Mineral policy over the past 100 years can be viewed as a pendulum which swings between the interests of governments on one side and the interests of the investment community on the other.
In developing jurisdictions in particular, the laws and policies concerning the mining industry have been characterised by successive attempts to achieve a balance between these two interest groups.
Over the past century, mineral policy has shifted from a colonial era, characterised by the appropriation of mineral rights by colonial powers, to a post-colonial era dominated by intense nationalism and attempts by governments to take control of their mining sectors, and then to the reorganisation of the industry following a wave of globalisation founded on a market-based economy, and characterised by increased movement of capital and extensive privatisations.
Further to restructuring plans carried out under the auspices of the World Bank and to the impetus of a prevalent market-based ideology, mineral-rich developing countries attempted to attract foreign investments by privatising former government-owned assets and enacting legislation with favourable tax rates. Experts were brought into those jurisdictions to help revise their mining codes so as to attract foreign capital and make them competitive. A number of jurisdictions amended their mining codes or enacted new mining codes between 1996 and 2002, for example Argentina (1997), Botswana (1999), Brazil (1996), China (1996) and the Democratic Republic of the Congo (DRC) (2002).
Previous policy trend
By all accounts, it appears that the 1996-2002 cuvée of mineral legislation was highly successful. Tanzania, regarded by some as the poster child for this success, enacted new mining legislation in the form of the 1998 Mining Act. Mining exports from Tanzania increased from US$1 million in 1997 to US$500 million in 2003, with more than US$1.3 billion invested by major mining companies including Barrick Gold Corp and AngloGold Ashanti Ltd.
Mining is increasingly becoming the leading sector in export value in Tanzania, with nearly half of its exports attributed to the mining industry. In addition, Tanzania has become the third-largest producer of gold in Africa after South Africa and Ghana, both of which are internationally renowned for their rich tradition in the mineral sector.
The 1998 Mining Act was clearly an improvement over Tanzania’s former mining laws, as it improved security of tenure, provided a more stable taxation regime, enhanced the ability to procure equipment and materials, and provided for the free convertibility of currency. The favourable economic impact felt by the country after the introduction of the new act is generally regarded an uncontroverted evidence of the success of the mineral policies that were adopted.
Critics have, however, argued that as the mining industry contributes only 3.2% of GDP and 3.6% of the government’s total tax revenues, and the majority of the population has not seen any improvement in their standard of living, the current mineral policy can only be regarded as a failure.
Some of the sentiment which led to the nationalisation of the mining industry in the 1960s is finding its way back to the forefront of public discourse. The mounting public discontent over the perceived lack of tangible economic benefits flowing from the mining industry to the public led the government of Tanzania to order a commission led by Judge Mark Bomani in 2007 to review mining contracts.
New trend
The Bomani Commission reported its findings in the summer of 2008. It recommended significant reforms to the mining tax regime, including an increase in the gold royalty from 3% to 5% and new rates for stamp duties, with-holding taxes, local government taxes, import duties (mining-related imports will remain exempt) and fuel levies (except fuel used for electricity generation in the mines). The pendulum thus appears to be shifting again in countries such as Tanzania.
In fact, since 2003, there has been increased scrutiny over the mining sector across Africa and several attempts to review mining contracts or revise mining legislation, as governments seek to obtain a larger share of revenues.
Between 2007 and 2010, the DRC, Guinea, Zimbabwe, Sierra Leone and Madagascar ordered the review of mining contracts, while South Africa is still considering a new royalty bill initially introduced in 2003 on mineral and petroleum resources.
Zambia may have scrapped its controversial 25% windfall profits tax introduced in 2008, but has effectively raised the tax rate on miners. Meanwhile, Ghana, generally regarded as a stable mining jurisdiction, announced in November 2009 that it would double the amount mining companies pay in royalties, from 3% to 6%.
The recent trend is not limited to African jurisdictions. Mongolia passed a law in 2006 (since repealed, see p19), enabling the government to assess up to a 70% windfall profits tax on gold and copper, and India’s federal government approved an increase in mining royalties in August of last year. China has recently increased its value-added tax on minerals by 4%.
