Government participation in mining projects : Fiscal, financial and regulatory implications for developing countries

Government participation in mining projects

Fiscal, financial and regulatory implications for developing countries

Gerald Padmore

Governments of developing countries may obtain ownership participation in national mining projects in the hope of receiving greater policy control over, financial rewards f rom, and information about such projects. These objectives could be achieved by using their sovereign authority to tax, regulate and monitor projects more effectively. The principal problem is likely to be the administrative inability fully to enjoy rights that they lawfully possess. As such projects are nearly always controlled by foreign entities, and involve the exploitation of irreplaceable mineral wealth, they may engender feelings of suspicion and hostility. Government participation may sometimes be necessary to mitigate those feelings and to lead to more stable and successful projects. I f these political objectives are fully recognized, then government participation may be structured so as to minimize any detrimental effect it might have on the fiscal and financial structure of the project. It may also prove to be a vehicle f o r future participation by private local interests, thereby eliminating the alien enclave feature generally characteristic of such projects.

Governments of developing countries often obtain an ownership participation in mining projects within their borders. They do so with the objective of receiving both a greater and fairer share of the financial benefits of such projects and also more information about and greater policy control over them. But those objectives can be achieved in other ways.

A government that has an ownership share in a mining project, has a right derived from that ownership to participate in the management, and direct the affairs, of that enterprise subject to the rights of the other owners, if any, and to any agreement among them. It also has the right, with the other owners, to share in the financial benefits generated by the project. But since, as regards a businessenterprise within its jurisdiction, a government also has the sovereign authority by regulation to direct its affairs in ways it deems important and, by taxation, to obtain a financial benefit, the question arises as to what else, if any-

Gerald Padmore. an attorney who specializes in international business transactions and commercial litigation, is with Cox. Buchanan and Padmore. PC, 1775 Sherman Street, Suite 2SOl. Denver, Colorado. USA 80203-4322.

thing, is to be gained by its being an owner; and if so, at what price?

The first answer is an ideological one. Some governments believe that the ‘commanding heights of the economy’ or substantially all of the ‘means of production’ should be owned collectively through the government. With recent changes in eastern Europe and the former USSR, however, this ideological im- perative carries less force now than at any time in the past 70 years.

The second answer arises from nationalism. Most mining projects in developing countries are foreign owned or controlled. Such ownership or control by foreigners gives rise to popular concern about foreign domination of national economic activity. One author has correctly pointed out that this concern is not merely the product of sporadic anti-foreign feelings, but rather involves a ‘rational process . . . [designed] . . .to maximize local benefits from foreign investments . . . ’ [2]. National participation serves both to mitigate such concern and to provide a perceived basis for maximizing benefits.

This paper will analyse the benefits and detriments of government ownership participation in mining

132 0165-0203/92/020132-09 0 1992 Butterworth-Heincrnann Ltd

Government participation in mining projects: Gerald Padmore

typically are quite large relative both to other business enterprises in the country and, sometimes, to the entire national economy. In both respects, they may more easily be isolated and targeted for special treatment in a way that need not affect purely local enterprises. For example, special taxes on gross sales or gross exports, or even on net income, may be set at levels of income or receipts which are sufficiently high so that domestic producers in many developing countries would suffer no ill effect. So because of their size, and because they tend to be foreign owned, mining projects offer a tempting target for discriminatory treatment (or, in times of upheaval, for fiscal disruption).

If the government owns the project entirely, then these fiscal issues may not arise. But even government ownership often involves foreign management. In that event, the government may find that it has created new difficulties for itself by, in effect, aligning with a foreign group.

Moreover, when the government is the sole owner of the project, the temptation becomes overwhelm- ing to permit political considerations to dominate in the management of the mining company. Manage- ment jobs become a source of political patronage and are handed out with that in mind. In a recent report, the World Bank points out that state-owned mines have ‘generally failed to mobilize the investment funds necessary to maintain a steady growth of production’, and that their efficiency has been jeopard- ized by ‘political intervention in mine operation and management’ ([9]. p 125).

