Competitive Mining Tax Positions in South Africa
Brian W. Mackenzie
Department of Geological Sciences
Queen’s University
Kingston, Ontario, Canada K7L 3N6
Invited paper presented in the Third International Gold Symposium, held in Lima, Peru, from May 5, 1998
The original paper was available by the author for spreading in BRAZIL PAVILION - PDAC'99 (Toronto - Canadá)
Abstract
In the geologically prospective nations
of South America, mineral deposits offer great potential to create wealth
for social and economic development. The paper first examines the attributes
of potential mineral wealth based on 57 economic base and precious metal
deposits discovered in Chile since 1970. The variability of mineral wealth
attributes among these economic deposits is highlighted. Then, the impact
of mining taxation on the realization of potential mineral wealth is illustrated
by overlaying the mining taxation systems for ten countries in South America
on the 57 Chilean economic deposits. Measures of tax inefficiency, after-tax
investment incentive and government revenue are compared to delineate competitive
tax positions. Finally, these findings are placed in a global context by
calibrating the South American results against those of eight rival international
jurisdictions for multinational mining company investment.
Introduction
The level, structure, and competitive
position of mining taxation systems are undoubtedly key determinants of
corporate investment in mineral exploration and mine development.
Understanding the makeup of the potential
wealth of mineral deposits is essential for realistic analysis of the economic
consequences of mining taxation. The vital linkage between potential mineral
wealth and its actual realization, often ignored and seldom well enough
understood, is illustrated here by using a Chilean mineral deposit database
to examine the competitive positions of mining taxation systems in South
America.
Case Study Assessment
Several years ago, a study was made
of the economics of base and previous metal exploration in Chile, covering
the period 1970-92 (Mackenzie, Ortiz and Doggett, 1997). One aspect of
the evaluation was to determine which of the deposits discovered during
1970-92 would be economic if considered for development today.
Under a set of base case conditions
that include expected metal prices, a 10 percent cost of capital and minimum
acceptable return for an economic deposit, and a $20 million minimum acceptable
total revenue for an economic deposit, 57 deposits were assessed as being
economic. The evaluation was made on a total economic or before-tax basis,
with money values expressed in constant 1994 United States dollars.
For these 57 potential economic discoveries:
The 57 economic discoveries, comprising 33 base metal and 24 precious metal deposits, are used here to illustrate the wealth creating potential of mineral deposits and the impact of mining taxation.
- The expected export revenue totals $92.5 billion;
- The average rate of return is 25 percent, and the average net present value is $ 125 million per economic deposit, evaluated in the medium term from the start of mine development.
Attributes of Mineral Wealth
The attributes of mineral wealth can be examined in terms of the size and quality characteristics of economic deposits. First, the underlying variability in the geological attributes - tonnage and grade - of the 57 economic deposits is analyzed. Then, the reflection of these geological features in their counterpart economic measures of size and quality - revenue and rate of return - is considered. Finally, the deposit size and quality characteristics are combined to determine the bottom-line measure of economic worth -net present value (Mackenzie, 1996).
The relationship between deposit size and average grade for the 57 economic discoveries is shown in Figure 1. Size is measured by recoverable ore reserves; the recoverable in-situ value per tonne of reserves provides a proxy for grade. The average values for an economic deposit are 107 million tonnes and $41 per tonne, respectively.
An inverse relationship between the geological attributes of size and grade is apparent. Smaller deposits tend to be of higher grade and larger deposits of lower grade. A high degree of variability exists, however, in both the size and grade parameters with the distributions of these parameters being negatively skewed. Of the 57 economic deposits, only 10 are of above-average size, while 19 are of above-average grade. None come close to combining above-average size and grade as illustrated by the absence of points in the top right quadrant of Figure 1.
Not surprisingly, all but one of the larger discoveries are base metal deposits. The average size of an economic base metal deposit is 171 million tonnes as compared to only 19 million tonnes in the case of the precious metal finds.
The relationship between the economic attributes of deposit size and quality - revenue and rate of return -is illustrated in Figure 2. The average values for these measures of the return from the 57 economic deposits are revenue of $ 1,635 million, and 25 percent rate of return.
The association of these two types of economic value appears to be quite random and shows little evidence to support the notion of an inverse relationship between the size and profitability features of economic deposits. While three of the smaller precious metal deposits do give the highest rates of return, the most marginal rate of return outcomes are also associated with relatively small discoveries.
Precious metal deposits are well represented on the up side of the economic quality distribution, 9 of the 21 discoveries with above-average rates of return being precious metal deposits. Once again, base metal deposits predominate at the upper end of the economic size distribution. All three discoveries which are of above-average size and quality are base metal deposits.
