mining taxation issues for the future

Resources Policy 25 (1999) 221–227www.elsevier.com/locate/resourpol

Mining taxation issues for the future

Philip Andrews-Speed*, Christopher D. RogersCentre for Energy, Petroleum and Mineral Law and Policy, University of Dundee, Dundee, DD1 4HN, UK

Received 2 August 1999; received in revised form 29 October 1999; accepted 8 November 1999

Abstract

During the 1970s and 1980s the main concern of mining policies was to attract investment whilst at the same time balancingthe interests of governments and companies. By the turn of the century a new spectrum of challenges faces governments andcompanies in the mining sector. The need for fiscal regimes to adapt to price cyclicity is to some extent superseded by the require-ment that they adapt to a long-term decline of metal prices. The growing importance of environmental and community affairs inthe mining sector will force governments to design coherent and comprehensive tax regulations to complement the wide range ofinitiatives being taken in these fields. Finally, the age-old problem of tax collection continues to raise its head in transition anddeveloping economies. 2000 Elsevier Science Ltd. All rights reserved.

Keywords:Mining taxation; Environmental taxation; Rehabilitation; Community policy; Tax collection

Introduction

During the 1970s and 1980s the efforts of academicsand advisors in the field of mineral taxation weredirected at finding effective ways to split the economicrent accruing from mining projects between the investorand the host state in such a way that the interests of bothwere satisfied (for example: Garnaut and Clunies-Ross,1983; World Bank, 1994, World Bank, 1996; Inter-national Financial Corporation, 1997). The specific focuswas on the requirements for attracting foreign invest-ment, particularly in developing countries. As a result abroad consensus has emerged as to the desirable charac-teristics for a fiscal regime for mining, though concernsexist in relation to the potential for excessive fiscal com-petition between states seeking to attract investment.

The last 10 to 15 years have seen major mining sectorreforms being implemented or started in more than 90states (Otto, 1997a). These reforms have included newlegislation and mining codes, revised fiscal terms, theremoval of formal barriers to foreign investment, areduction in the role of the state in foreign investments,and the complete or partial privatisation of state mining

* Corresponding author. Tel.:+44-1382-344300; fax:+44-1382-322578.

E-mail address:[email protected] (P. Andrews-Speed)

0301-4207/00/$ - see front matter 2000 Elsevier Science Ltd. All rights reserved.PII: S0301-4207 (99)00029-X

companies. The desire to attract foreign investors, com-bined with the increased willingness to undertake therequired modification of fiscal terms, has resulted in ahigh degree of competition between host states to reducethe tax burden on investors. This phenomenon has hadtwo unfortunate side effects (Crowson, 1997). Firstly,the share of the rent passing to the host state maybecome inequitably low. Secondly, some governmentsseem to be unaware that possession of adequate legaland fiscal systems are insufficient by themselves unlesscomplemented by both effective implementation and anacceptable level of political risk.

For these and other reasons the intensity of inter-national debate concerning mining taxation has declinedin recent years, especially in the context of attractingforeign investment. That being said, considerable effortsare still required to apply these general principles to thecreation of new fiscal regimes and to adapt existingregimes to changing economic or political circumstances(e.g., Hollaway, 1999). Apart from the issue of thedivision of economic rent, a number of tax issues areremain inadequately resolved and these relate more toprotecting the long-term interests of the host state thanto the short-term commercial interests of the investors. Itis a selection of these issues which this paper addresses:namely, the long-term decline of mineral prices, theincorporation of fiscal mechanisms into environmentaland community policies, and tax collection.

222 P. Andrews-Speed, C.D. Rogers / Resources Policy 25 (1999) 221–227

The challenge of falling prices

The long-term trends for the prices of many mineralproducts has been downwards in real terms1. A higherdegree of competition in the metal markets has beenengendered by low growth in demand for metals, theincreasing political accessibility of mineral deposits, theincreasing globalisation of both mining company activityand capital markets, and the growth of the private sector(Palmer, 1997; Humphries, 1998). Companies haveresponded to this competition by cutting costs in explo-ration, development, production and transport thoughtechnological innovation, economies of scale and out-sourcing (Crowson, 1997; Palmer, 1997). It is likely thatthese trends will continue in the future, placing con-tinued pressure on long-term trends for real prices forminerals.

