public disclosure authorized - preface as part of the world bank’s work to support indonesia to...

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WB112742

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INDONESIA

Improving the Investment Climate for Sustainable Mining Development

December 30, 2004 Mining Policy and Reform Division Oil, Gas, Mining and Chemicals Department The World Bank Group

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PREFACE

As part of the World Bank’s work to support Indonesia to attract new investment and encourage economic growth, this report addresses the Investment Climate for Sustainable Mining Development. For the past several years the Government has been considering revising the Mining Law and the report provides detailed comments on the key characteristics of a modern mining law, associated implementing regulations and the mineral fiscal regime. These are issues central to sound mining sector governance and to establishing a responsive public/private sector interface. The work for this report was undertaken from 2001-2004. The legal, regulatory and fiscal aspects were mostly addressed in 2002-2003 when the Government was preparing a new Mining Law. The Government did not move ahead on the law at that time. Since then, further work has been undertaken on the report, in particular, regarding forestry issues. Given the interest of the new Government in attracting investment and encouraging economic growth, the report is now being issued to address these issues for the mining sector. While the main focus of the report is the investment climate and regulatory environment, the Report also emphasizes the importance of mining taking place in an environmentally and socially sustainable manner. The report should be viewed in the broader context of the Extractive Industries Review, led by Dr. Emil Salim, that was concluded in 2004. The World Bank Group Management Response to the EIR noted the following two fundamental messages of the EIR:

• Extractive industries can contribute to sustainable development, when projects are implemented well and preserve the rights of affected people, and if the benefits they generate are well-used; and

• There is a continuing role for the Bank Group in supporting EI provided its involvement supports poverty reduction and sustainable development.

In addition to addressing issues of sectoral governance, the report points out the importance of ensuring that benefits are shared with local communities and that there is an adequate regulatory environment and the competent institutional capabilities to mitigate mining-related environmental and social risks and to protect the rights of people and communities affected by mining investments. This can be best accomplished by the Government preparing a Mining Sector Sustainable Development Policy as recommended in the report.

Andrew Steer Rashad-R Kaldany Country Director Director The World Bank Oil, Gas, Mining and Chemicals Department Indonesia Washington DC, USA

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INDONESIA

Improving the Investment Climate for Sustainable Mining Development

Table of Contents

Page No.

EXECUTIVE SUMMARY v

CHAPTER 1: INTRODUCTION 1

A. Background to the Report 1 B. Indonesia No Longer an Attractive Environment 1 for New Mining Investment

CHAPTER 2: BENEFITS OF MINING 2

A. Mining in Indonesian Economy 2 B. Lack of New Development and New 5

Investment in Mining C. Future Potential 7

CHAPTER 3: MINING LICENCING REGIME 8

A. Introduction 8 B. Decentralization and Its Implications for the 9

Role and Authority of Different Levels of Government

C. Mining Business Agreement (PUP) 11 D. Establishing a Level Playing Field for Local 12 And Foreign Investors

E. Security of Tenure, Mining Cadastre, Mine 13 Closure Transition Provisions and Regulations

F. Conclusion 16

CHAPTER 4: COMPETITIVENESS OF MINING FISCAL REGIME

A. Mining Taxes and State Non-Tax Charges 16 B. Assessment of Fiscal Regime 17 C. Making the Mining Fiscal Regime More 21 Competitive

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Table of Contents (cont’d)

CHAPTER 4: COMPETITIVENESS OF MINING FISCAL REGIME

D. Tax Predictability and Tax Stabilization 23 Mechanisms E. Other Aspects of the Fiscal Regime 24

CHAPTER 5: ENVIRONMENT, SOCIAL AND FORESTRY ISSUES

A. Social 26 B. Environment, Health and Safety 27 C. Law and Order and Illegal Mining 28

D. Overview of Forestry Issues 29 E. Protection Forest 30 F. Findings of the Protection Forest Analysis 32 G. Conclusions and Agenda for Further 40 Forestry Work

CHAPTER 6: CONCLUSIONS 41

ANNEXES

A. Recommendations Regarding the 43 Proposed New Indonesian Mining Law

B. More Detailed Comments on Mining Cadastre and Regulations 83

C. Some Detailed Comments on the Enabling Regulations 87

D. More Detailed Comments on Mining Fiscal Regime 91 E. Recent Examples of Mining Fiscal Stabilization 108

In Other Countries E. Mining and Forestry Interface 111 F. Literature References 117

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Abbreviations and Acronyms

AMDAL Environmental Impact Analysis Procedure ANDAL Environmental Impact Statement COWs Contract of Work DGGMR Directorate General of Geology and Mineral Resources IMA Indonesian Mining Association INTAG Directorate for Forest Inventory and Land Use Planning IPR Smallholding Mining License IUP Mining Operation License KPs Local Mining Licenses MoEMR Ministry of Energy and Mineral Resources MoE Ministry of Environment MoF Ministry of Finance MoHARA Ministry of Home Affairs and Regional Autonomy PUP Mining Business Agreement RKL Environmental Management Plan RPL Environmental Monitoring Plan TGHK Consensus Forest Land Use Plans

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EXECUTIVE SUMMARY This report addresses how the Government of Indonesia can put in place an investment environment to attract new mining development that can contribute to economic recovery and environmentally and socially sustainable economic growth in Indonesia. The main findings are that Indonesia has lost its international competitiveness for new mining investment. New exploration and project development are stalled due to problems and uncertainties regarding the mining legal and fiscal regimes and difficulties in obtaining forestry permits. All these factors are under the control of Government, and can be addressed if the Government is willing to do so. The report offers a way forward in terms of the key elements to be included in a new mining law and improvements to the prevailing mining fiscal regime. The report also points to the importance of addressing illegal mining and logging activities. The report identifies some key social and environmental issues which also need to be addressed if new mining development is to contribute to sustainable development. The Report points out the importance of ensuring that benefits are shared with local communities and that there is an adequate regulatory environment and institutional capabilities to mitigate mining-related environmental and social risks and to protect the rights of people and communities affected by mining investments. This can be best accomplished by the Government preparing a Sustainable Mining Development Policy. While the report addresses changes needed in the policy and regulatory environments, the importance of capacity building to put in place the necessary institutional capabilities to successfully implement the rules in a consistent and competent manner cannot be emphasized enough. In parallel with preparing a Sustainable Mining Development Policy, introducing a new mining law and improving the mining fiscal regime, the Government should also take action to build the necessary implementing capacity – especially at the provincial and local levels. 1. Benefits of Mining Indonesia is an important mining country. According to an annual survey conducted by Price Waterhouse Associates (PWC), mining accounts for about 11 % of exports and in 2002 mining provided about US$920 million in tax and non-tax payments (i.e. levies and fees) to various levels of government. Taking into account other contributions such as domestic wages and purchases of goods and services, plus dividends and interest paid to local shareholders and banks, the total direct contribution of the mining sector to the Indonesian economy totaled nearly US$2 billion in 2002. Taking into account all the impacts, PWC estimate that mining contributes about 2.8% of gross domestic product. 2. Future Potential While the mining sector already makes an important contribution to the economy, Indonesia has some of the most prospective land areas anywhere in the world for further mineral development, and the sector has the potential to make a much larger contribution to the economy and to regional development. The Government is looking to new mining investment to be a source of economic growth and development, especially in Provinces with frontier regions such as Papua and Eastern Indonesia. But in recent years mining investment has slowed to a trickle – partly due to external factors such as declines in world mineral and metals prices but also due a decline in Indonesia’s international competitiveness. According to a review of international mining companies conducted by the Fraser Institute of Canada (the Fraser Institute Annual Survey of Mining Companies 2000/2001) regarding how mining policy factors affect a company’s decision to invest in exploration, the mining policy environment in Indonesia ranks 40 out of 43 countries with only Russia, Kazakhstan and Zimbabwe being considered less

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attractive from a mining policy perspective. Factors under government control which need improvement include:

difficulties in obtaining forestry permits needed for new exploration and mining development

uncertainties and delays in drafting a new mining law to reform the licensing regime in line with decentralization; and

increased royalty rates and tax payments in recent years making the mining fiscal regime unattractive compared with other mining jurisdictions.