More recently, the trend has been away from sole or majority ownership of mining enterprises by governments and towards at best minority ownership ranging from 5-35% ([I], p 52). When the government owns only a share of a mining project, or owns no share at all, the question of what its share of the take will be, and how that is to be calculated, assumes paramount importance. Putting aside as a focus of negotiation the indirect, and often more substantial, benefits that accrue from a mining project, such as employment, infrastructural improvements and in- creased demands for local goods and services, the parties tend to focus on the direct fiscal or financial benefits accruing to each side.

A prudent private investor looks to the total direct financial share that the government demands in de- termining whether or not the investment is desirable. In one respect, the private investor may not care whether or not the government receives its share in the form of royalties or income or other taxes, duties or fees, or as a ‘dividend’ or other share of profits. The bottom line appears unaffected by the method adopted.

projects from the standpoint of fiscal, financial and regulatory issues. If such benefits as exist are prin- cipally political, rather than fiscal, financial or regulatory, then in deciding whether or not to participate in a mining project as an owner, and if so how and to what extent, a government should evaluate its objectives in those terms. The goal should then be to respond to political imperatives while minimiz- ing, or neutralizing, the effect o n the government’s investment, financial and regulatory objectives of its ownership participation.

Fiscal effects of participation Two broad fiscal issues are critical to mining projects in developing countries. The first is how the pie is to be split. That is, what portion of the take from the project will go to the government and what portion will be available to private investors. The second issue, having decided on the first, is the extent to which this original decision is to be maintained for the life of the project or the extent to which it may be modified. The private investors tend to favour a deal that is absolutely binding and unchangeable except with the voluntary acquiescence of each side. This bias arises because the private investors, bound by economic and financial constraints, will not go forward with the project unless the basic terms as origi- nally negotiated are acceptable. And they will not continue a project when events make it significantly uneconomic to do so over the long term. The government, on the other hand, prefers a greater degree of flexibility so that it may obtain more favourable terms as the years go by, particularly if the project proves to be spectacularly successful.

Both parties operate, in the initial stages, with some degree of uncertainty. Depending upon the project, this uncertainty may arise from basic geo- logical questions such as whether or not a commercial deposit can be found, o r a known deposit will in fact prove to be commercially valuable. It may also arise from market concerns, such as whether or not reasonable prices can be expected during the life of the project (or most critically, at the inception of production). The private investors will also be concerned about political risks associated with operating in a foreign country, particularly a developing one, such as the risks of expropriation, delay, interruption or destruction of the project because of revolution or social instability and upheaval, rapid political or ideological changes, and war or insurrection.

These problems may be particularly acute for mining projects in developing countries because such projects tend to be foreign owned and controlled, and

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But in reality, the private investor generally prefers that the largest part of the government’s share from a mining project should bear a relationship to the success of the project, and become payable only after successful results have been realized. The requirement to pay import duties, for example, on mining or construction vehicles and equipment, is not favoured. Unlike payments derived from profits, such payments are required to be made before profits, or even revenues, have been generated from the project. They increase investment cost and, therefore, the amount that the private investor has at risk.

Charges, such as royalties on the value of minerals, excise taxes and land rental fees, must also be paid even if a mining project is not profitable. Therefore, the private investor will prefer that the greatest pro- portion of the government’s take should be received from net profits.

Sometimes deliberately, as an investment incen- tive, and other times inadvertently, governments of developing countries permit special or extraordinary charges to be taken against income so as to reduce, or defer the recognition of, net profits subject to taxation or distribution. For example, the private investor may be allowed to depreciate assets on a much faster basis than either ordinary practice or the reasonable lifetime or durability of those assets would dictate. Furthermore, private investors may be permitted to write off immediately, or over a short period of time, all pre-operational expenditures, rather than amor- tizing or charging them in increments either over the presumed life of the project, or over some other extended time, as good accounting practice requires. If a private investor may thereafter carry forward excess losses incurred in one year to reduce taxable or distributable profits in future years, it may obtain a significant benefit. Such accounting charges are, after all, only indirectly, if at all, related to the cash generated in a given year by mining activities. Thus, the private investor may be able to retain, rather than dis- tribute to the government or pay in taxes, cash which may then either be applied to recover its initial investment or set aside as a reserve for reinvestment in the project itself.