Superimposed on the long-term downward trend inprices are shorter period fluctuations in metal price.Governments of mineral-dependent countries havesought to protect their tax revenue from mining duringsuch downturns through a variety of mechanisms. At oneextreme is the knee-jerk reaction, resulting in ad hocmodifications to the fiscal regime. For example, inAugust 1998 Chile announced a package including therevocation of fines for non-payment of license fees,V.A.T refunds and income tax exemptions. These meas-ures apply only to small and medium-sized mining com-panies, and the latter two measures are now applicable intimes of low metal prices (Mining Journal, 1998). Suchamendments may solve a short-term problem, but havea number of drawbacks: the incentive to pay license feesis further diminished; they require a definition of theterm ‘low metal prices’ which may not be sustainable inthe face of long-term price decline; and they are clearlydiscriminatory, being directed at small and medium sizedcompanies which are presumably mainly domestic anddo not cover the, predominantly foreign, large miningcompanies.

An alternative approach taken earlier by Papua NewGuinea in 1974 was to create a Mineral ResourcesStabilisation Fund (Lum et al., 1995). All governmentrevenue from mining activities, including both taxes anddividends, are placed in the fund. Each year the publicservants managing the fund decide, within a givenframework, how much to pass on to the government.Despite the success of the fund in stabilising Papua NewGuinea’s revenue during the 1970s and 1980s, such amechanism has not been widely adopted by other coun-tries. Not only does such a fund depend on the abilityof the Fund managers to resist pressure from the govern-ment to release extra funds, but such a device does not

1 For example for aluminium, copper, nickel, lead and gold (Palmer,1997; Lietard, 1999).

address the types or rates of taxation, and thus is notwell suited to compensate for the long-term decline ofmineral prices.

Tax regimes must be responsive to low metal priceswithout the need for either ad hoc modifications or thecreation of special funds. As long argued by Garnaut(Garnaut and Clunies-Ross, 1983; Garnaut, 1995),flexibility lies at the heart of stability and flexibility canbe achieved by directing taxes at profits. Such anapproach has two advantages for governments. Firstly,the pain of reduced revenue is shared equitably betweenthe investor and the government. Secondly, and moreimportantly in the long term, the investors are providedwith incentives not to withdraw their investments but toseek ways to further reduce costs (van Meurs, 1988).The need to reduce costs is a national as well as a cor-porate challenge. The states that provide their investorswith the appropriate rewards for cost reduction willbenefit in the long-term.

The role of taxation in mine rehabilitation

Mining is one of mankind’s most environmentally-destructive activities, often involving the modification oflarge tracts of landscape and the production of a pro-portionately high output of waste material. The idea thatmining companies have the responsibility to manageand, to a great extent, pay for the rehabilitation of minesites during and after production is now widely accepted(Tilton, 1994; Hull et al., 1995). In economic terms, theexternal cost of the mining activity should beinternalised to the mining project (Westin, 1995; Auty,1998). Mineral jurisdictions are increasingly requiringmining companies to set up financial arrangements forrehabilitation before the production license is granted(Bassett, 1998).

To be effective, a regulatory system for mine rehabili-tation should provide incentives to minimise damage inthe first place, should ensure that sufficient funds areactually available for rehabilitation, should lay downclear standards for rehabilitation and should ensure thatmining companies receive equitable tax treatment withrespect to the costs incurred.

Two main mechanisms exist for preparing for therehabilitation of currently operating mines2. The firstmechanism provides for funds purely in accountingterms and is practised in the U.S.A. A notional reserveis created by accruing costs during production (Hull etal., 1995). Although such a mechanisms provides incen-tives for companies to prepare for the cost of rehabili-

2 This discussion does not include the U.S. Superfund Tax which iscollected to pay for the restoration of past mining sites (Tilton, 1994).

223P. Andrews-Speed, C.D. Rogers / Resources Policy 25 (1999) 221–227

tation, it does not guarantee that the funds will be avail-able when required.

The second, and more widespread, arrangement is forthe amount to either be physically set-aside or for bondsor guarantees to be used. For example trust funds areused in Canada and South Africa, whilst performanceguarantees are common in Australia (van Blerk, 1994;McAllistair et al., 1994; Hull et al., 1995).

Whichever of these mechanisms is applied, thegovernment has a responsibility to draft carefully-con-sidered and thorough regulations concerning the taxtreatment of rehabilitation costs. Companies are con-cerned with what tax relief is available and when(Bernhardt, 1998). In simple terms, two types of issuecan be identified: those relating to the mine rehabilitationitself and those relating to the financial arrangements.