3. Mining/Forestry Interface. There are a number of promising projects presently in the pipeline for which development licenses are already issued under previously signed Contracts of Work (COWs). In particular, there are four COWs with a potential investment of more than US$2.5 billion in investment which are in advanced stage of feasibility work. The fiscal regime for each of these projects was fixed previously at the time that each COW was signed and thus does not suffer from the shortcomings of the prevailing fiscal regime. But development is presently stalled on each of these projects due to difficulties in obtaining forestry permits. Thus, addressing the mining/forestry interface is a key priority if new investment is to take place in the immediate future for a final round of projects under existing COWs. 4. Mining Policy and Fiscal Environments. Looking beyond the presently known pipeline, new exploration is needed to identify new deposits which might be developed using the new Mining Business License (IUP) and the new Mining Business Agreement (PUP) which are to be introduced through the new mining law. But, according to PWC’s estimates, exploration in Indonesia has declined from a peak of US$155 million in 1997 to about US$19 million in 2002. Indonesia is losing its competitiveness at a time when other countries are seeking new mining investment. New exploration is stalled because of problems and uncertainties not only with the mining/forestry interface but also with the overall mining policy and regulatory environment and with the prevailing fiscal regime. All of these are issues under the control of government. Thus, improvements in the new mining law and the prevailing mineral fiscal regime, as well as in the forestry/mining interface, are essential if exploration is to be revived. World mineral markets have improved strongly in 2003 and 2004 but Indonesia is not sharing in the upturn in investment. Given the long lead times to find and develop new mines (as long as 10 years or more from discovery to production for mega projects), production declines will be inevitable unless the policy environment is improved. 5. Bringing the New Law in Line With Good International Practice. Bearing in mind the concerns outlined above, there are a number of improvements which would assist if the Government wishes to have a mining law that is in line with good international practice. The main body of the report provides an assessment of some of the key issues that need to be addressed in the mining law. It is recommended that specific attention be given to the following priority issues as identified below and outlined in Box 1:

Licensing Provisions; the Role and Authority of the National Government; the National Mining Register (Cadastre); Security of Tenure and Non-Interference in Commercial and Operational Decisions; Mine Closure and Reclamation; and Transition Provisions;

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6. Government Regulations. The approach of the proposed new law is such that much of the key detail will be set aside and addressed in associated implementing regulations and

Box 1: Priority Issues to be Addressed in the New Mining Law

Licensing Provisions

• Mining Business License (IUP) The IUP should grant the title holder exclusive rights to

explore for and develop any and all minerals found during exploration The Regent/Mayor should have full authority to issue an IUP so that license can be issued promptly and efficiently.

• Mining Business Agreement (PUP) The nature and structure of the Mining Business Agreement (PUP) should be elaborated in the new law to include collective approval, tax stabilization and international dispute resolution. In order to ensure full bankability and an efficient process, the PUP should be signed by the Minister following collective approval of the Governor and the Regent/Mayor. Foreign investment under the PUP should be on the same terms as domestic investment (equal treatment) and mandatory partnerships with domestic investors should not be required and there be no requirement for mandatory sale of foreign equity to domestic investors during the life of the project. The PUP could also be used to address community-related issues such as consultation and disclosure of information and small and medium business development.

Authority of National Government

• National Government. The national government should retain the responsibility for overall mining policy and law making and should also be responsible for supervising mine health and safety conditions through regional or local offices of a national agency. The latter may require that the relevant provisions of Law 22/2000 and/or PP25/2000 be modified accordingly.

National Mining Register

• National Mining Register (Cadastre) The national government should maintain and coordinate a decentralized national mining cadastre, which is open to the public and which registers all agreements relating to the license. There must be an official mining cadastre Register Book and Map Index maintained in every established regional mineral licensing registration office. Districts, Municipalities and Provinces should be obliged to provide the national government with required information so that a linked national records index of all license transactions can be maintained in a central agency.

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Box 1 (Continued)

Security of Tenure and Non-Interference in Commercial and Operational Decisions

• Security of Tenure The mining licensing regime should give security of tenure to license

holders • Stability and Predictability: The investment environment should be stable and

predictable and companies able to operate on a commercial basis with clear rules regarding license suspension or cancellation.

• Reserved Lands: There should be no provisions for land to be reserved for state mining • State Control: There should be no requirements for mandatory domestic marketing,

mandatory partnership or any other forms of state guidance and supervision of private mining companies.

Mine Closure and Reclamation

• Decommissioning, Rehabilitation and Post Closure Monitoring. A Mine Closure Plan

(which includes funding arrangements) should be prepared at the time of approval and be progressively updated over the life of the mining operation and used for the closure and liquidation of the mine and associated facilities.

• Reclamation Funds. Provision should be made for Reclamation Funds to be placed with any financially sound commercial financial institution, not just a state or regional bank. (This would also require that MOF Decree 89/KMK.04/1995 be modified accordingly).

Transition Provisions

• Transitional Provisions. Transitional provisions need to be stipulated to extend the

authority of the initial issuing authority to manage licenses issued under the old law and to transform local coordinates on locally issued licenses to the national coordinate system. This would be consistent with PP 75 of 2001 but would imply that Ministerial Decree 1453 of 2000 be modified accordingly.

• Conversion to Mining Business Agreement (PUP) A transitional provision should also be included for the holder of an existing COW to elect to convert any undeveloped areas in an existing COW to a PUP.

• COW Applications. There are presently a number of unprocessed COW applications. Transition provisions will be needed to specifically address how these applications will be processed.

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ordinances. In some cases, the details of the regulations will be equally important as the provisions of the law itself. This is especially important regarding decentralization which will be implemented for the mining sector through this law. Thus, at the same time as developing a sound mining law, it is also necessary for Government to prepare and have ready the associated Government Regulations. It is recommended that regulations be prepared in parallel with the new law for the following priority issues along the lines identified below and outlined in Box 2:

National Regulations and Standards; Smallholding Mining License (IPR); Mining Business Agreement (PUP); Traditional Small-holding Mining Activities; Relinquishment of Parts of License Areas; Mine Closure and Reclamation; Reporting Requirements; and License Cancellation

7. Need for Capacity Building Considerable capacity building is needed to ensure the necessary capabilities exist at local levels to properly administer the industry. While the most experienced provinces and Kabupatens may be able to administer the sector fairly effectively, it is estimated that there are as many as 90 Kabupatens (out of just over 360 Kabupatens at present) which presently have significant mining activities, or have the potential for such activities in future. Improving the present situation and building the necessary capacity in all of the Kabupatens will take a coordinated effort lasting several years. It is especially important that the needs of the lesser experienced kabupatens not be ignored, lest they get left behind. The importance of capacity building to put in place the necessary institutional capabilities to successfully implement the rules in a consistent and competent manner cannot be emphasized enough 8. Role of Provincial Governments – Regulators or Operators? Some of the past COWs include a requirement for the foreign investor to progressively offer part of their shares to local investors within a given time period. Given the very weak local capital markets this introduces the possibility that state companies or even provincial governments may become part owners of one or more major mining projects. This raises some important concerns regarding private assets becoming public assets – which seems at odds with the present macroeconomic policy direction of the public sector privatizing assets. It also creates a potentially major conflict of interest since the Provincial government would be both the regulator and part owner of the project. 9. The Mining Fiscal Regime Under the 7th generation COW. Mining is subject to a range of taxes (including (a) income taxes; (b) import duty and other charges on import and duty; and (c) regional taxes and regional tolls) and “state non-tax income” charges, levies and fees (including (i) permanent contribution; (ii) production contribution (royalty); and (iii) coal development fund). According to estimates prepared by PriceWaterhouse Coopers the total tax rate for the Indonesian Mining industry in 2001 (defined as total tax expense on companies profit before income tax, royalties and indirect taxes, levies and fees) was 68.1% - a significant share for Government. A review was made of the total tax take of all mining related taxes, levies and fees under the 7th generation COW which indicates that even at this level Indonesia’s mineral sector tax system under the 7th COW was broadly globally competitive.

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Box 2: Priority Issues to be Addressed in New Regulations

National Regulations and Standards. National Regulations and uniform national standards regarding criteria and procedures for granting licenses; land access agreements and compensation; relinquishment rules; reporting requirements; and reclamation fund requirements, dispute resolution etc. should be prepared in advance and put in place as a matter of priority following enactment of the law.

• Smallholding Mining License (IPR). An IPR should not be granted over land in an IUP or PUP. The IPR should be transferable, convertible into an IUP and subject to termination/cancellation provisions.

• Mining Business Agreement (PUP). The key elements of the PUP need to be elaborated in the regulations (including collective approval, tax stabilization and international dispute resolution.

• Traditional Small-holding Mining Activities. Traditional small-holding mining should only be legitimately carried out by registered small-holder miners and be by non- mechanized means. The traditional miners should be registered and issued with identification cards (or authorizations) specifying the location of their workings to avoid any conflict with IPRs, IUPs and PUPs.