As it happens, the calculation of net profits is generally such a complex matter, even when all parties are acting in good faith, that many developing countries may lack the administrative capacity fully to monitor whether or not they are receiving an appropriate and agreed share of net profits. Moreover, if the structure of the system for sharing profits with the government, whether on a tax or other basis, is not carefully designed, the developing country may find that in actuality it receives little or no tax or profit

sharing revenue even from a project that is quite successful.

Many specific devices have been employed to reduce the government’s ostensible share of the take in mining projects. They are quite well known, and generally beyond the scope of this paper. Nevertheless, it is worthwhile to mention a few to illustrate a point. We have already mentioned accelerated depreciation allowances, rapid amortization of pre-operational expenditures and loss carryforwards, (or back) to a future (or past) year. These devices are quite appropriate incentives utilized by many countries, but must be evaluated in any given instance in the light of other features of the tax or profit-sharing system so that they are not overly generous in the aggregate.

Excessive debt financing of projects, particularly when that financing consists of loans from related entities, will increase interest payments to the lenders and greatly reduce the government’s share of distributable profits or taxable income. Sometimes governments have agreed to receive dividends, or a profit share, in lieu of some or all income taxes. In such cases, amounts required to repay the principal of project debt may also reduce the net amount available for sharing with or payment to the government.

Because of its expertise, the foreign partner generally insists upon and is granted the right to manage the project and to provide marketing and sales services. Management and sales fees for such services may represent another benefit to the private investor that is deductible from net profits to be shared with the government. In some cases, these fees have been quite high and, like interest charges paid to foreign lenders, exempt from local taxation. Other types of ‘transfer pricing’ may arise from sales of minerals to affiliates or related entities, as well as from purchases of goods and services at a premium so that the foreign partner obtains a hidden tax-free dividend both directly, due to the premium, and indirectly, as a charge against distributable or taxable profits.

But the important point to keep in mind is that these problems may exist whether or not the government gets its profit share merely as a regulatory and taxing authority or as a participant and owner. If the government is a participant and owner, i t receives its share through a net profits calculation, just as it does when it taxes income. Additionally, the basis and computation of taxes, fees and payments to the government do not change because the government is a participant, as opposed to a mere taking authority, in a given project. These changes are imposed by the government as government (eg income and import or export taxes or duties), or as the owner of mineral rights or land (eg royalties and land rental). There is no necessary nexus between, on the one hand, the im-

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created whenever the participants are entitled to take a share of production, because the calculation of sale income in those circumstances is highly subjective, or the government may have to examine the income of a number of separate entities.

Other arguments exist to support government ownership participation in mining projects. Such participation is said to permit the government to share in ‘any high dividends resulting from unexpectedly higher mineral prices or other unanticipated favourable developments such as discovery of ore bodies of far higher tenor than initially expected by either side’ ([4], p 163). But given the complexity of net profits or dividend calculations, and the unpredictable consequences of other factors such as management and sales costs, it is questionable that any greater benefit is received in such cases through an ownership share than through direct taxation. Indeed, having an ownership share does not by itself result in a greater percentage of the take in cases where unexpectedly favourable results occur. I t may merely lead to a greater amount of revenue at a stable percentage share. Taxes typically do the same.