A histogram of net present values at 10 percent for the 57 deposits discovered in Chile during the 1970-92 period which have been evaluated as economic under base case conditions is presented in Figure 3. It provides a final illustration of the variability and skewness features of the return from economic discoveries. The very best of the 57 economic discoveries are base metal deposits which predominate in the upper intervals of the net present value distribution. In contrast, the 24 economic precious metal discoveries tend to be spread among the middle and lower value intervals. Once again, this reflects the six-times difference in average deposit size between these two commodity groups as well as quality differences among deposits. Skewed
Fourteen of the 57 economic discoveries in Chile are estimated to yield medium-term net present values in excess of $100 million and, as such, can be called world-class deposits. This suggests that, given the discovery of an economic deposit, there is approximately a one in four chance or a 0.25 probability of it being world-class.
Ten of the 14 world-class discoveries are base metal deposits, the remaining four are precious metal discoveries. In alphabetical order, by commodity group, they are:
> World-class base metal discoveriesCollectively, the 57 economic discoveries are estimated to generate a medium-term net present value of $7.2 billion. However, the 5 most valuable deposits, representing less than 9 percent of the total number of economic discoveries, contribute two-thirds of the total value. All together, the 14 world-class discoveries, accounting for about one-quarter of the total number of economic deposits evaluated, represent 88 percent of the overall net present value. Thus, in Chile as elsewhere in the world, the relatively few world-class discoveries account for the lion’s share of potential mineral wealth.
Candelaria Rosario Porphyry Cerro Colorado Sur-Sur Damiana Tesoro-Leonor Escondida Ujina Mansa Mina Central Zaldivar
>World-class precious metal discoveries
El Indio La Coipa El Tambo Refugio
Most importantly, this Chilean case study demonstrates that there is no such thing as a typical deposit. Potential mineral wealth is characterized by high degrees of uncertainty, variability, skewness, and randomness. Flexibility in mining taxation policy is essential, therefore, to accommodate realistically and efficiently the attributes of potential mineral wealth.
Impact of Mining Taxation
The realization of potential mineral wealth is particularly sensitive to the way in which public policy provides for sharing the as associated costs and benefits between industry and government. Mining taxation policy is a key determinant of the trade-off involved.
Given an appraisal of potential mineral wealth, the impact of tax policy can be evaluated as portrayed in Figure 4. Three types of mining taxation criteria are depicted.
How actual mining taxation systems measure up in terms of the foregoing criteria depends on both the level of taxation, a function of the percentage rate of taxation applied, and the structure of the fiscal policy. With respect to the latter, it is helpful to distinguish between four types of tax structure.
- Economic inefficiency, measuring the degree to which the actual value realized after tax falls short of the potential value. The number of economic deposits and total export revenue are used as indicators of economic inefficiency in the competitive position analysis which follows.
- After-tax investment incentive to the mining company as appraised, for example, by after-tax rate of return and after-tax net present value.
- Government tax revenue criteria, including the effective tax rate. The effective tax rate is defined here as the share of the before-tax net present value which is realized by government in tax payments.
> Capital-Based TaxationAn important policy issue is the extend to which taxation distorts mining investment decisions. If the effective tax rate on projects which are marginally economic before tax is positive, then the tax system provides a disincentive to invest. Under these conditions, projects which are economic on a before-tax basis can become uneconomic after tax. This represents an important type of government policy inefficiency.• Taxation is levied at c percent per year of the assessed value of capital assets.> Revenue-Based Taxation• Taxation is levied at r percent of annual revenue. For this purpose revenue can be defined in various ways.> Profit-Based Taxation• Taxation is levied at a flat rate of t percent of annual profit or income. Alternatively, the tax rate can be graduated, increasing with the annual level of profit.> Profitability-Based Taxation• Taxation rate of y percent of annual profit is a function of the relationship between profit and investment or, in other words, of profitability as measured, for example, by the rate of return on investment. No tax is levied until a certain threshold rate of return is attained, with the tax rate increasing above this threshold value to a specified maximum marginal rate for highly profitable projects.
More generally, it is of interest to examine trends in the effective tax rate as a function of the before-tax profitability of projects. A progressive tax collects an increasing proportion of before-tax net present value as profitability rises. On the other hand, a regressive tax takes a diminishing proportion of before-tax economic value as profitability rises. Regressive tax systems tend to have their strongest impact at the investment margin, resulting in economic distortions and inefficiencies.
Profitability-based taxation is the most progressive structure for fiscal policy, followed by profit-based taxation. At the other end of the policy spectrum, capital-based taxation is the most regressive, followed by the revenue-based structure of taxation.
Mining Taxation in South America
Competitive tax positions are assessed here for the ten South American countries which represent the main targets for investment in mineral exploration and mine development. With apologies, Paraguay, Suriname and Uruguay are excluded.
