1 Mining Taxation Professor James Otto Director of Graduate
Studies Environmental and Natural Resources Law Program University
of Denver College of Law Slide 2 2 Division of Mine Revenues 20
Year Typical Medium Sized Copper Mine Gross revenues - 3.3 billion
USD (50% Effective Tax Rate) Contractors Suppliers Infrastructure
Others Wages Consumables Spares Power Water Community? New
exploration New mines Dividends National? Provincial? Local? Banks
Note: 50% division Slide 3 3 Structure of Talk Taxation and
investment Principal issues affecting modern taxation design
Principal taxation methods & incentives Analyzing a mining tax
system Recommendations Slide 4 4 Part 1. Role of Tax in Investment
Decisions Most nations have reformed or are now reforming their
mining sector fiscal system Most developing and transition nations
reformed so as to attract investors Since 1985 over 100 countries
have introduced new mining law Has there been a race to the bottom?
Are taxes too low? Too high? Slide 5 5 Australia Canada USA Rest of
World SE Asia / Pacific Latin America Africa Exploration Investment
is Cyclical Slide 6 6 Source: MEG, WMC, ABM 1997 $5 billion 2002
$1.7 billion 2005 - $5.1 billion Investment Cycle Affects All
Regions Slide 7 7 2006/7 Top of the cycle? Is now a good time to
raise taxes? Exploration Downturn & Upturn Global exploration
expenditure: 1997: US$5.2 billion 1998: US$3.7 billion 1999: US$2.8
billion 2000: US$2.6 billion 2001: US$2.2 billion 2002: US$1.9
billion 2003: US$2.4 billion 2004: US$3.8 billion 2005: US$5.1
billion MEG Temptation to lower taxes Temptation to raise taxes
Slide 8 8 Role of Tax in Investment Decisions Companies have many
options, but only limited budgets Key factors need to be met to
attract investment Companies will screen investment opportunities
applying criteria balancing risk and reward How does taxation fit
in? Slide 9 9 Fraser Institute Poll 2005/2006 Geology the most
important criteria Investor Perception Slide 10 10 Percent of
Surveyed Mining Companies That Consider Jurisdictions Mining
Taxation Regime a Strong Deterrent Ghana, Alaska, Mexico, Brazil
PNG, Indonesia, Mongolia (before reform) Russia, New Zealand,
Sweden Chile, Congo, Peru Fraser Institute Survey 2005/2006 Slide
11 11 Fraser Institute Poll 2005/2006 Geology must be balanced
against government policies Higher risk Lower Risk Tax is part of
policy Investor Perception Slide 12 12 Fraser Institute Poll
2005/2006 Companies balance different factors, like tax, when
balancing geological potential and risk Balancing Geology and
Policies in Investment Decisions Slide 13 13 Role of Tax in
Investment Decisions Geological potential for target mineral
Profitability of potential operations Security of tenure &
permitting Ability to repatriate profits Consistency of mineral
policies Realistic foreign exchange controls Stability of
exploration terms/conditions Ability to predetermine environmental
obligations Ability to predetermine tax liability Stability of
fiscal regime United Nations Survey of 45 companies Top 10 ranked
Company Decision Criteria for exploration (out of 62 factors) Tax
related Slide 14 14 Part 2. Principal Issues To Consider in Mining
Taxation Policy J. Otto Slide 15 15 Principal Issues Affecting
Taxation Systems - Primary Goal of mining taxation policy - J. Otto
to achieve a win-win situation for society & companies societys
objectives: achieve development and obtain income at an acceptable
social cost companys objective: achieve adequate return on
investment It is in the interest of both parties to obtain
successful projects Slide 16 16 Principal Issues Affecting Taxation
Systems The Governments taxation dilemma: fiscal diversity or
uniformity? same tax treatment for all sectors? (fishing, light
industry, mining) each sector can claim some uniqueness special
treatment can cause distortions between sectors Since each sector
is unique, shouldnt each sector be taxed in a manner that takes
that uniqueness into account? Government dilemma: uniform tax
system applicable to all sectors or system that accounts for
uniqueness in each sector Slide 17 17 Principal Issues Affecting
Taxation Systems - Unique nature of mining: tax policy response -
Trend is to harmonize fiscal systems across economic sectors, but
most nations still provide some special treatment to the mining
sector Slide 18 18 Principal Issues Affecting Taxation Systems -
Fiscal diversity or uniformity within the mining sector? - Mineral
type? (sand, dimension stone, coal, base metals, gold, diamonds)
Scale? (panners, small scale, large scale) Nationality?