It is, of course, possible to provide by an agreement or statute that the government’s share will increase if prices rise to a certain level such that higher than expected benefits are achieved, either automatically or by permitting the government to acquire a greater shareholding at a fixed price which is below market or economic value. But in effect, such a proviso amounts to a barely disguised tax, whatever it is called. In- deed, those countries that have addressed the issue of gaining a part of an unexpected ‘windfall’ have generally decided to do so directly by using a tax mechanism tied either to market prices ([3], pp 638-640) or, so as not to discourage good management practices and further investment, to an index and a specified level of net cash flow return to the private investor ( [ 3 ] , p 642; [5], pp 65-66, 188-190). These systems represent a less cumbersome way of achiev- ing the objective. Among other things, their effect is reversible automatically from year to year depending upon results, and they do not result in the unintended subsidiary effects that may accompany changes in ownership share (eg such as on voting weight or the right to control project policy and management deci- sions implied by a change in relative ownership share).

The government’s right to receive royalties derives in theory from the fact that most governments of developing countries (and indeed those of many de- veloped countries with the notable exception of the USA) own all subsoil minerals. Therefore, as any private owner would be, they are entitled to a royalty for the extraction and sale of those minerals. This

position, basis and computation of such charges and, on the other, the government’s participation or non- participation in a given project.

But some negative effects may flow from the decision by a government to participate in a mining project as an owner rather than merely as a regulatory and taxing authority. In Liberia, iron ore projects that went into production about 30 years ago provided that the government would receive a 50% ownership share of each project in lieu of income taxes. As the Liberian government soon learned, the right to dividends as a 50% shareholder is quite different from the right to a 50% tax on net profits. Generally, a 50% tax yields more revenue to the government than a 50% share of stock or other ownership interest, although i t is possible to structure the shareholder or participants agreement so as to avoid this result. Dividends, in the case of corporations, are ordinarily paid only out of surplus funds. Their payment depends upon and is subject to cash flow requirements. The directors, as a matter of law or prudence, take into account not only net profits but also debt servicing (ie both of principal and of interest) and capital reserve requirements in deciding on the amount of dividends to declare. As a shareholder, a government is subject to these determinations. As a taxing entity, i t is not.

A similar result may occur in the case of joint ventures. Although all joint venture net profits are typically attributed pro rata to the participants in accordance with their interest, only net cash flow may be distributed, and the explicit requirement generally exists that each participant must proportionally meet capital calls required to fund future project needs. The failure to make such capital calls may result in the reduction of one’s share in the venture and therefore of one’s share of future profits.

Given those constraints, one observer has stated that even a majority ownership by a government ‘can be quite meaningless’ ([8], p 18). He referred to the fact that, in the past, ‘agreements concluded with government majority in Guinea (both with Western companies and the USSR) have generated relatively little income to the government’ ([8], p 19).

It is true that if the government is one of several participants, then it may rely upon the self-interest of each of the other participants to ensure fair accounting for profits and the elimination of transfer pricing devices. However, collusive practices may occur even in those circumstances. And, in any event, the government may be able, solely as a taxing authority rather than as an owner, to establish a basis for the calculation of taxes which follows the system used by non-collusive participants to allocate profits among themselves. In either case, a degree of complexity is


Government purticipution in mining projects: Gerald Pudmore

theoretical justification for royalties to governments makes good sense. But we need to keep in mind that the private investor will still combine the royalty imposed with other taxes or profit sharing portions taken by the government in deciding whether or not the project is attractive. So the government’s share tends to be lumped together even though we can readily distinguish between those elements that a government is entitled to take as sovereign and those that it is entitled to take as an owner of the minerals themselves.

Because royalties are a charge against the private investor regardless of profitability, some have suggested that the royalty might be reduced or elimin- ated in return for government equity in the project. This equity would not be ‘free’ because it would be obtained through the relinquishment of a valuable right. In some cases, the government may also finance infrastructure (perhaps using its access to concessionary financing rates) in return for which it would receive either user fees and/or equity in the venture.

With regard to the reduction or elimination of royalties in return for equity, this proposition may be attractive in the case of certain marginal projects. It provides the government with a share to which it is entitled, but does not require the private investor to make payments even when a project is not profitable. On the other hand, even as to such projects, there is a substantial risk. A royalty is ordinarily paid irres- pective of profitability. Although burdensome, such payments may be appropriate because the mineral extracted and sold is a depletable resource that should not be sold over an extended period on a non- profitable basis, without any payment to the government. Furthermore, the royalty is generally a much simpler levy to calculate and collect than a profit share or income tax. In some cases, however, a reduced level of royalty in exchange for equity may be an acceptable middle ground.

