1 Some Economic Implications of Mining Taxation and What Does a
Good Mining Taxation System Look Like Graeme Hancock Oil Gas and
Mining Policy Department (COCPO) The World Bank Slide 2 2 Some
Fundamental Concepts in Mineral Economics Grade = concentration of
valuable mineral element within a rock mass. e.g. 1g/t Au or 0.5%
Cu Ore = rock which is economically viable to mine, where the value
of the metal exceeds the costs of mining, processing, (crush,
extract and purify) and marketing the commodity Waste = rock where
the grade is insufficient to cover the costs of processing and
marketing Cut-off grade (or breakeven grade) = The grade or
concentration of mineral in rock where the value of the metal
equals the costs of mining, processing and marketing the contained
commodity Slide 3 3 Some Fundamental Concepts in Mineral Economics
Minerals are fundamental to sustainable development and maintenance
of a developed lifestyle every commodity we use is either grown or
mined or synthesized from products that are either grown or mined
Take a moment to examine that statement If you drove to work, you
did so in a pile of minerals fueled by petroleum (liquid minerals)
- or perhaps by metro a pile of minerals powered by coal and
uranium (for electricity generation). The mineral resources of the
earth are virtually limitless, what constitutes ore is a function
of commodity price, technology, extraction cost and government
policy Slide 4 4 Some Fundamental Concepts in Mineral Economics
Most people are of the misconception that when you go to a gold
mine you dig gold or at a copper mine you dig copper. Wrong At both
mines you dig rock of which a tiny fraction will be gold or copper
Open cut gold mines these days average 1-3 grams of gold per tonne
of rock (i.e 1-3 ppm) Open cut copper mines average 0.5 - 0.6%
copper (or 5 - 6kg of copper per tonne of rock) Slide 5 5 1 2 3 4
Slide 6 6 Slide 7 7 At 0.4% Cu cutoff grade Mineable resource =
500Mt Average grade = 0.7% Cu Total tonnes of saleable copper =
3.5Mt At 0.2% Cu cutoff grade Mineable resource = 1000Mt Average
grade = 0.5% Cu Total tonnes of saleable copper = 5.0Mt Slide 8 8
Increase in commodity prices Improvements in Mining or Processing
Technology Reduction in unit operating costs Reduction in taxes on
inputs e.g. royalties duties etc What Factors Contribute to Lowered
Cutoff Grades Results in: Longer mine life Greater utilization of
resources Higher overall value of production Slide 9 9 Falling
commodity prices Increasing unit operating costs Increases in taxes
on inputs e.g. royalties duties etc What Factors Contribute to
Increased Cutoff Grades Results in: Shorter mine life Poorer
utilization of resources Lower overall value of production Slide 10
10 A quick example Gold price today is approx US$ 670 / troy oz 1 g
= US$21.50 A cutoff grade of 1g/t means it takes $21.50 to mine,
process and market to gold extracted from 1 tonne of rock Copper
price today is approx US3.60/lb ($7940 /t) A cutoff grade of 0.2%
Cu means it takes $15.80 to mine, process and market the copper
extracted from 1 tonne of rock For a high grade copper mine with
average grade 1% copper a royalty rate of 5% would at present
equate to an increase in cutoff grade of 0.05% Cu or in our example
from 0.2% to 0.25% cutoff grade with a corresponding reduction in
resources of approximately 100Mt grading 0.225% copper or
approximately 225000 tonnes of contained copper valued today at
US$1.8 billion Slide 11 11 Cut-off grade and the fallacy of
diminishing resources In 1972 Meadows and the Club of Rome declared
that by the year 2000 the world would have exhausted all reserves
of copper And yet today we have more undeveloped copper resources
in the ground than at any point in our collective history Meadows
failed to recognize that changes in commodity prices and advances
in technology turn waste into ore! However, royalties and input
taxes turn ore into waste Slide 12 12 Key Issues in Designing a
Mining Tax System What is Unique about the Mining Sector? Large
diversity of mineral types (sand, dimension stone, coal, base
metals, gold, diamonds) Diversity of scales of operations (from
very small to very large scale) Significant exploration