• Relinquishment of Parts of License Areas. Any exploration licenses granted within the IUP or PUP should be approved for a defined term with any renewals made based on approval of an advanced exploration program. There are a number of mechanisms that relate to relinquishment of land and the regulations should specify whether this will be by mandatory relinquishment provisions down to a certain minimum size or by licensee holding fees that progressively increase.

• Mine Closure and Reclamation The obligations of the license holder during the closure and post closure phases needs to be more fully elaborated. The ex-mining land designation should be consistent with the mine closure plan and set forth in the land use agreement made between the IUP Holder or PUP Holder and the title holder of the land, pursuant to the provisions as referred to in the prevailing rules and regulations stipulated.

• Reporting Requirements The reporting requirements of license holders needs substantial elaboration in terms of content, periods for submission and public release of data.

• License cancellation License cancellation should occur only for serious, repeated infractions not minor offences and the regulations should provide procedures and processes in order to ensure that minor infringements are not abused in order to justify cancellation or revocation of licenses.

10. The Prevailing Mining Fiscal Regime. The review also examined the prevailing tax system which will apply to any future operations which may result from new exploration using IUPs and PUPs. The review of the prevailing mining tax regime found that the present regime imposes a higher tax burden than is imposed (i) under the 7th COW , and (ii) in most other jurisdictions that attract significant levels of mineral sector investment. The higher tax burden

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relates to the following key differences between the prevailing mining tax regime and the 7th generation COW:

(i) a higher level of production contribution (also called a “royalty”) which averages about 4% which is about double the level of royalties in the seventh COW and which exceeds those in almost all other major mining jurisdictions;

(ii) the VAT treatment of coal, gold and silver, which were changed to VAT tax exempt status (Law 18/2000) which has the effect of increasing production costs (because unlike other minerals which are zero rated, VAT payments are no longer refunded for VAT exempt minerals); and

(iii) increases in district and provincial taxes, levies and fees (facilitated by Law 34/2000).

11. Making the Mining Fiscal Regime Competitive. In order to remedy the situation identified above and make the present fiscal regime more competitive and encourage new exploration, it is recommended that

the Ministry of Finance and The Ministry of Energy and Mineral Resources convene an Inter Ministerial Committee to improve the mining fiscal regime by

a) reducing the rates for production contribution (royalty) from the present average

of 4% to a uniform rate of 2% regardless of mineral type b) modifying Law 18/2000 to include coal and gold dore and silver dore, (but not

retail gold and silver bars), within the VAT system and zero rate them when exported

c) modifying Law34/2000 to establish a closed (but expanded) list of district and provincial taxes and state non-tax fees and levies (which specifically excludes turnover-related) taxes.

12. Tax Administration and Collection Issues. The recommended changes in the mining fiscal regime should not involve any undue administrative difficulties. The change in VAT should not present any problems. Since other minerals are zero rated for VAT, there is no reason to consider that the zero rating of coal and gold dore and silver dore produced at mine sites would create any major administrative difficulties. However, it is important to draw a distinction between primary gold and silver production and retail sales of gold and silver bars and gold and silver jewelry. Zero rating should be provided as an option for mining companies with primary production of gold and silver dore but it should not be applied to retail transactions. A second aspect is that the impact of the proposed changes on individual provinces and municipalities would need to be examined. Given that most mines operate under COWs the impact of the proposed tax changes would likely be fairly modest at least until such time as any large new operations start up using IUPs and PUPs. However, if there were to be any significant impacts at the sub national level, these would likely need to be addressed in order to avoid potential opposition to the proposed changes. 13. Tax Predictability and Tax Stabilization Mechanisms. In addition to having a fair and competitive tax take, investors and lenders are also concerned that agreements be honored and that taxes be stable and predictable – especially during the period when debt is being repaid.

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Mining companies raise concerns that the tax authorities are not always honoring conditions in the COWs, especially regarding the VAT treatment of gold production. Thus, there is no consistent VAT treatment of COWs at present. It is important for overall investor confidence that they be tax laws be implemented consistently. With regard to tax stabilization, many modern mining laws are now providing a fiscal stabilization option in order to give investors and lenders confidence to undertake large scale investments. It is recommended that:

• a tax stabilization provision be introduced into the PUP to provide for stabilization of state non- tax revenues such as royalties for a period of ten years from the start of production .

14. Tax Refund Issues. Some mining companies have reported delays in receiving tax refunds, in particular VAT refunds The reliability of tax administration is an important issue especially for investors with large investments and this would be a potentially important area for correction if the report is correct. 15. Other Tax Issues. It is also important to ensure that not only environmental protection expenditures, but also social support and mitigation expenditures are tax deductible. With the closure of the first large scale mine under a COW (Kelian) a perverse incentive has arisen whereby social assets (such as schools) with plant or equipment that has been imported on a tax free basis cannot be handed over to the local government or community without a tax payment being required because of the rules relating to tax-free imports. In order to address this situation, it is recommended that:

• the fiscal regime be modified to permit social assets, which may have been imported duty free during the mine life, to be transferred to appropriate social service delivery agencies at the time of mine closure without incurring tax liabilities

16. Social and Environmental Aspects. While the focus of this report is an investment climate review, there are also important social, environmental, illegal mining and mining/forestry land use issues that need to be addressed if mining is to lead to sustainable development. First, it will be important that a new law includes provisions designed to improve the benefits and protect the rights of local communities. These could be addressed in the Mining Business Agreement (PUP). Second, the management and mitigation of environmental risks needs strengthening. These are addressed largely through the Environmental Impact Analysis Procedure (AMDAL) which includes preparing an Environmental Impact Statement (ANDAL), an Environmental Management Plan (RKL) and an Environmental Monitoring Plan (RPL). The ANDAL includes provisions related to regional social and economic development. The AMDAL provides that communities affected by mining activity may play a very strong role in the ANDAL’s preparation and approval process. But, it is important that the capabilities are in place to be sure that this is implemented and existing implementation arrangements need to be improved. Among other things, it is necessary to ensure that construction does not start before the ANDAL is approved. Third, there are concerns that the present environmental legislation does not sufficiently address the environmental impacts of smaller operations with local mining licenses. While the largest operations have responded to the AMDAL requirements in a generally substantive manner, there are many smaller mining operations under local mining

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licenses (“KPs”) issued by the district governments which seem to fall below the AMDAL radar and which are reported to cause considerable environmental harm and have little or no social development plans. It is recommended that:

• The Ministry of Energy and Mines and the Ministry of Environment work together to take any necessary actions so that the necessary institutional capacities are in place at all levels of government (local, provincial and national) to ensure that all mining operations are in compliance with social and environmental requirements.

• Particular attention should be given to the adequacy of present procedures and institutional capabilities to address environmental impacts for KP license holders including controls, community development and conservation.

17. Law and Order and Illegal Resource Exploitation Activities There appears to be considerable illegal activities related to mining, logging and forestry clearing in many locations. With regard to mining, reports include illegal coal and gold mining in Kalimantan and tin mining in Bangka Island which are reportedly largely ignored by both regulatory authorities and criminal authorities. Such illegal mining often causes considerable environmental harm and social stress. It can worsen the reputation of the mining industry as well as making an unattractive environment for commercial scale mining. There are no easy solutions to the problems of illegal natural resource exploitation and the associated environmental harm. As a first step, it is recommended that:

• A broad based Inter Ministerial Committee including regional and local government representatives be established to (a) examine illegal natural resource exploitation including a fact finding analysis of the scale of illegal mining and environmentally irresponsible small scale mining; and (b) based on the findings, work with the relevant local and provincial officials in the most effected provinces and kabupatens to identify possible measures to improve the situation.