Government financing of infrastructure is sometimes useful. But it requires the government to use up some portion of its general borrowing capacity for a specific project, thereby reducing its ability to borrow for other (often non-commercial) national purposes. My view is that, in the ordinary case, resort to either of these approaches should not be taken.

Legal and financial consequences There is a fundamental legal consequence which arises when a government participates in a mining project (or in any other venture) either as a shareholder or as a partner or co-venturer. Anglo-US statutory law and common law legal concepts in general impose upon a shareholder, a partner and a

co-venturer a special or fiduciary duty towards fellow shareholders, partners and venturers. Additionally, each is held to owe a duty of loyalty to the enterprise itself which prevents it from appropriating legitimate enterprise opportunities for its own benefit (although this duty may be quite limited in the case of a single purpose joint venture). Those participants who, by virtue of their special status, have access to the enterprise’s plans and business information, should not make use of them in a disloyal manner. Yet, governments almost always will have sharply divided loyalties. Can a board or committee of directors or participants truly function as it should in evaluating, for example, the tax implications of a proposed activity, or ways to minimize the tax effects of that activity, when one of its members is the tax collector itself? Can an entity be assured that its intentions towards a prospective deposit will be kept in confidence by a government that may wish to have one or two other interested parties also bid for the rights to that deposit?

In some respects, this special duty may be said to have been eroded once the participants have ac- cepted the host government among their ranks, because it may be implicit that the government cannot fully assume that duty, and all would be fully aware of an inherent conflict of interest. But this dichotomy may yet lead to litigation or arbitration, particularly when the applicable laws governing the venture are those of a jurisdiction that strictly imposes such a duty.

More fundamentals problems arise with regard to the question of how the government should finance its interest. If the government is to be a true owner- participant (analogous to its independent role, for royalty purposes, as the owner of the minerals), i t should pay for its share and contribute financially to the project just as any other participant would do. I n that case, the government would be entitled to receive not only dividends or a profit share as would all other participants, but also income taxes at the rate provided by law (or negotiation). The other participants would hardly be able to complain about the combined amount of profit share the government would thus receive since presumably it would be com- mensurate with the risk the government has taken and the capital the government has invested, added to a reasonable level of taxes on income.

The real problem with a government making this sort of investment and taking this sort of risk is that developing countries, with certain notable exceptions (eg the low population, wealthy oil-producing countries), cannot afford to apply very scarce resources to what are generally highly risky mining enterprises. Even where the risk is (or is perceived to be) quite

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low, the fact remains that other sources of capital are generally available for those projects that, in purely economic and financial terms, justify the application of such capital. I t is much more difficult, however, to find sources of capital for those investments that uniquely are the responsibility of governments. Perhaps the most important prerequisite for growth, development and future prosperity is that a government invest in its people. This means that scarce capital made available to the government either from its own resources or from institutions like the World Bank should be applied first to ensuring that the health, educational and nutritional needs of the people are met so that they may be productive and dynamic contributors to the society. That kind of capital is scarce. Capital for mine ventures typically is not.

Another problem associated with government equity participation in mine projects is that the financial obligation does not stop with the initial investment. In order to maintain its relative share, the government must be prepared to provide additional equity financing as required. For example, despite the very thoughtful approach taken by the Papua New Guinea government with regard to the Ok Tedi project, requirements for additional financing led to a period during which the government’s share was reduced. According to one author, the PNG government has since restored its holding to the previous level [6]. Such a restoration may not be possible unless the relevant investment agreement gives the government that option. This entire area may become the subject of quite complex negotiations to assure that, on the one hand, the government is not exposed to manipulation by business interests which result in a diminution of its share and, on the other hand, the government is not given any special treatment as a participant different from that given to any other participant ( [ 5 ] , pp 115-122).

