Comparative Mining Tax Regimes

A Summary of objectives, types and best practises

Global Mining Group

Introduction What is mineral taxation? Basis for mineral taxation Types of mineral taxes
Economic rent User pay taxes Corporate citisenship taxes

1 2 2 3
3 3 3

Objectives of the mineral taxation regime Best practices

High risk Capital intensive Price taker Mining profits are cyclical Remote locations Finite life Restoration and reclamation State ownership of the mineral resources

3 4
4 4 5 5 5 6 6 6

Introduction
This paper examines some of the important aspects of mineral taxation policies and practices, with reference to the mining tax regimes of selected countries. The following subjects are addressed:
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Mineral royalties Conclusion

7 10

What is mineral taxation? Basis for mineral taxation Types of mineral taxes Objectives of the mineral taxation regime Best practices.

Written by: Bob Parsons, Partner, Global Energy & Mining Group, PricewaterhouseCoopers.
All Rights Reserved, PricewaterhouseCoopers, 1998. No part of the contents of this document may be reproduced or distributed in any form or by any means without the prior written permission of PricewaterhouseCoopers.

Many developing countries, often with the encouragement and assistance of international funding agencies, are actively assessing the international competitiveness of their mining tax regimes with a view to attracting investment. These countries recognise that the mining tax regime is not the only consideration that is taken into account by prospective investors. The countrys geological prospectivity, physical infrastructure, labour force, political risk, and regulatory system are also important factors in the investment decision making process. Although it is probably true that an attractive mining tax regime will not necessarily attract mineral investment, there is a real possibility that an unattractive regime can drive away investment.

Comparative Mining Tax Regimes - 1

What is mineral taxation?

Experience shows that a government official will often answer this question differently than an industry representative. The government official will generally be inclined to define mineral taxation quite literally for example, as consisting only of income taxes and government royalties. On the other hand, the industry representative is likely to define mineral taxation to include that portion of the mining projects total revenues that ends up in the governments hands. For example:
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Basis for mineral taxation

A tax that is imposed on the mining enterprise may have a deeply entrenched legal basis, or it may be based on more contemporary government policy. An example of the former would be the so-called economic rent* that a government collects in its capacity as owner of the mineral resource. Canada and Indonesia, for example, are two countries where the countrys constitution articulates that ownership of the resource vests in the government (in the provincial government, in Canadas case).
1

Where the mining enterprise was obliged by law to sell its output to a state-owned marketing board at 95% of market value, the marketing boards 5% profit would be considered by the enterprise to constitute mineral taxation; and Where the government was entitled to own 5% of the mining enterprises shares, without payment therefore, the dividends paid on those shares would be viewed by the enterprise as a form of mineral taxation.

For the sake of completeness, this paper adopts the so-called industry view namely, that the level of mineral taxation is measured with reference to the governments total take from the revenues that are generated by the mining project.

User pay taxes or charges, and corporate citizenship taxes are examples of taxes that the mining enterprise pays pursuant to contemporary government policy. These kinds of taxes tend to be introduced, modified, and repealed on a somewhat ad hoc basis, as government policies change.

*1 There are as many definitions of economic rent as there are economists. Generally speaking, an economic rent is a payment made by the mining enterprise to the state as compensation for using a state-owned resource.

Comparative Mining Tax Regimes - 2

Types of mineral taxes

Economic rent
The economic rent that is paid by the mining enterprise can take a number of forms, including:
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Royalties, duties, or taxes that are imposed on some measure of production, revenue, or profit The governments free equity participation in the profits or dividends of the enterprise The governments share of production pursuant to a production sharing contract*
2

Objectives of the mineral taxation regime

Designing a mineral taxation regime is not a simple task. Ideally, a government should want the mining tax regime to:
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Up-front bonus payments that are paid pursuant to an auction of mineral rights.

Royalties are the most common form of economic rent, and are discussed more fully later in this paper.

User pay taxes

User pay taxes are based on the concept that the enterprise should pay for certain government provided services or information. User pay taxes include:
n n

Provide for a fair participation by the state in the fruits of the mining enterprise Be stable over time Be transparent and provide an even playing field for all players Be easy to understand Be easy to administer Be internationally competitive.