18. Mining/Forestry Interface According to Law 41/2000 (Article 38) all mining is banned in higher quality “conservation forest” which covers about 20.5 million hectares (ha) (about 10% of Indonesia’s land). Law 41/2000 also bans surface mining from “protection forest” which involves hutan lindung which is typically forest and scrub land on steep slopes that is being preserved to protect watersheds from erosion, sedimentation, and disturbance to hydrologic regimes. Thus, for hutan lindung the primary concern is erosion control not bio diversity. Hutan lindung covers about 33.5 million ha (about 17% of Indonesia’s land area). As a result of the ban, some of the most highly prospective mineral land is now off limits for new licenses. But, available data provides indications that land being licensed for mining has lower rates of forest loss and higher rates of forest gain than other forest land. A possible explanation is that mining concessions can be more reliable than other (absent) management system in securing the territorial integrity of the land under their control. The situation is further complicated by the fact that the boundaries for hutan lindung areas are subject to mapping uncertainties. It is recommended that:

• Ministry of Forestry, in partnership with Ministry of Energy and Mines and other stakeholders, undertake empirical work on the question of whether, in

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situations where forestry governance and law enforcement are weak, a legitimately issued, properly deigned mining concession with clear forest management prescriptions may contribute to, rather than detract from, ensuring the territorial integrity of Protection Forest and protecting its canopy cover; and

• in the meantime that the representatives of Ministry of Forestry and Ministry of Energy and Mines sit together with the COW holders to review COW overlaps with hutan lindung and conservation areas, agree the forestry maps and then jointly post the maps on a web-site

19. Unresolved Policy Conflict. The ban on surface mining in hutan lindung has created an unresolved policy conflict and an impasse between the Ministry of Energy and Mines who believe the Contracts of Work should be honored and the Ministry of Forestry which believes that mining license holders should be denied access to hutan lindung. While this has been resolved for COWs issued prior to year 2000, there remains an underlying issue of ineffective policy coordination and lack of procedures to ensure that land usage decisions are be made transparently, in consultation with all stakeholders, and in consideration of all relevant information including potential environmental, social and economic impacts. 20. Proposed Forestry/Mining Interface Workshop. As a way forward to resolve the policy conflict, the Donor’s Forestry Forum could be a suitable forum to convene a Policy Workshop to address the mining and forestry interface with representatives of all involved stakeholders (the relevant government ministries, affected communities, mining companies, IMA and NGOs) including representatives of main concerned provincial governments and the Association of Bupatis. This workshop could (i) provide information on procedures and practices in other countries facing a similar situation; (ii) consider the results of any further empirical work on the impact of mining on protection forest (as recommended in para 18 above); and (iii) look at procedures for evaluating alternative land uses. The resolution of this type of policy conflict would be a positive signal to both the donor community and potential investors that the Government is prepared to make the needed improvements regarding inter-agency communication and co-operation to resolve conflicts and have sound development policy and procedures. It is recommended that:

the Ministry of Forestry and the Ministry of Energy and Mineral Resources jointly request the Donor Forestry Forum to convene a multi-stakeholder workshop to address how best to address mining/forestry interface land use issue

21. Proposed Improvements. The mining investment climate is in need of improvement. First, this report identifies a broad range of provisions which would help bring a new mining law in line with good international practice. Second, the report proposes measures to improve the international competitiveness and predictability of the mineral fiscal regime. Third, the report notes the need to improve the mining/forestry interface. Fourth, the report notes the need for improved overall inter-government coordination and better implementation of measures to address key environmental and social issues including benefits to and respecting the rights of communities and addressing illegal natural resource exploitation. Finally, the report underscores

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the importance of capacity building and having in place the institutional capabilities needed to successfully implement the rules in a consistent and competent manner. 22. Mining Sector Sustainable Development Policy. In view of the extensive range of issues that need to be addressed, the question arises as to whether these issues are best addressed on a piecemeal basis or through some type of more comprehensive partnership approach. First, the Government needs to decide where they want to position Indonesia in global competitiveness and then develop a plan on how to get there. Does Indonesia want to be in the top 5-10 countries for mineral exploration and development? If so, then the cabinet needs to set up a process involving representatives of all the key ministries and key stakeholder groups to prepare a Mining Sector Sustainable Development Policy Statement which would then be adopted by the Cabinet and then become the basis for developing a new law, improving the mitigation of social and environmental risks, and making other changes such as in the mining fiscal regime and the mining/forestry interface in a coordinated, holistic manner. By addressing the whole range of issues in a coordinated manner, the Government can take an important step towards (i) attracting new exploration and mining investment; and (ii) ensuring that new mining investment contributes to sustainable development for Indonesia. But if these issues are addressed only in a partial or piecemeal manner, the desired improvements in exploration and investment may not materialize and mining development not contribute to poverty alleviation and sustainable development.

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CHAPTER 1: INTRODUCTION A. Background to the Report 1.01 Background. This report addresses how the Government of Indonesia can position itself to attract, create and sustain new mining development that can contribute to economic recovery and growth in Indonesia. The report is designed to provide details on priority issues and recommended actions to improve the policy, legal regulatory – fiscal and institutional framework of mining sector management. The report was prepared by a team consisting of John Strongman (Team Leader), Jim Otto, Jack Garnett, Adriana Eftimie, Pawel Kaminski, Graeme Hancock, Enrique Ortega and Robert Scouller with contributions on forestry from Mario Boccucci and Joseph Lieberman. . 1.02 The team would like to thank the following for their assistance - officials from the Directorate General of Geology and Mineral Resources (DGGMR), Ministry of Energy and Mineral Resources (MoEMR). the Ministry of Finance (MoF), the Ministry of Home Affairs and Regional Autonomy (MoHARA), the Ministry of Environment (MoE); and representatives of municipal and provincial governments; members of Parliamentary Commission VIII; and officials from various mining companies and the Indonesian Mining Association (IMA). 1.03 Chapter 1 provides an Introduction to the report and Chapter 2 addresses the Benefits of Mining. Chapter 3 addresses the Mining Licensing Regime and Chapter 4 addresses the Competitiveness of the Mining Fiscal Regime. Chapter 5 addresses Environmental, Social and Forestry-related issues and Chapter 6 summarizes the key conclusions and possible next steps. Annex A provides some detailed comments on some issues related to the mining legal regime and Annex B provides comments related to the associated enabling regulations. Annex C provides more details on the mining fiscal regime and Annex D three examples of mining fiscal regime stabilization in three other countries. Annex F provides background on the analytical work regarding the mining/forestry interface. B. Indonesia No Longer an Attractive Environment for New Mining Investment

1.04 Unattractive Mining Policy Environment. Mining has been an important engine of growth for Indonesia over the past two decades. But in recent years mining investment has slowed to a trickle – partly due to external factors such as declines in world mineral and metals prices but also due to factors that are directly under the control of government – including an uncompetitive mineral tax regime and growing uncertainties regarding a range of critical factors such as mining licensing conditions, access to land, respect for the rule of law and decentralization. There has been an upswing in minerals prices and in worldwide mineral exploration and investment activities in 2003 and 2004. But Indonesia is not sharing in this due to the unattractive investment environment.

1.05 According to a recent review of international mining companies conducted by the Fraser Institute of Canada (the Fraser Institute Annual Survey of Mining Companies 2000/2001) regarding how mining policy factors affect a company’s decision to invest in exploration, the

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mining policy environment in Indonesia ranks 40 out of 43 countries with only Russia, Kazakhstan and Zimbabwe being considered less attractive from a mining policy perspective. Several mines are scheduled to close in the next 5-10 years and none are scheduled to open. This report identifies a number of policy and other improvements that could be made by the Government which could help improve the mining policy environment for Indonesia and thereby facilitate new environmentally and social responsible mineral exploration and mining investment and reversing the present trend which is for decline.

CHAPTER 2: BENEFITS OF MINING

A. Mining in Indonesian Economy (i) Fiscal Benefits 2.01 World Class Producer. Indonesia is a leading player in the global mining sector. Indonesia ranks second in tin production, is the world’s 7th largest producer of gold, the 4th largest producer of copper, the 5th largest producer of nickel and the 8th largest producer of coal. According to an annual survey conducted by Price Waterhouse Coopers (PWC), mining accounts for about 10 % of exports and in 2002, mining provided about US$920 million in tax and non-tax state payments (i.e. levies and fees) to various levels of the Government (see Tables 2.1 and 2.2). 2.02 Economic Contribution of Mining. Indirect taxes which include payments to local and provincial governments increased over three times from US$35 million in 1997 to US$125 million in 2002 (Table 2.1 and Figure 2.1). Taking into account other contributions such as the value of wages paid to local labor and the value of purchases of goods and services from domestic supplies, plus dividends and interest paid to local shareholders and banks, the total direct contribution of the mining sector to Indonesian economy totals nearly US$2 billion in 2002. Taking into account all the impacts, PWC estimate that mining directly contributes about 2.8% of gross domestic product. According to data prepared by the Indonesian Mining association, the mining industry in year 2002 provided direct and indirect employment for around 150,000 and used less than 0.1% of Indonesia’s landmass. Formal direct employment is about 35,000 of which 98.5% are Indonesian nationals.