Is there a plausible argument that a government as sovereign should have special rules applicable to itself such that it should not be required to participate in future equity financing in order to maintain its original level of participation? Certainly the parties could so agree. And creditable arguments in favour of that proposition could be made on a number of grounds. But such arguments could equally support the government’s right to obtain a shareholding without making any equity investment whatsoever. In other words, however posed, such a proviso amounts in effect to a form of taxation and would have to be recognized as such and taken into account in evaluating the overall tax burden to be carried by the project. If the government is to be a participant like any other participant without regard to its role as a taxpayer, then it must play the game as all other participants do.


In many respects the most difficult problems that arise when a government is a participant relate to the provision of loan financing to the project. When loan capital is provided to the project based on, and subject to, the credit and guarantees of the participants, the government as a participant will also be called upon to provide such guarantees. Indeed, when the government is the only participant, such guarantees become a major drain on its own borrowing power. These problems have been documented with regard to the copper industry in Zambia and Zaire ([7], pp 106-109). The reality is that even national governments have only so much borrowing power. And regardless of the borrower, lenders may impose limits on the loans made to projects in one country (unless secured by the credit and assets of outside entities). When that borrowing power is used for mine projects, i t may not be available for other purposes. When those mine projects are not well and efficiently run, the availability of additional borrow- ings may actually contract rather than increase as they would with well-run operations. This lesson, according to one author, Zambia learned to its dismay in managing its copper industry [7].

Sometimes, ‘project financing’ is employed so that guarantees from the participants are not necessarily required, except a guarantee of completion of the project in accordance with feasibility and other studies ([S], p 177). Project financing, unlike more traditional financing, became necessary as the equity available to finance mine operations contracted both because of economic conditions during the 1970s and because the size and cost of mine projects grew. Pro- ject financing ‘emphasizes anticipated cash flow from an operation rather than the creditworthiness of the sponsoring company . . . the assembling of a variety of different sources of capital; and, most important, . . . as wide a sharing (or ‘syndication’) of the risk involved as possible’ ([7], p 107).

However, completion guarantees may still involve a commitment to assure adequate levels of future debt and equity financing such that the project can go forward as planned. More than that, the government in particular must take into account how such financing, guaranteed as it is by project assets and cash flow, ties in with the government’s desire to maintain effective control over its natural resources.

Pintz, describing project financing concerns in the Ok Tedi project, questions ‘the implications of con- tingent liabilities and the mortgage rights that lenders require over a project’s mineral base, (ie over a developing nation’s resource sovereignty)’ ([S], p 177). Does a default (even in a project in which the government is not a participant) mean that the lenders can assume control of the mineral deposit and other min-


Government participutiorl in mining projects: Gerald Padmore

ing assets and convey them to any willing third party buyer? On the other hand, if the government has an absolute right of veto over such default conveyances, will lenders be prepared to lend to a project if the asset security nominally given them will, in fact, be valueless? Some compromise must be found involving either the government’s own purchase of the project from the lender o r an agreed formula or other basis for the purchase of the assets by qualified mining private investors ( [S] , p 123).

But if a participating government insists that it should not bear any responsibility for financing the project, it may be pressured to agree that all debt servicing and some special equity financing in the form of preferred stock should be paid prior to any payments to it as a participant. The Liberian government agreed to such provisions in the LAMCO iron ore project.

I t is with this background in mind that I will now discuss so-called ‘free equity’. What is the role of this free equity and what purpose is it intended to serve? Typically, at levels of 5-35%, it does not provide control ( [ I ] . p 52). Presumably, it conveys a right t o dividends or a profit share. This means that it is, in effect, no different than an income tax (although the payment of this dividend or profit share may be subject to the constraints, legal and financial, previously described). Being free, it should be at a fixed level, carrying with i t no responsibility to meet capital calls or t o guarantee loans. In other respects it is presumably treated like other equity.