expenditures and risk will precede startup of mining, exploration
expenses will occur long before taxable income is available or even
a decision to mine Mine development is often hugely capital
intensive Capital is captive you cannot move the mineral deposit
Slide 13 13 Key Issues in Designing a Mining Tax System What is
Unique about the Mining Sector? Mines will initially import most of
their specialized capital equipment Most mineral products compete
in an open market where they are price takers Different minerals
have very different labor, cost, price, and environmental and
social impacts When mining ceases there is no income to deal with
mine closure and environmental costs Mines may have either long or
short lives Minerals are usually the property of the State
Commodity prices are often highly cyclical Slide 14 14 Australia
Canada USA Rest of World SE Asia / Pacific Latin America Africa
Exploration Investment is Cyclical usually a response to prices
From Otto 2006 Slide 15 15 Price and Exploration Cyclicity 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 Source MEG and Otto Many Countries lowered
taxes in the period 1997-2002 to attract new investment Temptation
to raise taxes or in some cases to nationalize - often due to
regressive tax systems and politicians feeling that the country is
not getting a fair share Slide 16 16 Key Issues in Designing a
Mining Tax System Dealing with Cyclicity When prices are high:
Surpluses are available to be taxed Special taxes may be levied:
e.g. additional profit tax, graduated (sliding scale) royalty When
prices are low: Without relief from input or revenue based taxes,
mines may become loss making and close This can result in both
short and long term fiscal reductions Possible Approach: loss carry
forward, discretionary relief from royalty Optimally you design a
tax systems which can cope with Both the ups and downs of commodity
cycles Slide 17 17 Key Issues in Designing a Mining Tax System Why
Fiscal Stabilization Investor Risk Mitigation Company perspective:
Need to provide assurance to lenders that cash-flow will be
sufficient to meet repayments Reduces risk that a mine may be
subject to increased taxes (moving the goal posts) once the capital
is captive but before payback is achieved Government perspective:
Administrative challenge: different mines will have different tax
systems Should we bind the hands of future lawmakers? Should a
risk-premium be paid? ( e.g. Peru, PNG, Chile) How long? For the
financing period? 10 years? Life of mine? Which mines (all, or only
large mines)? Which taxes? Slide 18 18 Key Issues in Designing a
Mining Tax System How to Influence taxpayer behavior: some examples
Encourage value added processing: High royalties on ore, lower
royalties on concentrates, lowest royalties on metal free trade
zones & special industrial zones that provide reduced tax
regime Encourage exploration: Double deductions for exploration
costs (Argentina, PNG) Encourage R & D: Tax credit for approved
research to improve mineral processing Slide 19 19 Should a
Government treat mining taxation differently or should it tax
mining the same way as all other sectors of the economy? Almost all
Governments choose to have some specific provisions for Mining and
some Governments have entirely separate mining fiscal codes Slide
20 20 Key Issues in Designing a Mining Tax System Characteristics
of a good mineral tax system: From the Investors viewpoint 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 penalize increased efficiency
encourage investment in exploration encourage investment in
marginal mines Slide 21 21 Key Issues in Designing a Mining Tax
System Characteristics of a good mineral tax system: The
Governments view Tax system should: maximize the value of tax
revenue support macroeconomic stability by providing predictable
and stable tax revenues capture more revenues during periods of
high profits capture more economic rent from extraordinarily low
cost, or high grade mines be effective with low-cost administration
not be vulnerable to tax avoidance encourage exploration and
expansion of the tax base Slide 22 22 So What constitutes an
optimum tax policy? Remember our cutoff grade lesson? Mineral