The analysis examines the impact of four tax components:
- Income tax;
- Government royalty;
- Capital tax;
- Government profit share
- Other government fiscal levies are not included.
Table 1. Mining Taxation Components by Country
| Contry/Tax Component | Income Tax | Government Royalty | Capital Tax | Profit Share |
| Argentina | X | X | X | |
| Bolivia | X | X | X | |
| Brazil | X | X | X | |
| Chile |
|
|||
| Colombia | X | X | X | |
| Ecuador | X | X | X | |
| French Guiana | X | X | ||
| Guyana | X | X | X | |
| Peru | X | X | X | |
| Venezuela | X | X | X | X |
Table 2. Governments Royalty Bases
| Country | Refined Metal Value | Minesite Revenue | Mine - Mouth Value |
| Argentina |
|
||
| Bolivia |
|
||
| Brazil | X | X | |
| Colombia |
|
||
| Ecuador |
|
||
| French Guiana | X | X | |
| Guyana | X | X | |
| Venezuela | X | X |
In South America, for all countries except Argentina, Brazil and French Guiana, governments allow unwritten-off-balances for tax purposes to be indexed for the general rate of inflation when carried forward to a subsequent year. For Argentina, Brazil and French Guiana where there is no indexing provision, it is necessary to consider inflation in order to correctly evaluate the impact of taxation. A 3-percent annual US dollar rate of inflation is assumed for this purpose.
The impact of mining taxation is analyzed from the perspective of a multinational mining company considering investment in a country for the first time. Thus, the individual project basis of taxation is assumed. This means that tax deductions can only be taken against production income arising from the project being evaluated.
Comparative Tax Inefficiencies
Figure 5 compares the number of economic deposits evaluated after tax in each of the ten South American jurisdictions with the 57 economic deposits appraised on a before-tax basis. The after-tax range extends from 49 economic deposits in Chile, down to 38 economic deposits in Guyana and 37 in Ecuador. The other countries are distributed across the middle ground: 46 economic deposits in Argentina and Brazil, 45 in Peru, 43 in Bolivia, Colombia and French Guiana, and 40 in Venezuela.
Thus, between 14 percent and 35 percent of the potentially economic deposits discovered are rendered uneconomic by these mining taxation systems. This highlights a serious government policy inefficiency.
The impact of taxation on total export revenue is not so strong, as illustrated in Figure 6. More than 96 percent of the $92.5 billion before-tax export revenue associated with the 57 economic deposits would be realized in seven countries: Chile, Argentina, Brazil, Peru, Colombia, French Guiana and Bolivia. Even in the cases of Venezuela, Guyana and Ecuador, more than 89 percent of the potential value would be actualized. This finding is explained by the predominant contribution of the relatively few large and high quality world-class deposits which remain economic after tax.
Comparative After-Tax Investment Incentives
To provide a level playing field for comparing the after-tax incentive to invest in new mine development, the set of economic deposits has to be standardized. The 36 deposits found to be economic after-tax in all jurisdictions analyzed are used for this purpose.
Figure 7 presents the average after-tax rate of return on investment based on development of this standard set of 36 economic deposits. Profitability varies from approximately 22 percent in Chile and Brazil, and 21 percent in French Guiana, Argentina and Colombia, to 20 percent in Bolivia, Peru and Ecuador, and 19 percent in Venezuela and Guyana.
Differences in the average net present value at 10 percent for an economic deposit after tax among the ten selected nations of South America are depicted in Figure 8. As shown, the after-tax net present value which a mining company would realize ranges from $116 million in Brazil, $114 million in French Guiana, $110 million in Chile and $109 million in Argentina, down to $101 million in Colombia, $98 million in Peru, $97 million in Bolivia, $90 million in Ecuador, $85 million in Venezuela and $82 million in Guyana.
Comparative Government Tax Revenue Criteria
Government tax revenue indicators are assessed utilizing the same standard set of 36 economic deposits.
Figure 9 illustrates variations in the overall effective tax rate, and the make up of the overall rate for the ten nations under study. Remember that effective tax rate is defined here as discounted tax revenue divided by before-tax net present value, expressed as a percentage. Overall effective tax rates are highest in Guyana (57%), Venezuela (55%) and Ecuador (51%). Bolivia and Peru (48%), Colombia (46%), Chile and Argentina (42%), French Guiana (40%) and Brazil (39%) are positioned in descending order to the low end of the range.
The relative contributions of the individual tax components in each country is of interest.
The income tax and profit share components tend to be relatively progressive and efficient because they are profit based. The unified tax system in Chile is solely profit based, and the tax regime in Peru is almost entirely profit based. On the other hand, several countries
have large regressive tax components, particularly revenue-based revenues. The worst offenders in this regard are, in order of importance: Bolivia, Colombia, Guyana, Brazil, French Guiana and Ecuador. This regressive feature explains the relatively strong impact that the tax regimes in these countries have on rendering potentially economic deposits uneconomic after tax (Figure 5).