It is vital for the government to define in detail whatitems of rehabilitation cost are tax deductible. Forexample, the Australian regulations exclude the planningfor site rehabilitation, any rehabilitation during mineoperations and any restoration activities off the mine siteitself (Thompson, 1991). Namibia’s income tax regu-lations provide for deductions in respect of contributionsto funds established to remedy “any damage caused bysuch mining operations to the surface of, and theenvironment on, the land in question”, with the provisionthat these deductions may be clawed back by the govern-ment in the event that they are not eventually used forsuch remedial action3.

More complex is the issue of when such tax reliefmay be claimed. Most companies operate on the basisof discounted cash flow, and therefore earlier tax reliefis more attractive than later (Bernhardt, 1998). Australiaagain provides an extreme example. If a trust fund is setup, no deductions can be claimed until the rehabilitationcosts are actually incurred, with no provision for loss-carry back or tax credit (Bernhardt, 1998). Such asscheme is clearly unattractive to mining companies. InSouth Africa the contributions to the fund are tax deduct-ible at the time of payment, though it is necessary todefine how the acceptable level of contribution is calcu-lated in order to prevent abuse (van Blerk, 1994). Losscarry back is available in the U.S.A. and the U.K.(Bernhardt, 1998). Alternatively a unit-of-productionmethod may be used to allocate rehabilitation costs, asin the petroleum sector of the Netherlands (Goedkoopand Veltema, 1992).

With respect to the financial arrangements, it is neces-sary to define who receives the interest accrued, what istax deductible and what is tax-exempt. In South Africathe interest earnings of the trust fund accrue to the min-

3 See the Income Tax Amendment Act, Clause 8, GovernmentGazette of the Republic of Namibia, No.487, 23 September 1992, pp.15-16

ing company and are tax exempt (van Blerk, 1994),whereas in Canada such income is taxable as are anydrawings from the fund (Hull et al., 1995). The govern-ment needs to consider whether or not the service feesand interest costs attached to the various forms of finan-cial arrangements should be tax deductible (McAllistairet al., 1994).

Estimating the actual future cost of rehabilitation isextremely difficult for many reasons: mines may have alife in excess of 50 years; the ultimate size and life ofthe mine is essentially almost unknown at the start ofoperations; the technology available for both mining andrehabilitation is certain to change during the life of themine; and the standards of rehabilitation acceptable tosociety are likely to rise. One way to address thisdilemma is to set a ceiling for the fund for each mine.If the costs of rehabilitation exceed the value of the fund,the government pays the excess. If the costs are less thanthe value of the fund, the government keeps the differ-ence (Scott, 1992). Few governments may want toexpose themselves to such risks and the more sophisti-cated approach taken by South Africa may have moreappeal. Here the annual contribution is calculated bydividing the estimated present cost of rehabilitation notalready set-aside by the estimated remaining life of themine (van Blerk, 1994). This latter method requires moreeffort, but does start to address the uncertainties listedabove.

All rehabilitation funds, even of the sophisticatedSouth African type, run the risk that the actual cost ofrehabilitation differs significantly from the amount heldin the fund. Clear guidelines are required concerning thefate of any excess. If the surplus passes to the govern-ment, then companies are likely to underestimate thecosts of future rehabilitation in order to reduce the riskof such revenue loss. If the surplus reverts to the com-pany, the tax treatment of this flow of funds must beclarified in advance.

Whichever methods are chosen, the government hasthe responsibility to put in place a regime for environ-mental protection and mine rehabilitation which not onlyprotects the national interest but which also imposes onthe mining companies financial obligations and incen-tives which are detailed, transparent and equitable. Thosestates which fail to do so will lose in the long-term,either through the degradation of their environment orby their failure to attract investors.

The role of taxation in community policy

The need to satisfy the aspirations, reasonable orunreasonable, of communities living in and aroundmines has been brought home forcefully in recent years.Governments and companies are beginning to recognisethat these communities may be entitled to legal rights


over the deposits and are certainly entitled to be con-sulted during mine development and to receive directand indirect benefits from the mining activity (Garnaut,1995; Crowson, 1997; Otto, 1997b; Auty, 1998; Chubb,1997). Such benefits should flow to the community bothduring and after the period of operation of the mine(Rocha and Bristow, 1997).

