Rio Tinto and BHP Billiton moved closer to a $116 billion iron ore joint venture after the Western Australia government approved the plan in return for payment of higher mining royalties, a deal that undermines Prime Minister Kevin Rudd's planned mining super tax.

Rio and BHP are still waiting for anti-competition regulators from Canberra to Brussels to Beijing to sign off on the joint venture, which will enable them to formalize production sharing in the world's biggest iron ore deposit.

But the agreement with Australia's biggest mining state marks the crossing of a major hurdle before forming the alliance, aimed at saving $10 billion in duplicate costs.

The ability to blend iron ore from any of our mines, and the flexibility in the use of all rail and port infrastructure, will be major enablers for our operations, Marcus Randolph, Chief Executive Ferrous and Coal at BHP Billiton, said.

BHP's shares on the London Stock Exchange were up 4.4 percent while Rio was 5.6 percent higher, outpacing earlier gains posted in their Australian-listed shares but in line with other LSE mining shares.

The pact with opposition-controlled Western Australia state comes amid a row between Australia's miners and the federal government over plans to impose a hefty new tax on mines, with Canberra on June 10 promising to hand A$2 billion of that revenue to Western Australia to fund new roads, schools and other community projects.

Rudd at the time challenged Western Australia's premier, Colin Barnett, to come up with a better alternative after he criticized the tax as harmful to the mining sector.

The miners said in separate statements on Monday they would pay the state government a royalty of 5.625 percent on sales revenue of iron ore fines, up from 3.75 percent, and 5 percent for lower grade ore, up from 3.25 percent.

These royalty increases simply confirm that the mining companies know the Australian people have not been getting a fair return on their own non-renewable resources, especially given the huge price increases enjoyed by the mining companies in recent years, Australian Treasurer Wayne Swan said.

The new rate is in line with that paid by other miners, ending an incentive that the world's no.2 and no.3 iron ore miners had been given decades ago to build up Australia's iron ore industry.

Without the subsidy, rival miners such as Fortescue Metals and Atlas Iron will find it harder to push for access to rail lines run exclusively by BHP Billiton and Rio Tinto.

Iron ore, after a brief hiatus, is gold again for anyone who can dig it up and get it on a ship, preferably bound for China, whose strong appetite for imported ore was barely blunted by the global financial crisis.

For commodity-dependent Australia, only coal brings in more export revenue than iron ore each year.

If the joint venture goes through, BHP and Rio combined will be mining more than 350 million metric tons of ore, overtaking current top producer Vale of Brazil.

That is more than a third of global seaborne trade in iron ore and about two-thirds of top buyer China's total imports.

Rio iron ore division chief executive Sam Walsh said the agreement will help in the company's next growth stage, aimed at taking Rio's output to 300 million metric tons a year.

Since the 1960s Rio and BHP have turned the Pilbara into two separate spaghetti bowls of rail lines leading to exclusive ports on the Indian Ocean until now off limits to each other.

The companies also agreed to make a one-off payment of A$350 million ($305 million) together, earmarked to help pay for a new children's hospital.

Higher-valued lump ore will attract a royalty of 7.5 percent, already the prevailing rate for most of lump ore produced from BHP Billiton mines, BHP Billiton said.

The higher rate will add A$340 million to the state's coffers in the 2010-11 financial year, according to Barnett.

(Reporting by Mark Bendeich, James Regan and James Grubel; Editing by Michael Urquhart)