Comparative mining tax levels measured relative to an index of 100 for Peru are presented in Figure 10. Bolivia, Ecuador, Venezuela and Guyana collect tax revenue in discounted terms which vary from 1 percent to 18 percent above those which would be collected Peru. On the other hand, Colombia, Argentina, Chile, French Guiana, and Brazil receive tax payments which vary from 97 percent to 80 percent of the Peruvian standard. In this respect, Peru stands in the middle of the South American competitive tax league.
Placing the South American Findings in a Global Context
Finally, the South American findings are compared with the impact of taxation in two main competitor nations for multinational mining company investment - Australia and Canada. The following eight rival jurisdictions are used to calibrate South America’s competitive tax position:
Northern Territory, Queensland, South Australia and Western Australia in Australia.
British Columbia, Manitoba, Ontario and Quebec in Canada.
For comparative purposes, the 1997 taxation and royalty systems in these Australian and Canadian competitor domains are applied in turn to Chile’s before-tax base and precious metal deposit potential. All other specifications and assumptions remain unchanged.
With respect to the number of economic deposits after tax (Figure 11), the South American range extends from 49 deposits in Chile down to 37 deposits in Ecuador. Results for the four Australian jurisdictions are distributed along the bottom edge of this range, while the four Canadian provinces fall in the upper half of the range. As we will see, the level of taxation in the selected Australian and Canadian jurisdictions are quite similar. The sharp distinction between them apparent in Figure 11 is attributable to the fact that state royalty payments in Australia are predominantly revenue based whereas the counterpart provincial mining taxes in Canada are entirely profit based. This illustrates the practical difference in impact of regressive and progressive tax structures.
Figure 12 presents the global comparison of the average after-tax net present value for an economic deposit based on the set of 36 economic deposits. The South American findings for this measure of medium-term investment incentive range from $116 million (Brazil) to $82 million (Guyana). The Northern Territory, Western Australia, British Columbia and Ontario fall below the bottom end of the South American range. Queensland, South Australia, Manitoba and Quebec penetrate into the lower quartile of this range.
In terms of the effective tax rate (Figure 13), results for the ten countries of South America extend from 57% in Guyana down to 39% in Brazil. The eight selected Australian and Canadian jurisdictions are positioned either above or well up on this scale, with effective tax rates which vary from 59% (British Columbia and Ontario) to 54% (Queensland, South Australia, Manitoba and Quebec).
Summing Up
The results presented are intended to illustrate a realistic approach to the analysis of mining taxation policy.
From the perspective of corporate investment strategy for mineral exploration and mine development, the ranges of mining tax criteria associated with the ten selected South American nations are found to compare favorably with the eight selected Australian and Canadian jurisdictions. In fact, the stronger South American tax competitors - particularly Chile and Brazil - have a decided edge on their global rivals.
Nevertheless, there is much scope for improving the efficiency of mining tax policies in South America, particularly with respect to the harmful consequences of regressive revenue-based royalties. For example, our analysis demonstrates that between 14% and 35% of the potentially economic deposits discovered are rendered uneconomic by the existing South American tax systems.
Realization of the full economic potential of South America’s great mineral wealth will require progressive reforms in mining taxation.
Acknowledgements
Phillip Harman of BHP Minerals supported the basic empirical research in South America which underlies this work. Michael Doggett, Bill Orme and Jianping Zhang, Queen’s University, helped with the paper itself. These contributors are thanked and gratefully acknowledged.
References
Arantes, D. and B.W.. Mackenzie, A Posição Competitiva do Brasil na Mineracão de Ouro, Departamento Nacional da Produção Mineral (DNPM), Brasilia, 1995, 102 pp.Mackenzie, B.W., "Impacto de las Politicas Tributarias Peruanas en el Desarrollo del Potencial Minero", Informativo Mensal, Sociedad Nacional de Mineria y Petroleo, Lima, May 1997, pp. 28-34.
Mackenzie, B.W., "The Mineral Wealth of Nations", pp. 351-358 in Proceedings of the 1995 PACRIM Congress, Australasian Institute of Mining and Metallurgy, Melbourne, 1995, 686 pp.
Mackenzie, B.W. and M.D. Doggett, Competitive Position of Mining Taxation Systems in South America, prepared for BHP Minerals, Santiago, 1996, 110 pp.
Mackenzie, B.W., F.J. Ortiz and M.D. Doggett, Economic Potential of Mineral Exploration in Chile: Evidence from the Historical Record, Centre for Resources Studies, Kingston, 1997, 229 pp.