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SME Conference Current Trends In Mining Finance Tax and Accounting Issues Impacting Mining Finance 29 April 2013.

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Presentation on theme: "SME Conference Current Trends In Mining Finance Tax and Accounting Issues Impacting Mining Finance 29 April 2013."— Presentation transcript:

1 SME Conference Current Trends In Mining Finance Tax and Accounting Issues Impacting Mining Finance 29 April 2013

2 Current Trends In Mining FinancePage 2 Disclaimer ► Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US.

3 Current Trends In Mining FinancePage 3 Disclaimer ► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. ► These slides are for educational purposes only and are not intended and should not be relied upon as accounting advice. A detailed analysis of the company’s specific facts and circumstances is generally required to conclude on the appropriateness of the application of US generally accepted accounting principles.

4 Current Trends In Mining FinancePage 4 Tax and Accounting Issues Impacting Mining Finance ► J. Andrew Miller, Partner Ernst & Young LLP Americas Mining & Metals Sector Leader Tel: ► Robert Stall, Partner Ernst & Young LLP Americas Mining & Metals Sector Transaction Services Leader Tel:

5 Current Trends in Mining FinancePage 5 Tax and Accounting Issues Impacting Mining Finance ► Top ten business risks in 2012 – outlook for 2013 survey ► Impairments ► Valuations in M&M ► What is driving the impairments that occurred in 2012 ► Consequences ► Resource Nationalism and Mining Finance

6 Top Ten Business Risks for the Mining & Metals Industry

7 Current Trends in Mining FinancePage 7 Top ten business risks in mining and metals

8 Current Trends in Mining FinancePage 8 Trends in Business Risk – Mining & Metals ► Capital project execution ► Capital management and access ► Cost inflation ► Resource nationalism

9 Current Trends in Mining FinancePage 9 Inefficient management of project execution risk resulting in significant cost overruns Source: Publicly available information and Ernst & Young analysis In average cost over-run of select projects was 56% of original project estimates

10 Current Trends in Mining FinancePage 10 ►Diminished returns ►Weaker credit rating ►Impairments ►Margin pressure ►Inflexibility ►Loss of market share/missed opportunities ►Volatile equity valuations ►Severe cost inflation ►Resource nationalism ►Shareholder demands ►Uncertain demand/price outlook ►Risk averse capital providers Capital management and access Build, buy or return? ► Boards are facing a complex and uncertain environment within which to make capital allocation decisions in 2012 ► The risk of sub-optimal allocation of capital can have a significant and long-lasting impact ► Current shareholder preference is to return capital rather than growth Risk / Reward

11 Current Trends in Mining FinancePage 11 Cost inflation — overview ► Subdued commodity prices, while costs continue to rise ► Supply-side pressures exacerbate operating and capital costs — companies revisiting robust capex plans ► Crude oil prices, wage inflation, mining services suppliers using scarcity to raise process and increasing complexity drive operating costs ► Uncontrollable costs increase due to resource nationalism etc ► Falling grades are increasing cost per unit of production ► Cost inflation compounded by strong currencies of producer nations Increases in cash costs above CPI ( ) **Normalised: 5% Note: 2006 to 2009 shown on a total Group (Anglo American) basis, excluding AngloGold Ashanti, Mondi, Highveld Steel and Tongaat Hulett/Hulamin, 2010 onwards shown for Core operations only Source: “Preliminary results year ended 31 December 2011,” Anglo American presentation, 15 February 2012

12 What is driving the impairments and what are the consequences

13 Current Trends in Mining FinancePage 13 Mining Company Impairments – Top 10

14 Current Trends in Mining FinancePage 14 Mining Company Impairments – All Others

15 Current Trends in Mining FinancePage 15 Mining Company Impairments Key Value Drivers: ► Capital Cost Overrun ► e.g.: Anglo American ► Substitution (shale gas for thermal coal) ► e.g.: ANR, Arch Coal, Walter Energy, James River ► Reserve Assumptions ► e.g.: Rio Tinto ► Commodity Price Volatility ► e.g.: Moly, Cliffs

16 Current Trends in Mining FinancePage 16 Goodwill Impairment U.S. GAAP: ► ASC 350 – Goodwill and Other Intangible Assets ► Step 1: Compare current TIC to Balance Sheet carrying amounts (if Balance Sheet is greater than TIC, proceed to Step 2) ► Step 2: Measure the goodwill impairment through the application of a hypothetical purchase price allocation under ASC 805 and ASC 820 ► ASC 360 – Accounting for the Impairment or Disposal of Long Lived Assets ► Step 1: Undiscounted cash flow test for the Asset Group ► Step 2: Discounted cash flow measurement ► Step 3: Determine fair value of each identified assets

17 Current Trends in Mining FinancePage 17 Goodwill Impairment Issues / Opportunities: ► Reconciling discounted cash flows from life of mine models to market capitalization: ► Control premiums ► Lack of visibility to other Reporting Units that have not failed ► Commodity price volatility ► Terminal values where full life of mine models are not available ► Value of tons of ore not in LOM plan ► Discount rates – variability by commodity / geographic area

18 Current Trends in Mining FinancePage 18 Goodwill Impairment Issues / Opportunities: ► Performing the hypothetical purchase price allocation: ► Capacity rationalization issues for valuing property, plant and equipment ► Price volatility of commodity ► Market demand for volume ► Valuation of all identified intangibles ► Asset retirement obligation

