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Mining Taxation Country Risk Analysis

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					           Mining Taxation

            Professor James Otto

          Director of Graduate Studies
Environmental and Natural Resources Law Program
       University of Denver College of Law




                                                  1
                  Division of Mine Revenues
            20 Year Typical Medium Sized Copper Mine
                  Gross revenues - 3.3 billion USD
                      (50% Effective Tax Rate)
                                                       Wages
                             Banks                     Consumables
New exploration            Loan Costs
                Profits
                               2%            Operating Spares
New mines        17%                           Costs   Power
Dividends                                      44%     Water
                                                       Community?
 National? Taxes &
 Provincial? Fees
 Local?       17%


                          Capital
                                    Contractors
   Note: 50% division      Costs    Suppliers
                           21%      Infrastructure
                                    Others                  2
              Structure of Talk


• Taxation and investment

• Principal issues affecting modern taxation design

• Principal taxation methods & incentives

• Analyzing a mining tax system

• Recommendations

                                                      3
       Part 1. Role of Tax in Investment Decisions




Since 1985 over 100 countries have introduced new mining law

 Most nations have reformed or are now reforming their mining
 sector fiscal system

 Most developing and transition nations reformed so as to attract
 investors

            Has there been a race to the bottom?
               Are taxes too low? Too high?
                                                               4
           Exploration Expenditures : Gold + Base Metals
                 Exploration Investment is Cyclical
  Constant June 2002 US$ Million
$5000

                                                          SE Asia / Pacific
$4000


$3000      Rest of World


$2000
                                                                         Latin America

$1000                                                                             Africa
           USA
   $0
                               Canada
    1970      1975    1980   1985   1990   1995       2000        2005
                                           Sources : WMC, MacKenzie & Metals Economic Group
                                           Australia



                                                                                    5
                               Investment Cycle Affects All Regions
1997 – $5 billion
                                          Exploration Expenditure by Region
2002 – $1.7 billion                                   1993 -2005
2005 - $5.11600
            billion
                        1400
                        1200
      millions US$




                        1000
                         800
                         600
                         400
                         200
                               0
                                                    d
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                                                                                         ica
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                                                                 Source: MEG, WMC, ABM         6
       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      Temptation to lower taxes
      • 2002: US$1.9 billion
      • 2003: US$2.4 billion
      • 2004: US$3.8 billion
      • 2005: US$5.1 billion      Temptation to raise taxes
MEG
                   2006/7 – Top of the cycle?
               Is now a good time to raise taxes?
                                                              7
         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?
                                                          8
                              Investor Perception
                   Pure Mineral Potential Index (Geology)
    Ireland
New Zealand
    Sweden
      Spain
   Ecuador
      India
  Venezuela
     Bolivia
 Philippines
    Quebec
W.Austraila
     Congo
       Peru
     Russia

               0         20        40           60          80            100
     Geology – the most important criteria
                                        Fraser Institute Poll 2005/2006   9
     Percent of Surveyed Mining Companies That Consider Jurisdiction’s
                 Mining Taxation Regime a Strong Deterrent

      Russia
New Zealand                                       Russia, New
    Sweden                                        Zealand, Sweden
 Philippines
  Venezuela
        PNG
  Indonesia                           PNG, Indonesia,
  Mongolia                            Mongolia (before reform)
        Peru
      Congo
WesternAus
       Chile                                 Chile, Congo, Peru
       Brazil
     Mexico
      Alaska                      Ghana, Alaska, Mexico, Brazil
      Ghana

                0        25             50             75                100


                              Fraser Institute Survey 2005/2006      10
Fraser Institute Poll 2005/2006
                                        Investor Perception
                                      Policy Potential Index
        Papua New Guinea
                    Congo
                    Russia
                   Zambia
                      Peru                            Tax is part of policy
                    China
                  S. Africa
                 Mongolia
                    Ghana
                    Brazil
              W. Australia
                   Mexico
                     Chile
                   Nevada


                              0        20      40       60        80          100
                              Higher risk                      Lower Risk

              Geology must be balanced against government policies            11
         Balancing Geology and Policies in Investment Decisions

                        Overall Investment Attractiveness Index - World
            India

          Zambia
                                                                  Companies balance
 Papua New Guinea
                                                                  different factors, like
        Mongolia                                                  tax, when balancing
           China                                                  geological potential
        Indonesia                                                 and risk
           Russia

            Peru

           Brazil

      W Australia

          Nevada

            Chile
Fraser Institute Poll 2005/2006                                                      12
                    0      10    20   30    40    50   60    70     80    90   100
              Role of Tax in Investment Decisions

      Top 10 ranked Company Decision Criteria for exploration
                       (out of 62 factors)
                •   Geological potential for target mineral
                •   Profitability of potential operations
                •   Security of tenure & permitting
                •   Ability to repatriate profits
Tax related     •   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           13
            Part 2.