Land access fees that purport, for example, to fund the provision and servicing of government maintained roads, air strips, and port facilities Licensing and permitting fees, that are intended to fund the governments cost of administering land title records, maintaining mineral data bases, and monitoring mining enterprises activities Payroll taxes that are earmarked for social service payments such as government sponsored pensions, compensation for injured workers, or unemployment insurance arrangements Water taxes that are intended to compensate the government for the maintenance of waterways, dams, and related facilities Property taxes that are used by government to fund public works projects such as roads, bridges, and so forth.

n n n

In some countries, particularly where the government feels that it has no more room to increase more visible taxes such as income taxes, user pay taxes are becoming increasingly popular as a means of raising revenues. At the same time, mining enterprises in these countries are becoming increasingly concerned about the impact of these taxes on the viability of their operations, mainly because these taxes are not linked to the enterprises ability to pay the taxes and the taxes cannot be passed onto the enterprises customers.

As a practical matter though, other government policies often conflict with these idealistic objectives, so that the actual mining tax regime is less than optimal. The mining tax regimes that are summarised at the end of this paper reflect a number of best practices in the context of mineral taxation policy.

Corporate citizenship taxes

This category of tax encompasses all those taxes that are not earmarked for any particular use, but rather are levied in order to fund a vast range of government operations. These taxes are not specific to the mining industry, and include:
n n n

Income taxes VAT, GST, and sales taxes (so-called turnover or transaction taxes) Customs duties.

*2 This form of economic rent is unusual in the mining industry. It is more common in the petroleum industry.

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Best practices
An internationally competitive mining tax regime should recognise the unique characteristics of the mining industry.

High risk
Relative to most other industries, the mining industry is characterised by high risk. This risk is present at all stages of the projects life cycle, including the exploration, development, and production stages. A tax regime can recognise the relatively high risk that is faced by the typical mining enterprise as follows.
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Some countries have sought to deliver certainty of tax rules by incorporating the tax regime in a bilateral contract between the government and the mining enterprise. The most notable example is Indonesia. Under Indonesias Contract of Work system, the government and the mining company sign a Contract of Work, which covers all of the companys rights and obligations, including tax obligations, for the life of the mine. The Contract of Work system has been particularly successful in delivering stability, because the government has been completely honourable in abiding by the terms of the Contracts of Work since the systems inception in 1967. Some countries have a hybrid regime, whereby a legislated mining tax regime applies as a default system to most mines, but certain mines are subject to tax rules that are set out in a bilateral contract. In Guyana, for example, the taxes that apply to the Omai mine are fixed by the terms of a contract between the mining enterprise and the government.

Permit the mining enterprise to reap a reward that is commensurate with this risk. The type and level of taxes that are imposed on the mining enterprise have a direct bearing on the rate of the enterprises return on capital. As a general rule of thumb, the base (minimum) return on investment that will be sought by the mining enterprise is in the 15% to 18% range. A medium-sized gold mine that is subject to the United States tax rules that are set out on page 8 would earn a 14.14% rate of return over ten years of production. The same mine in Chile would generate an 18.34% return, due mainly to Chiles more favourable mining tax regime. Although a 14.14% return on investment might be quite attractive in certain industries, an ore body in the United States would probably not be developed based on this return. However, the same ore body in Chile might very well be developed on the basis that the estimated rate of return sufficiently compensated the investor for the usual project risks.

Capital intensive
The mining industry is capital intensive. Huge amounts must be spent annually on exploration to discover sufficient ore to replace the ore that is currently consumed. The Government of Canada, for example, has estimated that approximately Cdn$800 million has to be spent each year on exploration in Canada in order to replace reserves that are consumed in that year. The cost of preparing an ore body for production also commands enormous capital investment. Today, a world class base metal mine can typically cost in the range of US$2 billion. A countrys mining tax regime can recognise the capital intensive nature of the industry as follows.
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Allow the enterprise to generate sufficient after tax cash flow in the early years of production to service project debt. One of the important criteria considered by lenders is payback. A lender will want to minimise its exposure to project risk by being repaid as quickly as possible. Canada and Zimbabwe offer examples of mining tax regimes that permit the mining enterprise to recover its capital costs before paying income tax. This capital cost recovery is achieved by allowing immediate 100% tax deductions for capital costs that are incurred during the pre-production period. By comparison, the United States and Mexico prescribe relatively low tax depreciation rates. This generally means that project cash flow in the early years of production is eroded by income tax payments, thus impinging upon the enterprises ability to repay debt quickly.

Provide for certainty of tax rules. The investors decision to proceed with a project is based on a feasibility study. The feasibility study is based on some important assumptions regarding metal prices, production levels, operating costs, taxes, and other possible variables. Once the project is up and running, the continued viability of the project is a function of these variables. If the variation of taxes over project life can be minimised - that is, if the tax regime is stable then there is one less variable to worry the enterprise. One risk factor is either reduced or eliminated.