One of the better arguments for using some form of free equity to obtain a profit share is that it may permit a government to alter or adjust (and the flexibility to do so) the share to be received from a given project depending upon how good a project it proves (or is expected) to be. Thus, it becomes a way to discrimin- ate, by varying the level of ownership, among projects at the upper or lower end of feasibility, and to do so for the industry as a whole without affecting generally applicable tax rates.

On the other hand, a dividend or profit share paid t o the government is generally not considered by most other countries to be a tax paid to that government. To the extent, therefore, that the dividend or profit share is indeed a payment in lieu of tax (ie a disguised income tax), the mining company may lose any tax credit otherwise obtainable in its home jurisdiction.

Some have criticized government participation as an equity holder on the grounds that it requires the government to wear too many different hats as tax man, equity participant and regulator, for example. These roles sometimes have contradictory objectives. Thus, the government as shareholder or taxing entity

may not prefer the project to absorb the extraordinary charges against income necessary to provide protection against environmental damage. As an equity participant, the government may be concerned that adequate reserves be set aside to fund new equipment or maintain old facilities. As a taxing entity, the government simply wants to obtain its taxes. Yet in a sense, these contradictions exist even when the government is not an equity participant. They are therefore not really a critical factor in evaluating whether or not i t should assume that role.

Governments can certainly obtain the right to sit on boards of directors or participate in joint venture participants’ meetings whether or not they themselves are shareholders or participants, merely by requiring it in the relevant investment agreement or in the mining code. Any information available to a participant (and more) can by agreement or statute be required by the government as sovereign. The effectiveness o f this flow of information or, indeed, of regulatory activities generally, depends much more on whether or not the government has the technical and administrative capacity to enforce its authority and lawful rights than on whether or not it is an equity participant in a project.

Symbolic equity and national ownership If it is true that no special or significant financial, fiscal or regulatory benefits are to be obtained specifically from government ownership participation in a mining project, and that, indeed, significant detrimental effects may result, should a government ever take an ownership stake in a mining project‘?

The answer lies in re-examining what I believe are the true and valid bases for such participation. First, there may be circumstances in which, but for government participation, the project would not go forward. Such circumstances may exist because either no other private investors are available, or public financing (perhaps on a concessionary basis) is a necessary element. In those instances, the government must fully evaluate the direct and, most importantly, indirect benefits of the project before committing to i t . If those benefits (taking into account accompanying risks) are indeed substantial relative to all competi- tive public obligations or objectives, then the utiliza- tion of the government’s own precious and limited borrowing capacity or other financial resources may be appropriate.

Additionally, some private investors may insist upon government participation. Such participation is believed to provide secondary benefits such as, in some cases, better labour-management ties (at least

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from the standpoint of the private investor). Moreover, a partnership with government may reduce the likelihood of future expropriation while in- creasing the possibility of favoured treatment from the government. The private investors like to say to the government that they are in the same boat and if one loses money, the other also loses money. Of course, this conclusion is generally also true even when the government is merely a taxing authority.

But most importantly, mining companies must in- creasingly come to understand that the most difficult problems associated with an investment in a foreign developing country relate to the very fact that the people view the project it spawns as an alien intru- sion, a foreign enclave basically detached from the people and the country itself. That enclave may therefore attract not merely the suspicions but the re- sentment of the people of the country. Its special, alien feature makes it the more subject to discriminatory treatment ranging from outright expropriation to some of the discriminatory tax treatment previously described.

A mining concession agreement concluded in Liberia during 1988 had some interesting features. At its insistence, the government received a 40% free equity participation in the form of shares of voting stock. The mining company received 60% of the shares of voting stock. I t also received all of the shares of a special non-voting, but dividend receiving stock.

All sides recognized that this equity granted the government was designed strictly to serve symbolic purposes. Thus, these shares of stock, while endowed with the authority to elect directors and, therefore, indirectly to exercise partial control over policy, are not eligible to receive any dividends whatsoever except upon liquidation. In addition to receiving royalties, land rental payment and, to some extent, import duties and other taxes and fees, the government agreed to limit its share of profits to net income taxes of 40%.