In Latin America, Ecuador approved the increase of a 70% windfall revenue tax on non-renewable resources, and Brazil is currently looking to revamp its mining legislation and increase its share of revenue derived from mining.
Earlier this year, Chile, perhaps the most highly-regarded mining jurisdiction in Latin America, moved to raise royalties paid by mining companies from 5% to 9% in order to help pay for post-earthquake reconstruction. The Chilean government even went so far as to state that it expected most companies voluntarily to pay higher royalties.
Even mature mining jurisdictions have joined in this recent trend. In 2007, the government of Ontario introduced a controversial new diamond royalty based on the value of a mine’s output. Most recently, Australia, widely regarded a mining-friendly country, announced plans to impose a 40% tax rate on mining profits on top of the corporate tax rate which would be reduced from 30% to 28%.
The Australian government contends that the public have not shared enough in the wealth generated by the bull cycle in commodity prices over the past decade; a case of good old-fashioned resources nationalism from one of the leading mining jurisdictions.
In fact, even Quebec, the top mining jurisdiction in the world according to Fraser’s Institute annual survey, introduced new mining taxes in March 2010 so as to mitigate its budgetary deficit. The new taxes introduced in Quebec include an increase in the tax rate from 12% to 16%, changes in depreciation rules, and restrictions on claims of exploration and development expenses.
While the trend might have been expected to slow down by the near depression experienced in the global economy between 2008 and 2009, it appears to be moving ahead, undeterred.
Industry response
As would be expected, the recent trend has not been welcomed favourably by the mining or investment communities. On May 3, 2010, on announcement by Australia of its proposed new mining taxes, the markets witnessed a precipitous drop in mining company shares, and the commodity-heavy S&P/TSX composite fell by 23 points in a single day. As a result of the taxation increases, certain companies have chosen to stop work. This option is typically available only to those larger companies that have a diversified enterprise portfolio and are better able to use work stoppage in selected jurisdictions as a bargaining tool or as a reaction to the changes in taxation.
Other companies have chosen the route of arbitration, notably with the International Centre for the Settlement of Investment Disputes (ICSID). While this option is available to most companies that are granted protection under investment protection treaties, companies that choose to go the arbitration route put themselves in a difficult predicament should they wish to continue to conduct business in the jurisdiction they are suing.
Arbitration is also available to companies that have taxation stability agreements. Such agreements make it much more difficult for host governments to raise taxes or impose new taxes, and companies with stability agreements are usually better equipped to ensure that they are not negatively impacted by changes in taxation.
Certain companies have successfully negotiated carve-outs or exemptions to new legislation.
For example, De Beers, which was materially impacted by the Ontario government’s new royalty on diamonds, was able to negotiate a number of allowable deductions which reduced the income amount to which the royalty applied, thereby effectively reducing the royalty payments.
Defensible increases?
The basic premise is that, in the management of its country’s natural resources, a government’s objective typically is to generate as much tax revenue as possible without discouraging continuing investment, while safeguarding the environment and social framework. As various governments emerge from the recent global economic crisis weakened economically, they are looking aggressively for ways to fill their coffers, which usually includes raising taxes. In addition, natural-resource nationalism is a powerful card in any politician’s arsenal, making mining companies particularly vulnerable during election years.
Thomas Baunsgaard, of the International Monetary Fund, states that the opportunity cost of supplying a commodity is given by the supply price of investment, which is the return that is required by an investor to justify a decision to invest. This should be sufficient to cover the cost of exploration, development and production, the cost of capital, and a risk premium. For a given total return on an investment, the lower the supply price of investment, the higher the potential economic rent. The allocation between these two will determine how high a tax burden the government can impose without discouraging the investment from taking place. The investor’s risk premium will reflect both sovereign (political) and project (commercial) risk.
A country’s perceived risk premium directly affects its ability to increase its tax revenues from mineral production. The political instability in a country such as the DRC will limit its ability to impose higher tax burdens on the mining industry compared with Québec, a jurisdiction generally regarded as having little political risk and being well disposed towards the mining industry.