(ii) Other Benefits of Mining

2.03 Beside fiscal and monetary contributions paid to government, the mining industry makes less quantifiable but equally important contribution to the economic development of Indonesia by providing local employment and spin off businesses. Development of new mining projects is a long process taking about 2-4 years for exploration and about 5 years for development and plant construction. Then comes the phase of mining operation which may last from 10-30 years.

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INDONESIA: GOVERNMENT REVENUE AND CONTRIBUTION OF MINING

Table 2.1: Mining Taxes and Government Revenue (in US$ million) 1997 1998 1999 2000 2001 2002 Income tax expenses

236

302

340

267

355

376

Mineral and cash royalties 111 65 117 144 177 226 Total direct taxes 348 367 457 411 532 602 Other taxes and duties 28 16 29 89 67 115 Other government fees and charges 8 9 11 85 1 10 Total indirect taxes 35 24 40 173 68 125 Total tax expense on companies 383 391 497 584 601 728 Employee tax paid 39 33 42 33 51 54 VAT on sales 26 15 37 36 41 50 Withholding tax paid 86 84 104 66 71 62 Total taxes levied to others 151 133 182 135 163 167 Total taxes 534 524 679 719 764 895 Input VAT 127 131 185 98 73 25 Total Government Revenue 661 655 864 817 837 920 Note 1: numbers may not add up due to rounding Note 2:

Table 2.1: Mining Sector Contribution to Indonesian Economy (in US$ million)

1997 1998 1999 2000 2001 2002 Employee compensation (excl. expatriates) 101 54 108 113 105 160 Purchases from domestic suppliers 504 302 412 567 419 712 Government revenue 661 670 888 802 835 1011 Dividends paid to Indonesian shareholders 62 20 38 77 33 44 Interest paid to Indonesian companies/banks 92 87 37 31 26 51 Total contribution 1419 1133 1483 1590 1418 1978

Source: PriceWaterhouse Coopers

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Figure 2.1: Indonesia: Indirect Taxes Paid By the Mining Sector

(US$ million)

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New skills are required for which the mining company provides training to local workers. Typical examples of new skills required for the mining operation are earthmoving equipment operators, truck drivers, welders, electricians, power plant workers, port docking workers, fitters, warehouse workers. These are jobs for the most part fulfilled by local employees who gain new skills and they can use them in other mining projects or other industries post mining operation.

2.04 Spin-Offs . In addition to labor needed for the mining project itself, the local community, organized around the mining operation, becomes a new local labor and market place for new industries to grow. Typical examples are fishing and agriculture industries which develop to service the market place for their produce provided by the mine employees and their families. New business skills grow as the mining operation usually requires provision of maintenance and repair services that can well fulfilled by local small businesses after they have grown and gained capacity. As Table 2.2 illustrates, the mining sector has been paying close to US$700 million a year for local labor and purchases of domestic supplies of various goods and services. While these estimates are very important, it must be noted that they do not include any attempt at measuring or quantifying any negative environmental and social costs of mining that are not being internalized by companies. These should be taken into account to get the net benefits from mining. Given the estimate that mining contributes 2.8% of GDP it would seem likely that most if not all of the major projects provides a significant net benefit both at the local and at the national level. This would be a useful area for future research.

2.05 Community Benefits. While it has not always been the case, today most mining operations, especially those done by foreign international companies of good reputation, also contribute significantly to local institutional capacity building community planning and management for health, education, roads and sanitation services and work with local

1997 1998 1999 2000 2001 2002

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communities to support their interest and their rights. Many international companies pay donations to support regional activities as well as organize training and scholarships, help build schools and local village health centers. Today, well planned and implemented projects typically use good international practice regarding the mitigation of environmental and social risks, health issues and respect for rights By comparison, illegal mining operations do more harm to the natural environment and often to local communities than projects implemented up to best practices and international standards.

B. Lack of New Development and New Investment in Mining

2.06 Declining Investment. Mining companies which hold their titles to land under the existing COWs, have virtually stopped making expenditures in exploration and development of new projects as illustrated by the below chart showing mining sector cash spending on new investment in exploration, development in contrast to total new investments. As shown in Table 2.3, total investment in exploration, feasibility work, development activities and fixed assets (including plant and equipment) has declined from a peak of over US$2.1 billion in both 1997 and 1998 to less than US$400 million in 2001. Investment today is mainly for maintenance of existing plant and equipment

Table 2.3: Indonesia: Mining Industry Investment (US$ million)

1997 1998 1999 2000 2001 2002

Investment

Exploration and Feasibility Work 155 96 78 67 38 19

Development Work 197 192 367 191 73 107

Plant, Equipment and Other Fixed Assets 1749 1879 963 657 167 237

Total investment 2101 2168 1408 915 278 363


2.07 Minimal Exploration. Exploration expenditures (which are the first stage in the mining development process) for identifying new deposits and proving up reserves for possible development have declined by about two thirds (from a high of over US$150 million per year in 1996 and 1997) to about US$19 million in 2002 (Figure 2.2). While some of this may have been due to aftermath of the “crisis year” of 1997, the trend has not been reversed and continues to worsen. Indonesia’s share of global exploration has declined from over 5% in 1995 to 1% in 2001 according to the Indonesian Mining Association – indicating that there are more fundamental forces at work in terms of Indonesia’s relative competitiveness with other countries.

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Figure 2.2: Indonesia - New Investment in Exploration and Mining Project Development (US$ million)

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2.08 The lack of activity in development of new mining operations by the existing mining companies is also reflected in a vast decline in new debt raised to finance development as reported in aggregate companies financial statements. The new debt raised by the mining sector in year 2001 was US$170million - less than ten percent of its peak of US$2.4 billion in 1997 when major investment activities including new projects such as the Batu Hijau project were being financed. Given these very modest levels of expenditure there would seem to be little danger that mining is crowding out other borrowers from the capital markets. Even in times of high investment this seems unlikely since the vast majority of investment funds are raised on the international capital markets. 2.09 In 2001 75% of exploration dollars and investment flows went to the top seven countries (as shown in Figure 2.3) all of which have well regulated mining policy environments.. If Indonesia wants to attract much needed exploration and investment funds, then Indonesia needs to develop good competitive policy and a environment conducive to investment

1997 1998 1999 2000 2001 2002

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Figure 2.3: Worldwide Exploration by Country in 2001

Source: Indonesian Mining Association

C. Future Potential

2.10 Best Prospects with Existing Investors. While the mining sector already makes an important contribution to the economy, Indonesia has some of the most prospective land areas anywhere in the world for further mineral development, and the sector has the potential to make a much larger contribution to the economy and to regional development, especially for Eastern Indonesia, if new exploration and investment take place. Unlike many other countries (including China) where coal has been declining in recent years, coal production in Indonesia has been steadily increasing in recent years doubling from 1995 to 2001 when production reached 89 million tons. Looking ahead, it is likely that the next round of growth will come from mining companies already present in Indonesia. These companies know the de facto rules and prevailing situation in different municipalities most importantly, many are already holding good mineral prospects under existing Contracts of Work (COWs) (or presently have new COW applications in place for promising areas), but are unable to proceed with exploration and development because of access difficulties related to obtaining forestry permits.

2.11 Importance of New Foreign Investment. New mining projects are capital intensive and commercial scale mining developments can cost anywhere from US$50 – 100 million for smaller projects to US$1–2 billion for very large “mega” projects. While it is possible that smaller projects (about US$10-50 million) may find some modest amounts of local funding, the local capital markets are such that any new or larger/mega project or major expansion can only be developed if international financing can be attracted to the project. There are three projects in advanced stage of feasibility work under existing COWs. These projects consist of (a) a proposed PT Nusa Halmahera gold mine; (b) the proposed US$ 1.2 billion Gag Island nickel project; (c) the proposed US$1 billion Weda Bay Nickel development; and the proposed

US$ M illion

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South Africa

Namibia

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Tanzania

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Phillipines

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India

Total W or lw ide Ex pen ditu r e

is U S$1 043 M ill ion

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US$180 million Tayan bauxite project in West Kalimantan, where finalizing arrangements for an international partner and foreign loans has been delayed due to uncertainties regarding the decentralized licensing arrangements. If these four projects t proceed Indonesia could benefit from more than US$2.5 billion in investment in the next few years at a time when new investment is badly needed to support the economic recovery of the economy.

2.12 New Exploration. As far as domestic and “junior” exploration companies are concerned, new exploration is also stalled due (i) to a lack of forestry permit; (ii) uncompetitive prevailing tax regime; and/or (iii) uncertainty about future licensing arrangements. Smaller companies undertake exploration in the expectation that they would develop a small discovery themselves or farm out a large discovery to a bigger company to develop. If existing companies are unable or unwilling to develop projects in potential areas within their COWs and new investors are not coming because of unfavorable feedback from the existing ones regarding the business environment then the outlook for the industry is one of contraction not growth.