Principal Issues To Consider in
    Mining Taxation Policy




                                  J. Otto 14
      Principal Issues Affecting Taxation Systems

           - Primary Goal of mining taxation policy -

• to achieve a win-win situation for society & companies

   • society’s objectives: achieve development and obtain income
   at an acceptable social cost

   • company’s objective: achieve adequate return on investment



        It is in the interest of both parties to obtain
                      successful projects

                                                           J. Otto 15
      Principal Issues Affecting Taxation Systems
             The Government’s 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, shouldn’t 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
                                                                 16
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




                                                    17
      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)


                                                                18
      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

                                                               19
      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


                                                               20
      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
                                                                    21
      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                                      22
  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



                                                              23
       3.50                   Real Copper Price: 1870 – 2001
       3.00                           (US Prices, $2001/1b)
       2.50


       2.00


       1.50


       1.00


       0.50


       0.00
                                          1910




                                                        1930


                                                                  1940


                                                                         1950
                                   1900




                                                 1920




                                                                                1960




                                                                                                             2000
                            1890
                     1880




                                                                                                     1990
              1870




                                                                                       1970


                                                                                              1980
                                                           Year


Tilton 2006
                      Tax system needs to recognize cycles
                                                                                                            24
     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)          25
       Principal Issues Affecting Taxation System

                        - Tax Stabilization -
• Government perspective:
   –   Administrative challenge: different mines will have different tax systems
   –   Don’t 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
                                                                             26
       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

                                                                    27
Community related costs – deductible/credits?




   clinic / school / water supply / housing / nutrition
                                                          28
Sustainable development programs – deductible?




       improve or introduce new skills and
       capacities that will outlive the mine   29
     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


                                                                 30
     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

                                                              31
       Principal Issues Affecting Taxation Systems

          Characteristics of a good mineral tax system:
                         Investor’s view

Tax system should:

   •   maximize the net present value of the company’s 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                  32
     Principal Issues Affecting Taxation Systems

         Characteristics of a good mineral tax system:
                     Government’s 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
                                                              33
            Part 3.

   Taxes & Incentives

What types of taxes are assessed?

What rates are imposed?

What incentives are available?




                                    J. Otto 34
             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 )
                                                                     35
                                                           J. Otto
                 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
                                                          J. Otto
     •   loss carry back                                            36
           Typical 2006 Mining Tax System
•   Income tax                      30%
•   Dividend withholding tax        15%
•   Royalties (sales value based)   2-4%
•   Import duty on equipment        none
•   Export duty on minerals         none
•   VAT                             negated
•   Depreciation                    accelerated (5 yr)
•   Depletion                       none
•   Ring fencing                    none
•   Exploration                     amortized (5 yr)
•   Environmental costs             expensed
•   Tax holidays                    none
•   Loss carry forward              5 year limit


                                                         37
Part 4. Analyzing a Mining Tax System




                                 J. Otto
                                           38
             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
                                                                 39
                Analyzing a Tax System
               Model Mine Cashflow Diagram

 250
 200                                               Sales
                                                   Revenues
 150
 100
  50
   0                                               Capital
                                                   Costs
 -50
-100
-150
-200                                               Operating
                                                   Costs
-250
       1   3   5   7   9   11 13 15

  Models can be created for representative mines
                                                        40
         Analyzing a Tax System
       - Model Mine Cashflow Diagram -
150

100                                      Before Tax
                                         Cashflow
 50

  0

 -50
                                         All Taxes
-100                                     and Fees

-150




                                               41
                  Analyzing a Tax System
             - 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)


                                                                     42
                          Model Copper Mine: Comparative Effective Tax Rates
        Sw eden
Western Australia
            Chile
      Zimbabw e
       Argentina
            China
     P.N. Guinea                                                 Ideal range ?
           Bolivia
     South Africa                                                ETR = 40 to 50%
       Philippines
      Kazakstan
       Indonesia
             Peru
        Tanzania
          Poland
          Mexico
   USA (Arizona)
       Greenland
          Guinea
          Ghana
        Mongolia
      Ivory Coast
      Uzbekistan

                     0   10    20     30      40     50     60     70     80   90   100        110
                                           Effective Tax Rate - %                         43
              Analyzing a Tax System
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


                                                              44
    Part 5.

Recommendations




                  45
           Mining Tax Policy




 “Don’t kill geese that lay golden eggs -
                    –
  leave enough eggs to grow the flock”



It is in the interest of both parties to obtain
              successful projects

                                                  46
                         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?



                                                            47
  Don’t 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?
                                                      48

				
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Description: Mining Taxation Country Risk Analysis