Fiscal volatility in mining

Mayer Brown’s Ian R. Coles looks at government taxation of the African mining industry
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Photo: iStock.com/claffra

Ian R. Coles

On September 28, 2018, Bloomberg headlined a news item as follows: "Zambia plans to increase mining royalties next year as Africa's second-biggest copper producer seeks to reduce its budget deficit. It's the 10th tax change miners have faced in the past 16 years."

In fact, the ultimate change may not end up being as severe as reported, and certainly Zambia cannot be singled out as the only resource-rich nation to have dipped into the mining cookie jar when national budgets are constrained. However, the headline quite neatly encapsulates the issues which mining companies can face when caught in the trap between the commercial need to encourage mining activity and the political need to deliver on promises to the electorate. Cynics may observe that darker motives may also be involved in these decisions, but that is not the concern of this article.

Mining is of course a highly capital-intensive industry. Depending on the size and commodity involved, the cost of advancing a project from exploration to commercial production may involve investing anything from tens of millions to billions of dollars. Those funds will come from a variety of sources, from sponsors' own funds, public or private equity, debt, streams, prepayments and royalties. All sources of investment will have one common requirement: as much certainty as possible. One risk that is very difficult to assess is that of the certainty of the fiscal regime imposed by the host government of the country in question. Given the long lead time for the development of a project - maybe decades in the case of a large copper or iron ore project - then this risk takes on increased importance for the long-term investor.

An OECD survey noted that both the ability to pre-determine tax liability and the stability of the relevant tax regime featured in the top 10 criteria taken into account by mining companies when determining whether or not to make an investment. The risk is enhanced through the fact that regime change, particularly in the emerging markets, is highly unpredictable and can impact taxation levels.

The flip side of the coin to encouraging investment is so-called resource nationalism - the view that the principal aim of a government when considering mining policy should be to maximise revenue. There is a difference here between ‘maximise' and ‘optimise'. The former may well result in restricting mining investment. There should be some bandwidth in the middle of the expectations of governments and sponsors which is capable of producing an optimal result for both parties. Nevertheless, for many countries revenue generated by the mining industry is a core component of government income and therefore maximising the same can become a key policy aim.

an  oles Ian R. Coles

For example, in 2017-2018, Deloitte calculated that company tax and royalties paid by mining companies in Australia amounted to A$30.6 billion (US$20.9 billion) - an amount equal to aggregate federal government spending on schools, universities and vocational training. In many emerging markets the proportion of government revenue provided by mining companies - particularly hard foreign currency revenue - can be even higher. 

In Ghana almost 20% of government revenue comes from the mining industry, whereas in Guinea that percentage can approach 90%. In the DRC (another country which recently proposed increases to taxes on the mining industry) the mining sector has contributed 22% of GDP and 28% of government revenue in recent years.

Pursuing the Zambian theme for the moment, the proposal in September 2018 was to increase the sliding scale of royalties (depending on the commodity in question, as well as current market price) by 1.5%, as well as to introduce a new 10% tax when the price of copper exceeded US$7,500 per tonne. To place the royalty increase in context, the 1.5% increase was on top of the existing range of 4-6% - obviously a significant hike. This was all proposed in the context of an attempt to reduce the fiscal deficit from 7.4% of GDP to 6.5%. Introduce a difficult political atmosphere due to allegations of hidden borrowing and corruption (which at one stage led to a halting of international aid from some countries - including the UK) then the toxic soup at the time was clear to see. The reaction of the major mining companies operating in Zambia, such as Glencore, Vedanta and FQM, was swift with threats to suspend production, etc., unless the proposals were reversed. However, the standoff has continued and a recent proposal to initiate a refundable sales tax in place of VAT has inflamed the situation. As recently as May 18, 2019, however, President Edgar Lungu insisted that the changes would be implemented notwithstanding the withering reaction of the mining industry.

One of the paradoxes to be faced by both sides is the tendency for governments to increase taxation in an environment of falling commodity prices and a consequential decline in tax revenues. That of course is just the time when mining companies can least afford to see an increased fiscal take. An interesting study produced by the Natural Resource Governance Institute (NRGI) in June 2018 concluded that of 34 resource-rich countries (including both energy and hard rock commodities) with at least one fiscal rule (i.e. debt, budget balance, expenditure and/or revenue rules) in place in 2015-2016 only six adhered fully to those rules during the commodity price crash over that period. This helps to explain the volatility in so many countries' approach to fiscal policy in a changing price environment.

Tanzania implemented changes to the fiscal regime for the mining industry in 2017, which led to significant increases in the government take from the industry (for example, 18% VAT and a 7.3% inspection fee). Most famously - or at least publicly - this led to a prolonged dispute with Acacia and an immediate reduction in mining activity being conducted by other sponsors. NRGI recently published a paper on the taxation of the mining industry. The paper concluded that under the new tax code proposed in Tanzania the effective tax rate applicable to a new mining operation (existing operations are grandfathered) would rise from 51% to 74%. The countries following most immediately behind were Guinea (61%), South Africa (59%), Ghana (58%) and Chile (48%). There are some recent signs however that the level of tax in Tanzania is beginning to have some effect on the government and that possible reductions may be on the cards in the future. NRGI is apparently engaged in preparing a series of proposals which address alternative fiscal regimes.

Multiple research bodies, NGOs and global policy influencers have published extensively on the topic. For example, the widely respected Fraser Institute survey of mining jurisdictions breaks out a table illustrating the contribution of taxation regimes to the overall investment attractiveness of the various countries covered by the survey. It will be no surprise to see that in the 2018 survey American, Australian and European jurisdictions figured highly in this table. Only Botswana and Mali of all the African jurisdictions featured in the first half of the list. The OECD has posited three questions which should form the basis of any fiscal policy affecting the mining industry. First, are the payments to society "adequate"? Second, are investors receiving a "fair return"? Finally, is the tax regime competitive with other jurisdictions? Simple questions with complex answers and certainly, in each case, prone to less than objective inputs. 

The UN Handbook on Taxation of the Extractive Industries (a mammoth tome of almost 500 pages published in 2017 and intended as a primer for both governments and investors) pointed to the importance of avoiding uncertainty over rates of taxation. This is not a one-way game though. The handbook points out that with added certainty on fiscal terms a mining company may be willing to offer more to a government.

In analysing the issue in any particular jurisdiction account must be taken of the total tax take - royalty payments, VAT, import and customs duties, etc., as well as standard corporate income tax. Revenue at both the federal and provincial levels must be included, as well as any free carried interest in a project granted to the government. 

A paper published by the Institute of Development Studies in June 2018 sought to present a comprehensive review of revenue sharing between governments and mining sponsors in Africa. The study attempted to compare the proportion of government revenue provided by taxes on the mining industry to the proportion of GDP attributable to that industry. Botswana emerged as the most efficient country in realising government revenue from mining - although that was in part due to its ownership stake in Debswana. The most important determination was found to be by far the level of tax - almost three times more than the next determinant (mineral prices). No doubt this study has informed the thinking of many governments. 

The theme of revenue sharing between governments in Africa and elsewhere and the mining industry continues to be one of the most controversial policy issues. It is at the same time one of the most influential factors in determining levels of investment, and both sides of the table must be careful to ensure that short-term considerations do not adversely impact long-term investment decisions. Resource nationalism encompasses many legitimate aims, but investors do have options.


Ian R. Coles is partner and global head of mining at law firm Mayer Brown