Two approaches may be taken to create and managea flow of funds to the locality, which may be referredto as conventional and novel. The conventional approachbuilds on the existing system for taxation in which taxrevenues are either collected at levels below that of thecentral government or are collected by central govern-ment and distributed to lower levels. For example in Bra-zil various forms of tax, royalty and fee may be collectedat three levels of government (Federal, State andMunicipal) in addition to the royalty due to the land-owner (Andrews-Speed, 1998). In Ghana, the main taxand royalty revenues are collected by the central govern-ment, but two mechanisms have been put in place toensure that a proportion of funds derived from theexploitation of natural resources flow to lower levels ofgovernment. The first provides for at least five percentof all such revenues collected by central government tobe passed to local governments, regardless of thelocation of the sources of revenue. The second mech-anism established a Mineral Development Fund intowhich 20% of all royalties are paid. Half of the incometo this fund should be paid to those local governments“in whose jurisdiction the operation took place and thetraditional representatives of the landowning communityand any other persons or communities adversely affectedby the mining operation” (Date-Bah, 1998). In the Phil-ippines a combination of these two fiscal mechanismsare employed. Not only may local governments imposetaxes within certain limitations, but the central govern-ment must also pass 40% of its mining revenues to prov-incial, municipal and village governments (Balce etal., 1995).

Whilst such federal tax regimes do provide mech-anisms for channelling a share of the economic rent tolower levels of government in mining regions, they suf-fer from a number of drawbacks (Andrews-Speed,1998). Of greatest relevance to the communities affectedby the mining activity is the possibility that the localgovernment is unable or unwilling to spend this revenuefor the long-term benefit of the community for which ithas responsibility. One solution is for the mining com-pany itself to take on this responsibility, a feature ofmany transition economies such as the former SovietUnion and China. However the tasks of governmentshould be administered by government, and the compa-nies should be left to do what they do best, which ismining (Crowson, 1997).

Two novel mechanisms which secure the directinvolvement of the communities affected are illustrated

by examples from Papua New Guinea and Alaska. InPapua New Guinea the Canadian major, Placer, partici-pates in a scheme in consultation with the central andprovincial governments and the indigenous land-ownercommunities called the Infrastructure Tax CreditScheme. Under this scheme a proportion of the grossincome of the mining project4 is used by the miningcompany to build community infrastructure projectssuch as roads, bridges, and education and health facili-ties, chosen by the community in consultation with themining company and subject to approval from the rel-evant government agencies. The amount thus spent iscredited against corporate income tax (Togolo, 1997).

An alternative approach has been taken for the RedDog Mine in north-west Alaska. Here the indigenouspeople have set up community corporations whichreceive financial benefits including a share of both themineral royalties and the mining profits (Horswill etal., 1997).

Both mechanisms have the advantages that the miningcompany is largely removed from local administration,that a share of the wealth generated by the mine is chan-nelled directly to those affected by the mining, and thatthe mining company itself can see the impact of thefunds its provides on the local people’s lives.

The fiscal or quasi-fiscal system put in place to chan-nel funds to the local community should define not onlythe tax implications for the mining company, but alsofor the institutions and individuals who are drawing onthese funds. Does the community gain the benefit freeof tax or is it liable for tax to the central or regionalgovernment?

As is the case with environmental protection, govern-ments ignore the interests of local communities at theirperil. The costs of disruption to the community may beinternalised to the project, but the government has theresponsibility to provide a framework of financial andfiscal arrangements which are acceptable to both themining company and the peoples affected by the project.

Tax collection

The most stable, equitable and flexible tax system inthe world has no value if the government cannot collectthe tax revenue which it is due. The issue of tax collec-tion has two aspects, administrative and political. Theadministrative requirements include the formulation ofclear definitions from which the tax base can be assessedand skilled personnel, either in-house or contracted, toensure compliance (Garnaut and Clunies-Ross, 1983;Garnaut, 1995). Failure to collect the expected levels of

4 The proportion in 1997 was 0.75% and was due to rise to 2%(Togolo, 1997).


revenue from the mining sector, or indeed any sector ofthe economy, is a perennial headache for governmentsof developing and transitional states. In many cases thedifference between expected and actual revenue is attri-buted to fraudulent book-keeping, under-reporting orunder-valuation of mine output, or plain bribery (Balceet al., 1995). Such evasion may be reduced through moreeffective administration.

A much more serious cause of systematic failure tocollect taxes has its root in the distribution of politicalpower. Two examples will suffice to illustrate the prob-lem, one from China concerning a conflict between dif-ferent levels of government and the other from Russiabetween government and company.