Accordingly, governments, particularly in developing countries, need to understand that while there may be nothing intrinsically wrong in asking for more revenue (provided that this does not contravene prior obligations), they need to work towards putting themselves in a position to be able to make demands.
Not only should governments reduce political risk (for example by strengthening macroeconomic and fiscal stability) they should also seek to reduce commercial risk, by having a strong legal framework, with security of tenure and an effective system of approval respecting the development and operations of a project during its economic life. Commercial risk can also be cut by having a strong mining cadastre with a useful database of mineral exploration data.
Hence, one way to consider the matter is to ask whether the developing countries that are looking to increase taxes and/or royalties have improved sufficiently from a political and commercial risk perspective over the past decade to demand a higher return on mineral investment.
Assuming that this is so, their demands may be reasonable and they would have to decide carefully which tax framework would be most appropriate to attain their objectives: an increase in direct tax instruments (such as corporate or resource rent tax), indirect tax instruments (such as income tax, royalties, duties, or VAT), non-tax instruments (such as claim maintenance fees, bonus payments, or state equity participation), or a combination thereof.
Governments should also understand that the higher the level of taxation on mining companies in a particular jurisdiction, the greater the incentive to engage in tax-avoidance schemes. In this regard, governments may want to ensure that they are doing an effective job collecting tax revenue under existing legislation by closing loopholes such as those which enable companies to engage in transfer pricing (whereby companies seek to minimise income and maximise deductions in high tax jurisdictions) before they consider raising taxes or imposing new royalties.
In addition, considering the negative publicity that accompanies any announcement to increase taxation, governments should ensure that their current tax structures are effective before seeking to add more layers of taxation.
Looking ahead
Governments tend to demand a larger share of the mining revenue when the commodities cycle is swinging upwards. As the economic contraction has ended in Canada, and is ending in most major economies throughout the world, the industry can expect a more bullish phase of the commodities cycle. This would allow governments to be more aggressive in their demands.Moreover, China has become an important player in the commodities industry. This is significant not only because China is an additional credible trading partner from the perspective of mineral-rich countries but, more importantly, because China has a different and unique investment approach.
Traditionally, investors in the mining sector were privately-held or publicly-listed companies with a strict economic approach to investment. China approaches investments in the mineral sector from a strategic perspective, however, owing to its enormous need for mineral resources, and China’s actors in the mineral sector tend to be state-owned enterprises that operate with the backing of the Chinese government.
As a result, China is showing a willingness to pay a premium and to make strategic alliances with host countries to secure access to mineral resources. The advent of China in the mineral sector thus changes its dynamics, which tends to favour mineral-rich countries.
The greater the number of governments implementing and seeking to implement increases in taxes and royalties, the less susceptible they become to losing out on investments because of more attractive fiscal terms being offered by competing jurisdictions.
In this environment, host governments may be less willing to grant foreign investors stability agreements. The granting of these agreements is usually a function of a particular country’s bargaining position, and as countries find themselves in an improved bargaining position, they may be less willing to bind themselves with these types of instruments.
Governments are becoming more demanding regarding social and environmental considerations and issues. New mining legislation can be expected to contain extensive requirements in respect of environmental impact assessments and studies, mine closure and rehabilitation.
The compliance costs of increased environmental and social requirements now being imposed in a number of jurisdictions can add substantially to the cost of doing business, and may be regarded as a new form of taxation.
It is always a fine line for government to try to receive as much revenue as possible while remaining attractive to investment.
In light of the recent developments in mineral jurisdictions around the globe, it does appear that the mining policy pendulum is once again shifting towards natural-resource nationalism.
It is, however, not expected that this shift will lead to a freeze in global mining investment, though mining companies will have to find ways to strategically adapt to this paradigm shift.
In light of this trend, potential host-country costs may need to be estimated more carefully to avoid situations where available financing may be insufficient for completion of projects or projects cease to be economically feasible.
Daye Kaba is an associate in the Global Mining Group of the Toronto office of Fasken Martineau DuMoulin LLP. Special thanks to Robert Shirriff and Ian MacGregor