19 Current Trends in Mining FinancePage 19 Long-Lived Asset Impairment U.S. GAAP: ► Step 1 of ASC 360 is performed for all Reporting Units that fail Step 1 of ASC 350 prior to the application of Step 2 of ASC 350: ► ASC 360 Step 1 is an undiscounted cash flow test (Primary Asset Group) ► Life of the primary asset group ► Residual value at the end of the undiscounted cash flow period

20 Resource Nationalism and Mining Finance

21 Current Trends in Mining FinancePage 21 Resource nationalism and Mining Finance Beneficiation Taxes / royalties Government ownership Legend Type of resource nationalism Colour indicates year Source: Ernst & Young

22 Current Trends in Mining FinancePage 22 Resource nationalism Three key trends in resource nationalism in 2012–13: ► Increased or newly imposed royalties and/or mining taxes ► Mandated beneficiation and new export levies on upstream products ► Retaining or mandating state or in-country ownership of natural resources Resource nationalism no longer restricted to frontier and emerging markets alone

23 Current Trends in Mining FinancePage 23 Increased or newly imposed royalties and/or mining taxes ► “Super profits” taxes considered: ► Australia in May 2010 proposed Resource Super Profits Tax. ► Scaled back and limited to coal and iron ore, but began focus on higher mining taxes (minerals resource rent tax (MRRT)) ► India — March 2012 — modeled a similar proposal after Australian super profits tax proposal. ► Mineral resource rent tax of up to 50% of “super profits” earned by mining operations ► New or increased mining taxes: ► In fall 2011 Peru enacts mining tax that follows Chilean tax increase in the prior years. ► in 2011 and through the first six months of 2012, many countries have proposed or enacted new or increased taxes on the mining industry. ► Brazil, DRC, Ghana, Mongolia, Peru, Poland and the United States ► Australia’s MRRT on coal and iron ore

24 Current Trends in Mining FinancePage 24 Mandated beneficiation and new export levies on upstream products Governments are seeking to mandate in-country beneficiation of ore prior to export. ► Create jobs and turn into producer of higher-value downstream products rather than exporter of raw materials Countries announcing a “beneficiation” strategy include South Africa, Zimbabwe, Indonesia, Brazil and Vietnam. In order to ensure in-country processing, governments are imposing steep export levies on unrefined ores. ► Indonesia proposes a 25% levy on mining exports in 2012 rising to 50% in 2013.

25 Current Trends in Mining FinancePage 25 Retaining or mandating state or in-country ownership of natural resources Argentina and the re-nationalization of YPF South Africa — Black Economic Empowerment (26% participation): ► Considering mandatory equity participation of a state-owned mining company Indonesia — proposing to limit foreign ownership in mining operations to no more than 49% after ten years Zimbabwe — 51% indigenization mandate Mongolia — 49% limit on foreign ownership of strategic mines

26 Current Trends in Mining FinancePage 26 More recent trends in resource nationalism and taxation... Brazil: ► New transfer pricing regime for purposes of determining the CFEM royalty; price based on quoted metals prices ► New royalty regime in the mining states of Amapa, Minas Gerais and Para (TFRM) Peru — Legislative Decree 1120 in July 2012: ► Imposes new transfer pricing rules for the sale of commodities to related parties ► Transfer price based on quoted metals prices Mongolia: ► Draft legislation to unilaterally cancel double tax treaties with Luxembourg, Netherlands, Kuwait and United Arab Emirates

27 Current Trends in Mining FinancePage 27 Also consider corporate income tax reform proposals Australia: ► Proposal to reduce general corporate tax rate ► Offset, however, to include reduction in a range of natural resource development tax incentives United States: ► Obama Administration proposal to eliminate percentage depletion for fossil fuels, capitalize intangible drilling costs (IDCs) and mine development ► Mining Law of 1872 reform proposals to include 4% royalty for hard minerals (metals) mined on federal lands

28 Current Trends in Mining FinancePage 28 International Monetary Fund “Fiscal Regimes for Extractive Industries” ► IMF report issued in August ► Extractive industry taxes are more than 50% of total tax revenue in petroleum countries and more than 20% in mining countries ► Describes tradeoffs between royalties, CIT, and rent taxes ► Sales-based royalty--maximizes government revenue stability, not as simple as it appears ► Corporate income tax--imposed on normal return and rents ► “Rent” tax--challenge is defining the normal rate of return ► Multiple taxes to achieve multiple objectives ► Regimes include general business taxes, mining-specific business taxes, and project-specific fiscal contracts

29 Current Trends in Mining FinancePage 29 International Monetary Fund “Fiscal Regimes for Extractive Industries” IMF simulations and “recommendations”: ► “These simulations … suggest reasonably achievable ranges of discounted AETRs that will be 40-60% for mining and 65-85% for petroleum” ► AETR range was derived from “life of mine” model using a fixed price assumption and “typical” financial profile ► Actual range of results was from 35-75% for iron ore ► Countries that are above average may have trouble attracting investment even if they are within the recommended range Unresolved issues: ► Choice of normal rate of return is “a key and contentious issue” (p20) – IMF assumes 12.5% is normal return, which implies 2/3rds of income for “typical” mine is rent ► IMF recommends taxes that vary with profitability, but in practice it is the tax regimes that vary with profitability ► What is the right time horizon?

30 Current Trends in Mining FinancePage 30 Resource nationalism — implications Implications Keeping abreast of ever-changing regulations Increased costs Emerging markets represent investment opportunities Project pipeline could reduce License to operate could be jeopardized Growth options could be restricted

31 Current Trends in Mining FinancePage 31 Q&A


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