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1 Mining Taxation Professor James Otto Director of Graduate Studies Environmental and Natural Resources Law Program University of Denver College of Law.

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Presentation on theme: "1 Mining Taxation Professor James Otto Director of Graduate Studies Environmental and Natural Resources Law Program University of Denver College of Law."— Presentation transcript:

1 1 Mining Taxation Professor James Otto Director of Graduate Studies Environmental and Natural Resources Law Program University of Denver College of Law

2 2 Division of Mine Revenues 20 Year Typical Medium Sized Copper Mine Gross revenues billion USD (50% Effective Tax Rate) Contractors Suppliers Infrastructure Others Wages Consumables Spares Power Water Community? New exploration New mines Dividends National? Provincial? Local? Banks Note: 50% division

3 3 Structure of Talk Taxation and investment Principal issues affecting modern taxation design Principal taxation methods & incentives Analyzing a mining tax system Recommendations

4 4 Part 1. Role of Tax in Investment Decisions Most nations have reformed or are now reforming their mining sector fiscal system Most developing and transition nations reformed so as to attract investors Since 1985 over 100 countries have introduced new mining law Has there been a race to the bottom? Are taxes too low? Too high?

5 5 Australia Canada USA Rest of World SE Asia / Pacific Latin America Africa Exploration Investment is Cyclical

6 6 Source: MEG, WMC, ABM 1997 – $5 billion 2002 – $1.7 billion $5.1 billion Investment Cycle Affects All Regions

7 7 2006/7 – Top of the cycle? Is now a good time to raise taxes? Exploration Downturn & Upturn Global exploration expenditure: 1997: US$5.2 billion 1998: US$3.7 billion 1999: US$2.8 billion 2000: US$2.6 billion 2001: US$2.2 billion 2002: US$1.9 billion 2003: US$2.4 billion 2004: US$3.8 billion 2005: US$5.1 billion MEG Temptation to lower taxes Temptation to raise taxes

8 8 Role of Tax in Investment Decisions Companies have many options, but only limited budgets Key factors need to be met to attract investment Companies will screen investment opportunities applying criteria balancing risk and reward How does taxation fit in?

9 9 Fraser Institute Poll 2005/2006 Geology – the most important criteria Investor Perception

10 10 Percent of Surveyed Mining Companies That Consider Jurisdiction’s Mining Taxation Regime a Strong Deterrent Ghana, Alaska, Mexico, Brazil PNG, Indonesia, Mongolia (before reform) Russia, New Zealand, Sweden Chile, Congo, Peru Fraser Institute Survey 2005/2006

11 11 Fraser Institute Poll 2005/2006 Geology must be balanced against government policies Higher risk Lower Risk Tax is part of policy Investor Perception

12 12 Fraser Institute Poll 2005/2006 Companies balance different factors, like tax, when balancing geological potential and risk Balancing Geology and Policies in Investment Decisions

13 13 Role of Tax in Investment Decisions Geological potential for target mineral Profitability of potential operations Security of tenure & permitting Ability to repatriate profits Consistency of mineral policies Realistic foreign exchange controls Stability of exploration terms/conditions Ability to predetermine environmental obligations Ability to predetermine tax liability Stability of fiscal regime United Nations Survey of 45 companies Top 10 ranked Company Decision Criteria for exploration (out of 62 factors) Tax related

14 14 Part 2. Principal Issues To Consider in Mining Taxation Policy J. Otto

15 15 Principal Issues Affecting Taxation Systems - Primary Goal of mining taxation policy - J. Otto 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

16 16 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

17 17 Principal Issues Affecting Taxation Systems - Unique nature of mining: tax policy response - Trend is to harmonize fiscal systems across economic sectors, but most nations still provide some special treatment to the mining sector

18 18 Principal Issues Affecting Taxation Systems - Fiscal diversity or uniformity within the mining sector? - Mineral type? (sand, dimension stone, coal, base metals, gold, diamonds) Scale? (panners, small scale, large scale) Nationality? (discrimination, tax treaties, foreign investment act)

19 19 Principal Issues Affecting Taxation Systems - Unique nature of mining: tax policy response - Exploration will precede startup of mining-- exploration expenses will occur before taxable income is available. Response: special provision for how pre-production / pre- income exploration expenses are handled for future income tax purposes Mine development is capital intensive. Response: accelerate recovery of capital costs once production commences

20 20 Principal Issues Affecting Taxation Systems - Unique nature of mining: tax policy response - Mine will initially import equipment from specialized suppliers. Response: low or no import duty and VAT relief Mineral product must compete for share of global market. Response: relief from VAT and export duties

21 21 Principal Issues Affecting Taxation Systems - Unique nature of mining: tax policy response - In most nations minerals are the property of the state or the public. Response: assess a royalty (a public to private ownership tax) The scale of operation may be small or large. Response: exempt small scale miners from royalty Response: vary royalty by scale of production Different minerals have very different labor, cost, price, value- added, environmental and social attributes. Response: vary royalty rate for different groups of minerals

22 22 Principal Issues Affecting Taxation Systems - Unique nature of mining: tax policy response - After mining ceases and there is no income, a mine incurs significant costs related to closure and reclamation. Response: require a tax deductible set-aside of funds early-on Mining project may have a long life span & will live through many political regimes and national economic ups and downs. Response: stabilize some taxes Scale of investment may be huge and many laws may be involved. Response: negotiated agreement, including special tax terms, supplanting general laws Response: ring fence