2.13 Future Outlook Not Promising At Present. Indonesia has lost its competitive edge in mining, because the mining sector investment environment has deteriorated at a time when other countries are opening the door for private sector mining investment. Because of lack of new exploration and developments, in 3-5-year time period, the mining sector in Indonesia will start to pay less in government revenue because some mines (for instance gold) will have depleted their deposits and will not be replaced by newly developed projects. With the termination of production at the Kelian and Minahasa, primary gold production has declined from 4.85 million oz in 2000 to 3.8 million oz in 2004 and, given the lack of new projects, production is forecast to further decline to only 3 million oz in 2005. Given the long lives (20-40 years) of many other mines, production declines will start about a decade from now for other minerals. However, given the long lead times to find and develop a new mine (as long as 10 years or more from discovery to production for mega projects), production declines will be inevitable unless there is a resumption of exploration and development in the very near future.

CHAPTER 3: MINING LICENSING REGIME

A. Introduction. 3.01 Draft Mining Law. A number of drafts for new mining law have been prepared in recent years that provide for decentralization of mining licensing in accordance with the provisions of Law 22/2000. For purpose of better understanding, Box 1 (in the Executive Summary) identifies priority issues to be addressed in the legislation and Annex A provides further information on the mining cadastre. The drafting approach is such that much of the key detail is set aside to be addressed in associated implementing regulations and ordinances. In some places, we recommend that the new law include reference to some of the key matters to be addressed in the implementing regulations. Annex B provides further information on some of the more important areas for regulation. In some cases, the details of the regulations will be equally as important as the provisions of the law itself. This is

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especially important regarding decentralization – which will be implemented for the mining sector through this law.

B. Decentralization and its Implications for the Role and Authority of Different Levels of Government .

3.02 Authority to Issue and Sign Mining Business Licenses (IUPs) and Mining Business Agreements (PUPs). IUPs and PUPs are fundamentally different instruments. The IUP will likely be used for smaller projects, and as such it would desirable to have very simple procedures which would allow the license to be quickly processed. This is unlikely to be the case if approval by all three levels of government authority is needed every time a license is issued. A simpler procedure, which could avoid possible delays, would be for the IUP to be issued by the local authority without need to obtaining tri-partite approval. In the event that a license covers two or more local authorities then it would be issued by the provincial authority. Or if it covers two or more provincial authorities then it would be issued by the national authority. Thus, it is recommended that

The Regent/Mayor should have full authority to issue an IUP according to the provisions of the law so that license can be issued promptly and efficiently

3.03 Mining Licensing Decentralization is Taking Place. Decentralization is already well advanced in some sub-national government units and Kabupatens have issued about 600 mining licenses (KPs) of which about 100 are presently operating. Decentralization of mining licensing is now well established in provinces such as Southern Sumatra and East Kalimantan. A number of provinces and kabupatens are issuing licenses to Indonesian companies in accordance with provisions of the present law (Law 11/1967) in an orderly and effective but heterogeneous manner. 3.04 Need for National Licensing Standards and Consistency in Laws and Regulations. Decentralization brings a new level of complexity and mining rules and regulations are now being issued at three levels - National, Provincial and Local levels. If the decentralized mining licensing system is to work well then the Government will need to take a proactive role. A profusion of local laws is causing great uncertainty and increases risk regarding discretionary interpretation and implementation of laws, can also open the door to weak enforcement of legal framework and corruption. The issue of inconsistent laws is not one that is specific to mining alone and Government is addressing these issues in many sectors. In mining, this can be addressed by issuing national regulations that ensure that regional and local perdas/regulations are issued in full consistency with the rules and regulations, guidance and supervision provided by the national government. Investors will only be willing to commit large investments if they are certain of security of tenure. This will require local licensing rules that are consistent, predictable and non-overlapping and that provide exclusive title. It is recommended that :

National Regulations and uniform national standards regarding criteria and procedures for granting license; land access agreements and compensation;

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relinquishment rules; reporting requirements; and reclamation fund requirements, dispute resolution etc. should be prepared in advance and put in place as a matter of priority at the time a new law is enacted.

3.05 Dispute Resolution A most important issue will be to ensure that there are, in practice, satisfactory and effective dispute resolution arrangements at the Kabupaten and Provincial levels. This can be accomplished through the regulations. It may be useful to consider reinforcing the use of regulations with a Memorandum of Understanding between the National government and the Kabupatens and Provinces where mining is presently, or in future could be, important that addresses how the different levels of government will implement their respective functions and responsibilities as specified in the law and the regulations. This has been done in other countries, such as Argentina. 3.06 Need for Capacity Building Considerable capacity building is needed to ensure the necessary capabilities exist at local levels to properly administer the industry. While the most experienced provinces and Kabupatens may be able to administer the sector fairly effectively, there are as many as ninety kabupatens ( out of just over 360 kabupatens at present) which presently have significant mining activities, or have the potential for such activities in future. Improving the present situation and building the necessary capacity in all of the kabupatens will take a coordinated effort lasting several years, and it is important that the needs of the lesser experienced kabupatens not be ignored, lest they get left behind. It is also important that all of the kabupatens develop not only the capacity to administer and regulate the industry but also to have effective dispute resolution procedures. If undertaken successfully, such capacity building will be a key element in helping the sector move towards good international practice, which in turn should lead to new environmentally and socially responsible exploration and mineral development. 3.07 Environmental, Health and Safety Supervision One of the most important issues that needs to be addressed is the supervision of environmental, health and safety aspects of mining operations. Mining operations are typically much more complex and often very much larger than manufacturing and services activities and this means that mining operations generally require a considerable amount of technical supervision to ensure that operations are in compliance with license conditions and health, safety and environmental criteria. Investors look for certainty about the authority of different institutions to administer and regulate the mining industry and mining companies are presently concerned that at present it is not clear in practice who has supervising authority regarding mine health and safety, environment and other inspections. But the necessary skills and capabilities do not yet exist in many local and regional authorities.

3.08 The Advantages of a Central Supervising Authority. While environmental, heath and safety supervision would be part of the government functions that are due to be decentralized according to the provisions of Law 22, careful consideration is needed as to whether this is the best course of action in the mining sector – at least at the present time given that these capabilities do not exist at the provincial level in many places – but do exist at the central level. One possibility would be to set up a decentralized agency with temporary provision for a national (central) supervising agency while setting up a systemic, well-planned capacity building efforts to share the expertise to the kabupaten and provincial levels. But the preferred approach,

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as found in most modern mining laws is to specify that in a decentralized system the national government retains the responsibility for overall mining policy and law making as well as for supervising mine health and safety through regional or local offices. By keeping such functions centralized, it helps ensure that highly specialized expertise can be brought to bear at mines in different regions as needed, that there can be a high degree of learning and information sharing between offices regarding conditions at mines in different regions and it helps smooth out employment patterns because when necessary staff can be re-allocated from offices in regions where mines are closing to offices where new mines are opening. If these functions are decentralized too early it will lead to a situation where the responsible Government authorities lack the necessary capabilities to fulfill important supervisory and monitoring responsibilities which will be not only be highly unsatisfactory for companies and communities alike but also irresponsible. Thus, it is recommended that

• The national government should retain the responsibility for overall mining policy and

law making and should also be responsible for supervising mine health and safety conditions through regional or local offices of a national agency and that Law 22/2000 and/or PP25/2000 may need to be modified accordingly.

C. Mining Business Agreement (PUP)

3.09 Purpose of PUP. Good practice calls for the purpose and structure of the PUP to be specified in the law. If the main function of the PUP is to provide additional assurances needed to help attract the financing required for large scale or mega projects, then three main characteristics of the PUP should be as follows:

• First, the PUP should be a “bankable” document. This can be accomplished by providing “collective” approval. The PUP can be based on a model agreement that is approved by all 3 levels of Parliament. The standard contract should be approved by the National DPR at the same time as the new law.

• Second, the PUP can be used as an instrument to provide stabilization provisions which are of importance to both investors lenders, especially for very large and mega scale investments.

• Third, the PUP can provide for dispute resolution to take place in an international venue which is also of great importance to both foreign investors and international lenders.

In light of the above, it is recommended that

The nature and structure of the Mining Business Agreement (PUP) should be elaborated in the law to include collective approval, tax stabilization and international dispute resolution.

