5 International mineral taxation: experience and issues

Fiscal regimes for minerals (and other resources) tend to differ from those found in other sectors due to the presence of resource rents and unusual risks. Resource rents represent surplus revenues from a deposit after the payment of all exploration, development and extraction costs, including an investor’s risk-adjusted required return on investment.1 Since rent is pure surplus, it can be taxed whilst upholding the core taxation principle of neutrality. Furthermore, governments aim to capture the resource rent, not least because minerals are typically owned by the state. The unusual and substantial risks inherent in the mining sector need to be emphasized. These risks include, for example: a long exploration period with uncertain geological outcomes; a large significant outlay of development capital that is not transportable (i.e. becomes “sunk”) once invested; uncertain future revenues due to very volatile and unpredictable mineral prices; a long period of production to reach break-event point, which exposes the investor to politicaland policy instability; and potentially significant environmental impacts requiring large costs to be incurred when the mine closes, and often during production to support affected local communities. These considerations motivate measures, such as accelerated depreciation and extended loss-carry forward limits, to hasten payback of initial outlays. While rents and risks are also present in other sectors, their scale and characteristics (such as the rent being derived from minerals owned by the state) have led to special tax treatment of the sector, using a wide variety of fiscal instruments.2 These instruments include royalties, resource rent taxes, windfall taxes, corporate income taxes and state ownership. Each has its advantages and disadvantages with respect to the impact on investor behavior, the degree of progressivity (i.e. extent to which the “government take” increases as a project’s profitability increases), the sharing of risk between the government and investor, and the administrative and compliance costs. The characteristics of fiscal instruments are discussed in Section 3. Mineral fiscal regimes vary widely between countries and minerals for a number of reasons. For example, the level of taxation is likely to vary with country risk.3 This is because investors base their decisions on risk-adjusted rates of return, and the lower the country risk the higher the level of taxation consistent with a given project exceeding the minimum required return. The royalty rate and other instruments most directly targeted at rent are also likely to vary with the perceptions of the size of rent available.4 This explains why high value minerals like diamonds and gold tend to attract a higher royalty rate. The optimal mix of fiscal instruments will also vary depending on the country’s preferences and capabilities. Some governments may prefer production-basedinstruments as they are easier to administer and provide earlier and more stable revenue. However, as this shifts more of the risk onto companies, governments will most likely need to accept a lower overall expected level of taxation.5 Other countries might therefore prefer a more progressive regime that involves the government assuming more risk but also expecting to receive a higher take from profits. A summary of current arrangements for selected countries is provided in Appendix I. In addition to variation between countries, a number of global trends can be identified over the past half century. These have tended to be punctuated by external events that shifted the balance of power between mineral producing countries and investors. This shift in power, which is evident in the evolution of mineral prices (Figure 5.1), can usefully be analyzed with reference to a number of distinct periods.6 The experiences of Papua New Guinea, Chile and Zambia provide useful illustrations of these trends (Box 5.1).