. "Ultimately, what is required [for a successful challenge] is that the erosion of profits caused by the proposed resources tax amounts to an erosion of rights associated with ownership."
He added: "Expropriation obviously entails the erosion of rights associated with ownership and, to that end, the notion of expropriation under an investment treaty may be creeping or constructive. It need not be immediate but may unfold through a series of measures which have the cumulative effect of substantially depreciating the use or value of an investment. Measures such as tax increases may – in certain circumstances – amount to an expropriation.
"Alternatively, the proposed resources tax might be unlawful because it is unfair or inequitable. One well-recognised manifestation of unfair or inequitable treatment is discrimination against foreign investors.
"Of particular concern are comments by the Australian prime minister that particular mining companies are substantially foreign-owned, that profits of such companies were going overseas, and that Australians deserve a larger share of such ’super profits’."
Such comments raise the inference that discriminatory motives underlie the proposed tax and may be the basis of causes of action by foreign investors under BITs, says Mr Baykitch.
Whether such a legal argument would hold up is not yet clear, but major investors in the Australian resources sector are likely to pursue every avenue to try to mitigate the raid’s impact on the sector’s profits. There was no consultation on the proposals with mining groups ahead of the announcement last week, but a dialogue has now started in earnest.
A bloody battle lies ahead.