Despite two decades of dramatic economic growth inChina, the central government has struggled to collect areasonable share of the rising national income. Most taxcollection is implemented by the provincial and lowerlevel governments, and the proportion of this revenueflowing to the central government fell during the 1980sand early 1990s. The lack of central tax collection, com-bined with opaque procedures for determining the levelof revenue transfers between the provinces and the cen-tral government, resulted in a situation in which the levelof contribution payable by the province to the centralgovernment depended on their bargaining power at thetime. Central government revenue fell as a proportion ofboth GDP and total government revenue, and individualprovinces received inequitable treatment (Wong et al.,1995). The situation was exacerbated by provincial andlocal governments granting unauthorised tax exemp-tions. These serious deficiencies in the tax regime aresymptomatic of the increasing power of provincial andlocal governments at the expense of the central govern-ment, a phenomenon which is particularly well-developed in the energy and natural resources industries(Andrews-Speed et al., 1999).

The second source of political conflict impacting ontax collection has its roots in the recent waves of partialor total privatisation of mining and natural resource com-panies coincident with a rising level of democracy indeveloping and transition economies. Though the abilityto collect taxes due relies, in part, on the relative bar-gaining power between the government and the partyconcerned, Cheibub (1998) has argued that the empiricalevidence fails to show that democracies, even new ones,are less effective at collecting tax revenues than dictator-ships. That may be so statistically, but on the ground thesituation looks rather different in certain cases. A weakgovernment in a newly-created democracy is likely tofind great difficulty in extracting tax revenue from acompany which holds a monopoly over a vital resourceand which has been partially or fully privatised. Such acompany can hold the government to ransom, at leastin the short-term. The Russian gas monopoly, Gazprom,provides an example of this from the petroleum industry

(von Hirschhausen, 1998). Gazprom has consistentlyfailed to pay its full tax bill. In July 1998 the Russiangovernment exerted pressure on the company to pay infull its taxes, at least in the future. Gazprom respondedby threatening to cut supplies to all 2,800 companieswhich owed it money. The government retreated(International Petroleum Finance, 1998).

This highly unsatisfactory predicament can be tracedto two sources. Firstly, the privatisation and ‘liberalis-ation’ programme of the Russian energy industry hasbeen incompetent and corrupt, leaving Gazprom andother companies with too much market power. Secondly,the fiscal regime imposes an unreasonable tax burden onenergy and natural resource companies whilst at thesame time the legal system fails to provide the compa-nies with the means to collect the tariff revenue due tothem.

In the past, governments directed their energies atextracting the maximum amount of revenue from foreigninvestors. For many transition and developing economiestoday, raising the level of tax revenue collected maydepend more on resolving internal political conflicts andimbalances and creating transparent, equitable andenforceable mechanisms for the flow of revenue.

Conclusions

In the past much of the debate in mineral taxationfocused on the division of economic rent between theforeign investors and the developing host states. Mostcountries have already put in place fiscal regimes whichadequately or even excessively address the concerns ofthe mining companies. Despite the efforts problemsremain in ensuring that the fiscal systems are suitablyresponsive to changing economic or political circum-stances, and that governments recognise the need forfiscal stability.

It is now time for mining countries to examine moreclosely their own long-term interests and how their fiscalregimes may be adapted to more effectively satisfy theseinterests, whilst at the same time not deterring investors.

This paper has addressed four concerns: the need forfiscal regimes to be robust in the face of the long-termdecline in real metal prices; the requirement to draw-upcomprehensive tax regulations covering mine rehabili-tation; the obligation to allow local communities to playa more direct role in determining how they benefit frommining operations, which will in turn have fiscal impli-cations; and the potential for some governments to raisethe level of legitimate extraction of tax revenue fromdomestic entities. All of these issues require consideredresponses from the governments of mineral-extractingnations. Rapidly-formulated and ill-judged measures,especially on such issues as mine rehabilitation and localcommunities, are likely to receive a poor reception from


the mining investors and will serve to enhance the per-ceived level of political risk.

Failure to confront and tackle these issues will resultin loss of revenue or quality of life for the nations con-cerned. In today’s liberalised world, companies caninvest elsewhere. A country’s mineral deposits are stillimmovable.

Acknowledgements

The authors are grateful to Victorio Panzica, MichaelChubb, Dario Aras and Wasan Tieotragul for their helpduring the preparation of this paper, through discussionand provision of materials, and to two anonymousreviewers for their comments.

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