3.10 Community-Related Obligations The PUP could also be used as an instrument to provide for (i) information disclosure and community consultation, and (ii) support such as providing business opportunities for local small and medium scale entrepreneurs. This could be specified in a new mining law (para. 5.01). It is recommended that

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Consideration be given to using the PUP to address community-related aspects of the mining activity

3.11 Harmonization with Investment Legislation It is important to harmonize the mining legislation with any other implementation permit/investment approval requirement in broader investment legislation. In order to avoid the need for multiple investment approvals for one project, it would be important for the PUP to be sufficient to cover the requirements of any general investment legislation. Therefore, it is recommended that

Any requirement for an implementation permit under general investment legislation should instead be included in the PUP.

3.12 Collective Approval. Collective approval in the case of a PUP is a good thing that will signify support at all levels of government and increase the Bankability of the PUP. However, the possibility that three different authorities (the Minister, the Governor or the Regent/Mayor) will each sign the PUP may lead to uncertainty and confusion. Since the PUP may not be considered bankable unless it is signed by the Minister, and in order to ensure full bankablity and an efficient process, it is recommended that

the PUP should be signed by the Minister following collective approval of the Governor and the Regent/Mayor

D. Establishing a Level playing field for Local and Foreign Investors

3.13 Mandatory Requirement for Local Partner. Any mandatory requirement that foreign investment must take place in a partnership with a local investor will present a critical obstacle to major new investment since it constrains foreign investors from being fully in control of decisions regarding ownership and funding of new ventures – which are essential considerations for investments which can typically run into the hundreds of millions and sometimes billions of dollars for world class mining projects. While local investors and domestic mining companies can undertake small or medium size projects, few if any have the ability to raise the financing needed for mega projects – at least without a foreign partner. But international mining companies will want to be free to decide when to take and when not to take a local partner – and not be obligated in this regard.

3.14 A Backward Step. Furthermore, a mandatory requirement for a local partner would be a backward step from the provisions of the 7th generation Contract of Work (COW) which does not require local equity participation. It would also be inconsistent with the rules for foreign investment in the Foreign Investment Law. The next round of foreign investment in mining is likely to take place under COWs which already exist or for which applications have already been made, so it is probable that this requirement will not be a hindrance in these cases. However, a mandatory requirement for a local partner will be a major obstacle to new investment taking place once PUP’s start to be issued. Few, if any other countries, have such a requirement for local partnerships, which will put Indonesia at a competitive disadvantage in attracting foreign investment since international mining companies have many geologically attractive jurisdictions to choose from when considering exploration and mining investment targets.

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3.15 Equal Treatment If the Government wishes to encourage new foreign investment, then foreign investment should be on the same terms as domestic investment (equal treatment) and mandatory local partnerships should not be required. This issue should be left to the provisions of the Foreign Investment Law and not be mentioned in the Mining Law. Instead of requiring local partnership, the law could provide that an IUP or PUP involving a foreign investors may be implemented in the form of a joint venture between a foreign investor and an Indonesian Citizen and/or an Indonesian Limited Liability Company consistent with the Foreign Investment Law. It is recommended that

• Foreign investment under the PUP should be on the same terms as domestic investment (equal treatment) and mandatory partnerships with domestic investors should not be required.

3.16 Mandatory Divestment Requirements Some of the COWs include a mandatory requirement for the foreign investor to progressively offer part of their shares to local investors within a given time period. This has three potentially problematic impacts. First, it creates a disincentive for new investment by the foreign investor as the period for divestment approaches. As an example: Say a mining company is 5 years into a contract that has a contract with a divestment clause with could trigger a 51% sale and change of control in year 10; this company is not going to go out and actively explore. The same goes for a company that is 10-15 years into a 30 year contract, unless they are very low on reserves with a potential to find something that could operate through existing infrastructure. Second, given the very weak local capital markets, it may result in a bid well below the value in the international capital markets. Third, there is also the possibility that state companies or even provincial governments may become part owners of one or more major mining projects. This raises some important concerns. First, the idea of state companies and/or provincial governments purchasing private sector mining assets seems at odds with the present macroeconomic policy direction of the public sector privatizing assets. Second, there is a concern that there could be a potentially major conflict of interest since the Provincial government would be both the regulator and part owner of the project and, if the provincial government is part of a winning bid, then the seller may come under pressure to either reduce the price or provide a free carried interest, instead of receiving full price up front.. In view of the above, it is recommended that

there be no requirement for mandatory sale of foreign equity to domestic investors during the life of the project

E. Security of tenure, Mining Cadastre, Mine Closure Transition Provisions and Regulations

3.17 Predictability and Non-Interference. Predictability and non-interference in commercial and operational decisions is important to all investors and, in the case of mining, security of tenure is also a matter of paramount importance. In order to provide an attractive environment for both local and foreign mining investment, national laws and ordinances should clearly and consistently define the rights and obligations of investors, provide iron-clad security of tenure and prevent any government interference with commercial, operational decisions. This is also important for local/regional perdas. With this is mind, it is recommended that

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the government not withhold certain lands for state controlled mineral development and that public notification be provided in the event that any such reserved lands shall be released with international competitive tendering processes for licensing purposes to be used where released lands may be of interest to more than the investors.

there be no restrictions on marketing or sales of any minerals

no mandatory requirements for local mining partners

small-scale mining and commercial-scale mining be kept separate

the IUP be granted on a “first come first served” basis following receipt of an application.

the license grant the title holder exclusive rights to explore for and develop any and all minerals that are found by the IUP holder within the categories of minerals specified by the license (namely radioactive minerals; metal minerals; non-metal minerals; coal and bitumen) rather than just for one specified mineral

the Minister, Governor, Regent/Mayor pursuant to their respective authority should be responsible for “Monitoring and Oversight” (but not guidance and supervision) of the mining activities.

license cancellation should occur only for serious, repeated infractions not minor offence with a clearly stated process of warnings and appeals included in the law.

the law and the regulations provide procedures and processes in order to ensure that minor infringements are not abused in order to justify cancellation or revocation of licenses.

there be no provision for license cancellation for state interest

3.18 Licensing Information The Mining Cadastre is the national Register which records all matters related to each exploration and mining tenement granted within Indonesia, including ownership, transfers, encumbrances, joint ventures, etc. The new law should have a full elaboration of the mining cadastre and should specify that it will be decentralized, but coordinated centrally, including reference to the nature and legal status of the register of mineral licenses. The cadastre should be a nationally standardized system of management and the register should be centrally coordinated and maintained. The new law should stipulate that the register is a physical book that spells out the criteria for grant of a license (IUP) or agreement (PUP) as well as the application and approvals process and who has the authority to issue and sign licenses or agreements on behalf of the State. With this background, it is recommended that

• The national government should maintain and coordinate a decentralized national mining cadastre, which is open to the public and which registers all agreements

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relating to the license. There must be an official mining cadastre Register Book and Map Index maintained in every established regional mineral licensing registration office- which is open to the public and which records all transactions relating to mining licenses.

3.19 National Mining Data Base It is thus a matter of great importance that the kabupatens and Provinces keep accurate records (in a physical book or register as well as in computerized form) and provide the national mining database with changes in licensing information in a timely and complete manner so that the national data base is can remain up to date and accurate. This will be one of the most critical challenges if decentralized mining licensing system is to operate successfully. It is recommended that

• Districts, Municipalities and Provinces should be obliged to provide the national government in a timely manner with information relating to all mineral licenses previously issued or in the process of being issued by them so that a linked national records index of all license transactions can be maintained in a central location.

3.20 Mine Closure A modern mining law will specifically cover (i) “Decommissioning and Rehabilitation” which is a phase of the mining business when plant and equipment are decommissioned and removed, secured or handed over to new owners; and when mine impacted areas are stabilized and returned to the agreed final landform and land use; and (ii) “Post Closure Monitoring” which is a phase following completion of decommissioning and rehabilitation when monitoring and repair of the rehabilitated mining areas may be required. The decommissioning and rehabilitation should take place according to a Mine Closure Plan which should initially be prepared during the feasibility stage, progressively updated during the production operation phase, with the final version approved by relevant authority,. The Plan should provide the basis for that provides the basis for mine decommissioning and reclamation and post closure monitoring and supervision and that specifies the agreed final landform and land use. Funding of mine closure is done through a Reclamation Guarantee Fund, which is a fund to cover the cost of decommissioning, reclamation and ongoing chemical treatment in accordance with the Mine Closure Plan, plus any costs for monitoring or further expenditures needed during the Post Closure Monitoring stage. Good practice would call for the reclamation bond be placed with a financially sound commercial financial institution. It is recommended that

• The law should stipulate the preparation and use of a Mine Closure Plan. • Provision should be made for Reclamation Funds to be placed with any financially

sound commercial financial institution, not just a state or regional bank. (This would also require that MOF Decree 89/KMK.04/1995 be modified accordingly).