taxation policy which promotes resource wastage e.g. royalties,
levies and other taxes on revenue, and input taxes such as duties
and land use fees cause companies to increase cut-off grade and
waste potentially viable resources. This results in reduction of
the size of the resource, reduced total value of production, and
shorter mine life So how do countries balance the competing
positions of revenue maximization vs resource use optimization
Slide 23 23 Main Mining 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: Additional profits taxes RRT (very rare ) import
and export duties (zero rated or exempt ) VAT (refunded, offset or
zero rated ) free equity dividends ( indirect taxation ) Slide 24
24 Main Mining Tax Incentives Common Incentives accelerated
depreciation loss carry forward no ring fencing rules carry forward
and amortization of exploration, feasibility, development costs
deductible environmental and closure costs deductible community and
public infrastructure costs Less common incentives fiscal
stabilization tax holiday or initially reduced rates Depletion
allowances loss carry back Slide 25 25 Typical Components in a
Modern Mining Tax System Income tax30% Dividend withholding tax15%
Royalties (ad valorem)2-5% Import duty on equipmentnone Export duty
on mineralsnone VATnegated Depreciationaccelerated & pooled
Depletionnone Ring fencingnone Explorationamortized (5 yr)
Environmental costsexpensed Closure costsdeductible closure fund
Tax holidaysnone Loss carry forward7 year or unlimited Slide 26 26
How to Perform a Comparative Analysis of Tax Systems In analyzing
mining tax systems, it is essential to look at the complete system
of all taxes and fees rather than at individual rates in isolation
Need to establish the total effective tax rate (ETR) which will be
imposed on a mine The best way to do this is to use a standardized
mine model and apply all applicable taxes for each country in that
one model and compare the outcomes this has been done by Prof James
Otto and the Colorado School of Mines Slide 27 27 Effective Tax
Rate: the combined impact of all taxes value of all amounts paid to
government Effective Tax Rate =
-------------------------------------------------- value of profits
before taxes are paid But the ETR is not the complete story,
because the ETR does not tell you anything about the timing of tax
payments Note in the following slide that although Chile and
Western Australia have the same ETR they have significantly
different investor rates of return because WA does not offer
accelerated Depreciation whereas Chile does Note also that in Fiji
a 3% royalty increases the ETR by 6.5% Comparative Analysis of Tax
Systems Slide 28 28 CountryInvestors Internal Rate of Return (%)
Effective Tax Rate (%) Lowest taxing quartile Sweden15.728.6 W.
Australia12.736.4 Chile15.036.6 Fiji (no royalty)14.537.6
Zimbabwe13.539.8 Argentina13.940.0 China12.741.7 Fiji (2%
royalty)13.642.0 Second lowest taxing quartile PNG13.342.7
Bolivia11.443.1 Fiji (3% Royalty)13.244.1 South Africa13.545.0
Philippines13.545.3 Indonesia (7 t h, COW)12.546.1
Kazakhstan12.946.1 Slide 29 29 Ideal range ? ETR = 40 to 50% From
Otto 2006 Slide 30 30 Division of Mine Revenues A Typical Medium
Sized Copper Mine (50% Effective Tax Rate) Contractors Suppliers
Infrastructure Others Wages Consumables Spares Power Water
Community? New exploration New mines Dividends National?
Provincial? Local? Banks From Otto 2006 Slide 31 31 Conclusions
Countries compete for mineral sector investment and generally offer
terms of ETR between 40 and 50% Investment will flow to where the
geology is attractive, the regulatory systems are workable, and
taxation is reasonable and predictable Tax systems are converging,
there is a need for countries to be competitive without sacrificing
too much revenue provide incentives for exploration and increasing
the NPV of investor without changing the ETR Tax systems should be
responsive to periods of low and high prices many are currently
slightly regressive Well designed tax systems can provide a fair
contribution to the treasury whilst still promoting new investment
Slide 32 32 Dont expect mines to carry too heavy a tax burden Can
it carry one more input tax and still remain viable?