23 23 Principal Issues Affecting Taxation Systems Revenue raising objective: maximize immediate or long-term revenue? Cash cow? Short term maximization - government seeks to maximize fiscal revenues from every mine Grow the size of the herd? Long-term maximization - seek increased levels of investment with attractive, moderate taxes thus creating more tax-paying mines over the long-run

24 24 Real Copper Price: 1870 – 2001 (US Prices, $2001/1b) Tilton 2006 Tax system needs to recognize cycles

25 25 Principal Issues Affecting Taxation Systems Should the tax system adjust for price cycles? When prices are high: Surpluses are available to be taxed Special taxes: additional profit tax, graduated royalty Experience: almost all nations have eliminated these When prices are low: Without relief from non-profit based taxes, mines may close This can result in both short and long term fiscal reductions Approaches: loss carry forward, allow good year surpluses to offset poor years, discretionary relief from royalty Most mineral fiscal system today partially self-adjust because they are based mainly on profitability (income tax, withholding tax on remittances)

26 26 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

27 27 Principal Issues Affecting Taxation Systems Community Related Costs Policy Debate : –Should a mine be allowed a tax deduction or credit for investment in communities and public infrastructure? This will increase local benefits, but decrease treasury revenues available to benefit other communities –What types of investment qualify: hard infrastructure, recurring costs for teachers, non-essential school uniforms? Company perspective: –Such costs are an important part of doing business today and should be recognized for tax purposes

28 28 Community related costs – deductible/credits? clinic / school / water supply / housing / nutrition

29 29 Sustainable development programs – deductible? improve or introduce new skills and capacities that will outlive the mine

30 30 Principal Issues Affecting Taxation Systems - Fiscal decentralization & distribution (money is power!) - Should central government levy and collect all taxes? disburse revenues through the budgeting process a statutory percentage of some tax types automatically will be remitted by central government to lower levels of government Should different levels of government levy and collect taxes? Challenges: accountability, capacity, corruption, political will

31 31 Principal Issues Affecting Taxation Systems - Influencing taxpayer behavior: examples - Encourage value added processing: High royalties on ore, lower royalties on concentrates & metal “free trade zones” & “special industrial zones” that provide reduced tax regime (beware – transfer pricing problems) Encourage exploration: Double deduction for exploration costs (Argentina, PNG) Encourage R & D: Tax credit for approved research to improve mineral processing

32 32 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

33 33 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

34 34 Part 3. Taxes & Incentives J. Otto What types of taxes are assessed? What rates are imposed? What incentives are available?

35 35 Principal Tax Types & Rates Usually applied: income tax ( 25 to 35% ) withholding tax on dividends, loan interest and services ( 10 to 20% ) royalty ( 2-4% ) land use fees (per square unit area, low) administrative fees and transaction charges ( low ) Rarely applied: excess profits taxes ( very rare ) import and export duties ( zero rated or exempt ) VAT ( refunded, offset, exempted ) free equity dividends ( indirect taxation ) J. Otto

36 36 Principal Tax Incentives Common Incentives accelerated depreciation loss carry forward no ring fencing rules carry forward of exploration, feasibility, development deductible environmental and closure costs deductible community and public infrastructure costs Less common incentives tax stabilization tax holiday or initially reduced rates depletion loss carry back J. Otto

37 37 Typical 2006 Mining Tax System Income tax30% Dividend withholding tax15% Royalties (sales value based)2-4% Import duty on equipmentnone Export duty on mineralsnone VATnegated Depreciationaccelerated (5 yr) Depletionnone Ring fencingnone Explorationamortized (5 yr) Environmental costsexpensed Tax holidaysnone Loss carry forward5 year limit

38 38 Part 4. Analyzing a Mining Tax System J. Otto

39 39 Analyzing a Tax System In analyzing mining taxes tax, it is essential to look at the complete system of all taxes and fees The overall tax impact on a mine can be measured: –Is there an adequate return to the investor? –Is there an adequate payment to society? –Is the tax system competitive with that in other nations? J. Otto

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

41 41 Analyzing a Tax System - Model Mine Cashflow Diagram -

42 42 - ETR: A Measure of All Taxes Collected - What is the impact of all taxes combined? value of all amounts paid to government Effective Tax Rate = value of profits before taxes are paid Internal Rate of Return (a measure of profitability) Analyzing a Tax System

43 43 Ideal range ? ETR = 40 to 50%

44 44 Using mine models, it is possible to analyze the impact of: changing any existing tax rate adding a new tax deleting a tax offering tax incentives any combination of tax reform Mine model analysis: can be applied to an individual mine or to a sector-wide analysis Analyzing a Tax System

45 45 Part 5. Recommendations

46 46 Mining Tax Policy It is in the interest of both parties to obtain successful projects “Don’t kill geese that lay golden eggs - – leave enough eggs to grow the flock”

47 47 Conclusion Countries compete for investment Investment will flow to where geology is attractive, regulatory systems are workable, and taxation is reasonable Tax systems are converging, need to be competitive Tax systems should accommodate low and high prices Well designed tax systems can provide a fair contribution to the treasury ARE YOU COMPETITIVE? ARE YOU TOO GENEROUS?

48 48 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?


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