Comparative Mining Tax Regimes - 4

Minimise the imposition of customs duties, VAT, and similar up-front costs that are a function of capital investment. The imposition of a 10% VAT and a 10% customs duty on the importation of capital equipment can, in effect, add up to 20% to the cost of a project. These charges could add $200 million to the cost of a $1 billion project, and could render the project uneconomic. Indonesia addresses this issue by allowing for the suspension of VAT during the pre-production period, and by permitting machinery and equipment to be imported exempt from normal customs duties.

Mining profits are cyclical

Most metal prices show wide swings over the years, and the typical mining enterprises profits will reflect these price cycles. It is common for even the largest mining companies to record losses for a number of consecutive years as a result of soft metal prices. The mining tax regime can recognise the cyclicality of the industry by providing adequate loss carryover periods in the income tax system, and possibly in the countrys mineral royalty system, too. Some countries have indefinite loss carry forward periods. Two countries in the tables on page 8 and 9 (the United States and Canada) allow losses to be carried back for offset against taxable profits in prior years. The ability to carry losses back to prior years offers the optimum income smoothing to counter the cyclicality of mining profits.

Avoid the imposition of taxes on capital. Some jurisdictions impose an annual capital tax. For example, a mining enterprise in the Province of Ontario in Canada must pay annually both a federal tax and a provincial tax on the aggregate amount of the enterprises debt and shareholders equity. The federal tax is a corporate minimum tax that is intended to ensure that every corporation, including unprofitable ones, pays some amount of tax each year. But, the provincial capital tax must be paid over and above the amount of any income tax. Mexico and Peru are examples of other countries that, in effect, impose an annual tax on capital as a form of minimum tax.

Remote locations
Invariably, ore bodies are found in remote locations. Consequently, in most instances the mining enterprise is obliged to incur substantial infrastructure costs. The enterprise is often expected to pay for access roads, electric power facilities, port facilities, and social infrastructure such as a medical clinic, school, and recreation facilities. Also, the enterprises payroll costs can be relatively high in remote locations, as a result of the need to offer incentives to attract workers to the site. A mining tax regime can recognise these higher costs by:
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Price taker
The prices of most mineral products are established by the interaction of supply and demand in the global marketplace. The mining enterprise does not set the price for its product the enterprise is a price taker. A mining tax regime will be relatively attractive if it minimises taxes that are not based on profits. Because the mining enterprise is a price taker, the cost of such taxes cannot be passed onto the mining enterprises customer. The enterprise has to bear the burden of these costs, even though the enterprise may not be profitable currently. This burden can have a notably adverse impact on the economics of a project. Mining enterprises generally prefer taxes that are based on profits that is, taxes that are linked to ability to pay. For example, an unprofitable mine in the Province of Ontario (Canada) would not have to pay provincial mining tax or royalty, because that jurisdictions economic rent is a form of net profits interest. On the other hand, the same unprofitable mine in Brazil or Argentina would have to pay an economic rent, because the economic rents in these countries are not based on profit. Brazil imposes a royalty based on gross revenues, and Argentina charges a royalty based on net smelter return.

Providing generous tax depreciation rates for infrastructure costs Making employee incentives tax free.

Canada, for example, allows infrastructure costs that are incurred during the pre-production period to be depreciated for tax purposes at a 100% rate. Indonesia does not impose personal income tax on benefits-in-kind, but permits the employer to deduct these costs pursuant to the terms of the Contract of Work.

Comparative Mining Tax Regimes - 5

Finite life
Unlike a manufacturing plant or a service business, a mining project has a finite life. This means that the enterprise has a limited number of years over which to realise a competitive rate of return on its investment. The feasibility study, on which the project investment decision is made, takes into account the entire life of the project, and must assume that the tax regime will not change significantly during the projects life. A change to the tax rules part way through the life of the project could jeopardise the viability of the project and result in shut down. Whether a country seeks to build stability into its mining tax regime through either legislation or contract, the important consideration is that the country honours its commitment to stability. Unless the country has a proven track record of stability, the mining enterprise will view promises of stability with some suspicion.

Restoration and reclamation

There is a trend in the regulatory climate to charge the mining enterprise with stricter responsibilities for site restoration and reclamation, and mine closure. The modern mining tax regime recognises these increasing responsibilities by providing tax relief when funds are set aside or otherwise reserved during the production stage for reclamation, restoration, and mine closure. In fact, very few mining tax regimes address this topical concern. Canada and Indonesia allow a tax deduction when funds are set aside for the purpose of mine reclamation and closure. The United States permits a tax deduction when a reclamation reserve is set up in the books of account, provided that the appropriateness of the reserve is certified by a prescribed third party.