There is considerable merit in the honesty of this approach. It does not confuse a political requirement of ownership, which should be recognized, with the really separate issue of how the government’s take from the project is to be structured. Additionally, by making it quite clear that the financing of the project would be strictly the responsibility of the private investor (and providing that at least 25% of such financing would be in the form of equity), the government avoided tying up its own financial resources or borrowing capacity, while assuring that the project’s net taxable income would not be unduly reduced by a highly leveraged financial structure. The mine company was given the right to manage the project although, with regards to its mining plan, it must

Sovernment participation in mining projects: Gerald Padmore

submit a feasibility study and other documentation for government review and approval.

Because, in effect, the mine company was the sole venturer in the project, notwithstanding the free equity held by the government, there was no need for it to receive special management fees or sales commis- sions over and above costs and therefore the agreement explicitly excluded them. Presumably, if other private venturers should invest in the project, some arrangement will have to be made between or among them regarding the payment of fees to the manager.

This entire subject is obviously a very complex one, but if government participation in mining projects is viewed, as it should be, strictly in certain limited contexts, then a government may more objectively decide whether or not it should be an owner-participant in a given mine project.

In the course of this decade and the next, many mine companies in developing countries (and else- where) should seek a genuine participation of local partners for the political protection and special know- ledge about the host country such participation will convey. Because of difficulties such private, local investors have had in raising capital, particularly in the smaller countries, special measures will need to be taken into account to increase this prospect.

The concerns of people in all societies that major economic activity should not be entirely in the hands of foreigners will not go away. I t may be that, through the device of government free equity participation, structured along the lines of the recent agreement in Liberia, a pool of available equity can be provided for future purchase by citizens and entities resident in such countries, as conditions permit. Perhaps equity or debt financing by the International Finance Corpo- ration of the World Bank will provide a mechanism for the future sale of equity in these projects at market rates to private interests in host countries (or adjoining regions) after capital markets develop or other financing alternatives become available. The challenge, and it is a formidable one, is to apply our creativity towards the development of new ways to plan and implement mine projects in future years so as to address these fundamental concerns and foster greater levels of productive investment in developing countries.

References 1 Craig B. Andrews, ‘Mining investment promotion: a

view from the private sector‘, Natural Resources Forum, Vol 15, No 1, February 1991, pp 50-58. Beveridge, ‘Taking control of foreign investment: a case study of indigenization in Nigeria’, International and Comparative Law Quarterly, Vol304,1991.

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3 Malcolm Gillis, ‘Evolution of natural resource taxation in developing countries’, Natural Resources Journal,

Michael Gillis and Louis T. Wells, ‘Negotiating and implementing minerals agreements with multinationals: some critical tax and developmental issues, in Michael Gillis and Ralph E. Beak, eds, Tax and Investment Policy Toward Hard Minerals, Ballinger, Cambridge, MA, 1980.

5 William Pintz, Ok Tedi, Evolution of a Third World Mining Projecf, Mining Journal Books, 1984.

6 Thomas L. Reiner, ‘Government take in Pacific Rim mining and petroleum developments: the Papua New Guinea experience’, in International Resources Law, a

VOI 22, July 1982, pp 619-648. 4

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Blueprint for Mineral Development, Rocky Mountain Mineral Law Foundation and International Bar Associ- ation, Joint Program, February 1991, Mineral Law Series Vol, 1991, No 1, pp 10-1-10-28. Michael Shafer, ‘Capturing the mineral multinationals: advantage or disadvantage?’, International Organiza- tions, Vol37, 1983, pp 93-1 19.

8 Thomas Walde, ‘Methods of investment promotion in the minerals industries’, unpublished paper, delivered at IBA, New York Conference, September 1990, p 18. World Bank, Sub-Saharan Africa: from Crisis to Sus- tainable Growth. Washington, DC, 1989.

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NATURAL RESOURCES FORUM May 1992

Documents

Government participation in mining projects : Fiscal, financial and regulatory implications for developing countries