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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.

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Presentation on theme: "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."— Presentation transcript:

1 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

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

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

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)

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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

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

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

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

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

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

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

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

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

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

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?

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

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

20 20 Key Issues in Designing a Mining Tax System Characteristics of a good mineral tax system: From the Investor’s viewpoint 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 penalize increased efficiency encourage investment in exploration encourage investment in marginal mines

21 21 Key Issues in Designing a Mining Tax System Characteristics of a good mineral tax system: The Government’s 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

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

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 )

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

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

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

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

28 28 CountryInvestor’s 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

29 29 Ideal range ? ETR = 40 to 50% From Otto 2006

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

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

32 32 Don’t expect mines to carry too heavy a tax burden Can it carry one more input tax and still remain viable?

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