(discrimination, tax treaties, foreign investment act) Slide 19 19
Principal Issues Affecting Taxation Systems - Unique nature of
mining: tax policy response - Exploration will precede startup of
mining-- exploration expenses will occur before taxable income is
available. Response: special provision for how pre-production /
pre- income exploration expenses are handled for future income tax
purposes Mine development is capital intensive. Response:
accelerate recovery of capital costs once production commences
Slide 20 20 Principal Issues Affecting Taxation Systems - Unique
nature of mining: tax policy response - Mine will initially import
equipment from specialized suppliers. Response: low or no import
duty and VAT relief Mineral product must compete for share of
global market. Response: relief from VAT and export duties Slide 21
21 Principal Issues Affecting Taxation Systems - Unique nature of
mining: tax policy response - In most nations minerals are the
property of the state or the public. Response: assess a royalty (a
public to private ownership tax) The scale of operation may be
small or large. Response: exempt small scale miners from royalty
Response: vary royalty by scale of production Different minerals
have very different labor, cost, price, value- added, environmental
and social attributes. Response: vary royalty rate for different
groups of minerals Slide 22 22 Principal Issues Affecting Taxation
Systems - Unique nature of mining: tax policy response - After
mining ceases and there is no income, a mine incurs significant
costs related to closure and reclamation. Response: require a tax
deductible set-aside of funds early-on Mining project may have a
long life span & will live through many political regimes and
national economic ups and downs. Response: stabilize some taxes
Scale of investment may be huge and many laws may be involved.
Response: negotiated agreement, including special tax terms,
supplanting general laws Response: ring fence Slide 23 23 Principal
Issues Affecting Taxation Systems Revenue raising objective:
maximize immediate or long-term revenue? Cash cow? Short term
maximization - government seeks to maximize fiscal revenues from
every mine Grow the size of the herd? Long-term maximization - seek
increased levels of investment with attractive, moderate taxes thus
creating more tax-paying mines over the long-run Slide 24 24 Real
Copper Price: 1870 2001 (US Prices, $2001/1b) Tilton 2006 Tax
system needs to recognize cycles Slide 25 25 Principal Issues
Affecting Taxation Systems Should the tax system adjust for price
cycles? When prices are high: Surpluses are available to be taxed
Special taxes: additional profit tax, graduated royalty Experience:
almost all nations have eliminated these When prices are low:
Without relief from non-profit based taxes, mines may close This
can result in both short and long term fiscal reductions
Approaches: loss carry forward, allow good year surpluses to offset
poor years, discretionary relief from royalty Most mineral fiscal
system today partially self-adjust because they are based mainly on
profitability (income tax, withholding tax on remittances) Slide 26
26 Principal Issues Affecting Taxation System - Tax Stabilization -
Government perspective: Administrative challenge: different mines
will have different tax systems Dont bind the hands of future
lawmakers Should a risk-premium be paid? (Peru, PNG, Chile) How
long? Which mines (all, or only large mines)? Which taxes? Company
perspective: Need to provide assurance to lenders that cash-flow
will be sufficient to meet repayment Reduces risk that a mine may
be subject to changed rules once the capital is captive J. Otto
Slide 27 27 Principal Issues Affecting Taxation Systems Community
Related Costs Policy Debate : Should a mine be allowed a tax
deduction or credit for investment in communities and public
infrastructure? This will increase local benefits, but decrease
treasury revenues available to benefit other communities What types
of investment qualify: hard infrastructure, recurring costs for
teachers, non-essential school uniforms? Company perspective: Such
costs are an important part of doing business today and should be
recognized for tax purposes Slide 28 28 Community related costs
deductible/credits? clinic / school / water supply / housing /
nutrition Slide 29 29 Sustainable development programs deductible?