State ownership of the mineral resource

In most jurisdictions, the mining enterprise is obligated to pay some form of economic rent to the government as a consequence of the governments ownership of the resource. Depending on the nature of the economic rent, this tax can represent a significant component of the enterprises total tax burden. The ideal economic rent will:
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Be internationally competitive Relate to the enterprises ability to pay Be eligible for foreign tax credit in the home country of the inbound investor.

Comparative Mining Tax Regimes - 6

Mineral royalties
The most common form of economic rent is in the form of a royalty. Generally speaking, there are three basic types of royalty:
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Gross royalty, where the royalty is determined with reference to the volume of production, or is determined with reference to gross revenues Net smelter return (NSR) royalty, where the royalty is expressed as a percentage of the enterprises NSR* ; and
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Net profits interest (NPI) royalty, where the royalty is calculated as a percentage of net profit.

Indonesia offers an example of a gross royalty that is based on the volume of production. For example, in Indonesias 7th generation of Contract of Work, the royalty payable on gold production is US$225 per kilogram where annual production is less than 2000 kilograms, and US$235 where annual production exceeds 2000 kilograms. Examples of gross royalties that are based on gross revenues can be found in Guyana and Brazil. Argentina offers an example of an NSR royalty, and a number of Canadian provinces offer examples of NPI royalties. The royalty systems in some jurisdictions are hybrid systems. In Canada, for example, the annual royalty paid in the Province of New Brunswick is the greater of: 2% of NSR and 16% of net profit. As a policy matter, the purpose of the 2% NSR is to ensure that a royalty is paid by the mining enterprise in years when there is no profit. Not every country imposes a mineral royalty or collects an economic rent. Mining operations in Mexico and Chile, for example, are not subject to such charges. It is observed in the tables on page 8 and 9, that there is a direct correlation between the royalty rate and the type of royalty. Gross royalty rates tend to be in the 2% to 5% range, NSR royalty rates tend to be somewhat higher, and NPI royalty rates are higher still. This correlation also exists in the case of private royalties, and there is a logical reason for it. In the case of the NPI royalty, the government is less certain of collecting a royalty, because the royalty base (profit) is less predictable. The government will seek a higher royalty rate to compensate for this risk. At the other extreme, in the case of a gross royalty, the government is at less risk, because the costs of mining, milling, smelting, and refining do not affect the royalty base (revenues or production). Therefore, the government will seek a reduced royalty rate. NSR royalties fall between gross royalties and NPI royalties on the risk and rate scale.
*3 NSR is generally defined to be gross revenues, minus shipping, smelting, refining, and marketing costs.

Comparative Mining Tax Regimes - 7

Principal features of Mining Tax Regimes

Australia (Western Australia) National Income Tax Tax rate 36% Argentina Bolivia Botswana Brazil Canada (Ontario) 28%+4% surtax: 29.12% Chile Guyana

33%

25%

25%

33%

15% plus 35% on 35% distribution. Credit available for 15%. 2% of turnover

Minimum tax

Complementary Mining Tax at a rate that varies according to mineral and international prices Buildings SL method Rates vary depending on nature of asset. SL or DB may be used. Non-deductible with limited exceptions 10% SL 100% 100% Indefinite Infrastructure: 3 years 60%:20%:20% Other: 33.33% SL In accordance with GAAP ie. over estimated life of asset Units of production method may be used. 100% 100% 100% 100% Indefinite 10% SL 10% SL 10% SL 10% SL 10% SL 10% 10% 100% Indefinite 4% SL 20% SL 4% SL 20% SL Units of production 20% SL 20% SL 25% SL Indefinite

0.225% of net assets (4% surtax is creditable)

Depreciation Mine building Mine equipment Processing building Processing equipment Cost of concession Preproduction dev. Preproduction exp. On-going exploration Loss carry forward Depletion Allowance Other

100% deduction for assets acquired before production. Otherwise 25% DB. 30% DB 100% 100% Off-site: 100% On-site: 30% 3 year carry back, 7 year carry forward Resources allowance of 25% of resource profits, in lieu of deduction of provincial tax

12.5% SL 33.3% SL 12.5% SL 33.3% SL Units of production 16.7% SL 16.7% SL 100% Indefinite

20% SL 20% SL 20% SL 20% SL 20% SL 20% SL 20% SL 100%| Indefinite

Units of production Units of production Units of production 100% 5 years

Accelerated deductions for transport facilities and site rehabilitation.

Double deduction for expenditure relating to technical/economic feasibility of project. 1% of revenue (depending on province) 3% net smelter return Complementary Mining Tax as described above None None

State Income Tax Tax rate

None

13.5% of federal base

None

None

State Mining Tax Royalty Tax rate 3 systems: Gold: 5% gross sales - flat rate per tonne - % of revenue - % of profit Depreciation

15% of gross sales less realisation expenses

Gold: 3% gross sales

20% of taxable profit Exemption for first C$500,000 of profits 30% SL (100% for assets acquired before production) 15% SL 100% 100% Specified % of cost of processing asset (max 65% of profit; min 15% of profit)

Gold: 5% gross sales

Comparative Mining Tax Regimes - 8

Mining assets Processing assets Preproduction dev Exploration expenditure

Processing allowance

Comparative Mining Tax Regimes - 9

Principal features of Mining Tax Regimes

Indonesia National Income Tax Tax rate 30% 34% 30% 43-(215/x)%: companies 35% (5% credit on liable to secondary tax reinvested profits) 51-(255/x) %: companies exempt from secondary tax Secondary Tax: 12.5% on net amount of dividend 35% 30% 37.5% 35% for holders of Special Mining Licences Mexico Peru South Africa Suriname United States (Colorado) Venezuela Zimbabwe

Minimum tax

1.8% of gross assets (income tax can be carried back 3 years and forward 10 years) 10% or 20% SL 10% to 100% SL or DB 10% or 20% SL 10% to 100% SL or DB 10% to 100% SL or DB 10% to 100% SL or DB 10% to 100% SL or DB 100% 8 years 10% SL 10% SL 6% SL 6% SL 10% SL

0.5% of net assets as at end of 1997 year.

20% of adjusted taxable profit

Depreciation Mine building Mine equipment Processing building Processing equipment Cost of concession Preproduction dev. Preproduction exp. On-going exploration Loss carry forward Depletion Allowance

3% SL 20% SL 3% SL 20% SL Units of production

100% 100% 100% 100% Non-deductible

25% 25% 25% 25%

SL SL SL SL

7% DB 7% DB 7% DB 7% DB 70% in first year. Balance on SL basis over 5 years. 2 year carry back, 20 year carry forward Lesser of 15% gross income or 50% of net income (for gold, silver, copper, iron ore).

Rates vary depending on nature of asset. SL method is used. Units of production Units of production Units of production 100% 3 years

100% 100% 100% 100% Non-deductible 100% 100% 100% Indefinite

100% 100% 100% 3 year carry back 10 year carry forward

100% or 3 years 10 years

Units of production/100% 100% Units of production/100% 100% 100% 100% 4 years Indefinite

Other

Lump sum depreciation; operation fees

8% workers profit share calculated on net income before tax

Post 1973 gold mine: 10% capital allowance. Post 1990 gold mine: 12% capital allowance. None None 5% of federal base None

Additional 50% investment allowance on training buildings

State Income Tax Tax rate State Mining Tax Royalty Tax rate

None

None

None

None

<2000kg: US$225 per kg >2000kg: US$235 per kg (Gold) US$0.025-US$3.00 per hectare/per annum plus Land & Building tax

Metallic: US$2 per year/per hectare Non-metallic: US$1 per year/per hectare

Gold: 2% gross sales Other: 2% net sales

Severance tax 2.25% of gross income > US$11m Property tax: % of greater of 25% of net sales or net sales less operating costs.

Gold: 1% Base metals: 3%

0.875% of gross sales to MMZA

Depreciation Mining assets Processing assets Preproduction dev Exploration expenditure Processing allowance

Conclusion
There is no such thing as the perfect mining tax regime. A countrys tax regime is the product of balancing the need to have an internationally competitive regime with government policies that reflect the nations unique priorities. As a result, and as shown in the previous tables, mineral producing nations have implemented mining tax regimes that include a wide range of varying features. In comparing the competitiveness of these regimes, it is important to avoid focusing on one particular aspect the whole regime needs to be considered.

For further information please contact: Jakarta Bob Parsons Phone: +62 21 521 2901 Fax: +62 21 521 2911 bob.b.parsons@id.pwcglobal.com Sydney Geoff Cottrell Phone: +61 2 8266 2378 Fax: +61 2 8266 9999 geoff.cottrell@au.pwcglobal.com Vancouver John Webster Phone: +61 1 604 662 5359 Fax: +61 1 604 662 5300 john.webster@ca.pwcglobal.com Johannesburg Hugh Cameron Phone: +27 11 498 4292 Fax: +27 11 834 4745 john.webster@ca.pwcglobal.com www.pwcglobal.com

Comparative Mining Tax Regimes - 10

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