improve or introduce new skills and capacities that will outlive
the mine Slide 30 30 Principal Issues Affecting Taxation Systems -
Fiscal decentralization & distribution (money is power!) -
Should central government levy and collect all taxes? disburse
revenues through the budgeting process a statutory percentage of
some tax types automatically will be remitted by central government
to lower levels of government Should different levels of government
levy and collect taxes? Challenges: accountability, capacity,
corruption, political will Slide 31 31 Principal Issues Affecting
Taxation Systems - Influencing taxpayer behavior: examples -
Encourage value added processing: High royalties on ore, lower
royalties on concentrates & metal free trade zones &
special industrial zones that provide reduced tax regime (beware
transfer pricing problems) Encourage exploration: Double deduction
for exploration costs (Argentina, PNG) Encourage R & D: Tax
credit for approved research to improve mineral processing Slide 32
32 Principal Issues Affecting Taxation Systems Characteristics of a
good mineral tax system: Investors view Tax system should: maximize
the net present value of the companys revenue be based on realized
profitability permit early pay-back of capital recognize the
volatility of markets be stable and predictable transparent avoid
tax types that distort extraction profiles avoid tax types that do
not reward increased efficiency encourage investment in exploration
encourage investment in marginal mines Slide 33 33 Principal Issues
Affecting Taxation Systems Characteristics of a good mineral tax
system: Governments view Tax system should: maximize the net
present value of tax revenue support macroeconomic stability by
providing predictable and stable tax revenues capture more revenues
during periods of high profits capture more revenue rent from
extraordinarily low cost, high grade mines be effective with
low-cost administration not be vulnerable to tax avoidance
encourage exploration and expansion of the tax base Slide 34 34
Part 3. Taxes & Incentives J. Otto What types of taxes are
assessed? What rates are imposed? What incentives are available?
Slide 35 35 Principal Tax Types & Rates Usually applied: income
tax ( 25 to 35% ) withholding tax on dividends, loan interest and
services ( 10 to 20% ) royalty ( 2-4% ) land use fees (per square
unit area, low) administrative fees and transaction charges ( low )
Rarely applied: excess profits taxes ( very rare ) import and
export duties ( zero rated or exempt ) VAT ( refunded, offset,
exempted ) free equity dividends ( indirect taxation ) J. Otto
Slide 36 36 Principal Tax Incentives Common Incentives accelerated
depreciation loss carry forward no ring fencing rules carry forward
of exploration, feasibility, development deductible environmental
and closure costs deductible community and public infrastructure
costs Less common incentives tax stabilization tax holiday or
initially reduced rates depletion loss carry back J. Otto Slide 37
37 Typical 2006 Mining Tax System Income tax30% Dividend
withholding tax15% Royalties (sales value based)2-4% Import duty on
equipmentnone Export duty on mineralsnone VATnegated
Depreciationaccelerated (5 yr) Depletionnone Ring fencingnone
Explorationamortized (5 yr) Environmental costsexpensed Tax
holidaysnone Loss carry forward5 year limit Slide 38 38 Part 4.
Analyzing a Mining Tax System J. Otto Slide 39 39 Analyzing a Tax
System In analyzing mining taxes tax, it is essential to look at
the complete system of all taxes and fees The overall tax impact on
a mine can be measured: Is there an adequate return to the
investor? Is there an adequate payment to society? Is the tax
system competitive with that in other nations? J. Otto Slide 40 40
Analyzing a Tax System Model Mine Cashflow Diagram Models can be
created for representative mines Slide 41 41 Analyzing a Tax System
- Model Mine Cashflow Diagram - Slide 42 42 - ETR: A Measure of All
Taxes Collected - What is the impact of all taxes combined? value
of all amounts paid to government Effective Tax Rate =
-------------------------------------------------- value of profits
before taxes are paid Internal Rate of Return (a measure of
profitability) Analyzing a Tax System Slide 43 43 Ideal range ? ETR
= 40 to 50% Slide 44 44 Using mine models, it is possible to
analyze the impact of: changing any existing tax rate adding a new
tax deleting a tax offering tax incentives any combination of tax
reform Mine model analysis: can be applied to an individual mine or
to a sector-wide analysis Analyzing a Tax System Slide 45 45 Part
5. Recommendations Slide 46 46 Mining Tax Policy It is in the
interest of both parties to obtain successful projects Dont kill
geese that lay golden eggs - leave enough eggs to grow the flock
Slide 47 47 Conclusion Countries compete for investment Investment
will flow to where geology is attractive, regulatory systems are
workable, and taxation is reasonable Tax systems are converging,
need to be competitive Tax systems should accommodate low and high
prices Well designed tax systems can provide a fair contribution to
the treasury ARE YOU COMPETITIVE? ARE YOU TOO GENEROUS? Slide 48 48
Dont expect mines to carry too heavy a burden - every one wants a
bigger piece of the pie - Can it carry one more stakeholder and
still remain viable?