3.21 Transition Provisions When canceling one mining law and enacting another, a transitional provision needs to be inserted to extend the authority of the initial issuing authority to manage licenses issued under the old law and to address the conversion of existing licenses to the new licenses. It is recommended that

• Transitional provisions need to be stipulated to extend the authority of the initial issuing authority to manage licenses issued under the old law and to transform local coordinates on locally issued licenses to the national coordinate system.

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• A transitional provision should also be included for the holder of an existing COW to elect to convert the COW or any undeveloped areas in an existing COW to a PUP.

• Transition provisions be included to specifically address how these existing applications for COWs will be treated.

3.22 Enabling Regulations At the same time as finalizing the law, it will be important to move quickly to prepare the associated Government Regulations and in particular the Government Regulations relating to (i) the Standardization of mining licensing system, (ii) the function and content of the PUP. To the extent possible, implementation of the law should be through Government Regulations rather than Ministerial Decrees (as the latter are more at risk for rapid cancellation and amendment). Until national regulations and standards are in place for issuing IUPs and IPRs, there is a risk that provincial and local governments will prepare perdas that lack uniformity and which will then prove an impediment rather than a positive step towards attracting new investment in mining. With regard to the PUP, there will be a need to spell out the details of the PUP in the regulations, including the form of the agreement and procedures for signing the PUP.

F. Conclusion

3.23 By preparing a new mining law with the improvements noted above and with well designed supporting regulations, Indonesia could have a new mining regime in line with good international practice.

CHAPTER 4: COMPETETIVENESS OF MINING FISCAL REGIME

A. Mining Taxes and State Non-Tax Charges

4.01 Growing the Mining Tax Base. As noted in Chapter 2 (para 2.01) the mining sector paid about US$738 million in taxes in 2001, which is about 3% of total tax receipts. From 1996 –2002 annual mining tax payments ranged from US$636 million in 1996 to US$888 million in 1999. The mining tax payments are much smaller and much less volatile than oil industry tax payments which account for about 25% of government receipts. Consequently, the main issue for mining taxation is to how to grow the long term tax receipts from mining rather than how to manage highly volatile receipts.

4.02 Range of Taxes and Charges. The Mining Industry is subject to three broad categories of taxes, namely: (a) income taxes; (b) import duty and other charges on import and duty; and (c) regional taxes and regional tolls. It is also subject to three types of royalties, levies and fees namely: (i) permanent contribution; (ii) production contribution (royalty); and (iii) coal development fund. The latter three are also referred to as state non-tax charges. While the above lists of taxes and state non tax charges seems relatively straightforward, in reality the industry is subject to a very large number of different taxes and state non-tax charges. These include withholding tax (on (i) loan interest paid to foreign lenders, (ii) dividends remitted abroad, and (iii) salaries and fees paid to foreign entities); value added tax on equipment purchased locally and abroad: value added tax on minerals sales (where applicable); education levy; land and

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building tax; land use fees during exploration and mining; surface deposit; stamp tax; payroll taxes.

4.03 Provincial and Local Taxes. There are many different provincial taxes, levies and fees reported by companies including taxes on motorized vehicles and vehicles traveling on water, name-change fees for motorized vehicles and vehicles traveling on water, tax on vehicular fuel, tax on the exploitation and utilization of underground water and surface water. Regency/Municipality Taxes reported by companies include hotel tax, restaurant tax, entertainment tax, advertisement tax, street lighting tax, tax on mining of category C minerals, parking tax; regional levies: public service levies (about 10 types), business service levies (around 13 types), licensing levies (around 4 types). While many of these are small, the overall tax take can be quite significant.

B. Assessment of Fiscal Regime

4.04 Tax Take in 2001. The Government will be able to attract more investment and will achieve increased mining-related state and local revenues, employment and community economic development over the long term if the overall level is of mining tax take is internationally competitive and if the mining fiscal regime (which consists of all taxes, levies and fees) is predictable. As noted previously, PriceWaterhouse Coopers conduct an annual assessment of the Indonesia mining industry. According to the PWC estimates, the total tax take (consisting of income tax, royalties and indirect taxes, levies and fees ) from the Indonesian mining sector in 2001 was US$748 million – which was 68.1% of companies profit before the various tax payments.

4.05 Comparison with Other Countries. The overall effect of taxes in Indonesia is compared below to the overall tax regimes in other nations, using: (i) a simulation model of a typical base metal (copper) mine and (ii) a simulation model of a typical gold mine previously developed by Prof. James Otto of the Colorado School of Mines. (The models are described in detail in a comparison of mining taxes worldwide - Global Mining Taxation Comparative Study 2nd Edition). The results of the model simulations are shown in Tables 4.1 and 4.2 below. Table 4.1 shows the expected rate of return for an investor and total tax take for the government for the simulation model for the base metal mine. Table 4.2 presents the same information for the simulation model for the gold mine. 4.06 The 7th COW Tax Regime. The analysis for Indonesia considers, first, the taxes that would be payable for projects operating under the 7th COW Tax Regime. This tax regime applies not only to mines presently under COWs operation but also to a large number of projects under COWs which are only presently at the exploration stage or at the feasibility stage (including projects such as Nusa Halmahera, Gag Island, Weda Bay and Tayan (para. 2.11)). 4.07 Prevailing Tax Regime. The analysis also considers the tax regime for projects presently in operation for which a COW has not been signed. This typically is the case for small to medium projects and companies (including Aneka Tambang) where foreign investors are not involved. This tax regime will also apply to any new projects discovered and developed under future IUPs or PUPs.

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4.08 Tax Simulation Results for a Model Base Metal Mine. For the base metal mine simulation the results for the tax regime using the 7th COW place Indonesia in the middle of the second lowest taxing quartile, making the tax regime slightly more attractive for the investor that for the other jurisdictions considered. By comparison the results for the simulation using the prevailing tax regime (which would apply for IUPs and PUPs) place Indonesia in the middle of the third quartile, making the tax regime slightly less attractive for the investor than in other jurisdictions that attract significant levels of mineral sector investment.

4.09 Tax Simulation Results for a Model Gold Mine. For the gold mine simulation the results for the tax regime using the 7th COW place Indonesia in the middle of the third lowest taxing quartile, making the tax regime slightly less attractive for the investor that for the other jurisdictions considered. By comparison the results for the simulation using the prevailing tax regime (which would apply for IUPs and PUPs) place Indonesia in the middle of the fourth quartile, making the tax regime much less attractive for the investor that for the other jurisdictions considered.

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Table 4.1: Comparative Economic Measures for a Model Base Metal Mine in Selected Jurisdictions

Country

Foreign Investor’s Internal Rate of Return (%)

Total Effective Tax Rate (%)

Lowest taxing quartile

Sweden 15.7 28.6 W. Australia 12.7 36.4 Chile 15.0 36.6 Zimbabwe 13.5 39.8 Argentina 13.9 40.0 China 12.7 41.7 Second lowest taxing quartile Bolivia 11.4 43.1 South Africa 13.5 45.0 Philippines 13.5 45.3 Indonesia (7t h, COW) 12.5 46.1 Kazakstan 12.9 46.1 Peru 11.7 46.5 Tanzania 12.4 47.8 Second highest taxing quartile Poland 11.0 49.6 USA (Arizona) 12.6 49.9 Mexico 11.3 49.9 Greenland 13.0 50.2 Indonesia (Prevailing Regime) 11.2 52.2 Ghana 11.9 54.4 Highest taxing quartile Papua New Guinea 10.8 57.8 Uzbekistan 9.3 62.9 Ivory Coast 8.9 62.4 Ontario Canada 10.1 63.8 Burkina Faso 3.3 83.9

Note 1. Values in the table for all jurisdictions except Peru and Indonesia are extracted from: J. Otto, J. Cordes and M. Batarseh, Global Mining Taxation Comparative Study, second edition, IGRPM Colorado School of Mines, March 2000. Note 2. A ranking by IRR would be different. IRR takes into account the time value of money and EFT here does not Note 3. Treaty rates refer to withholding tax rates on loan interest and remitted dividends.

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Table 4.2: Comparative Economic Measures for a Model Gold Metal Mine in Selected Jurisdictions

Country Foreign Investor’s

Internal Rate of Return (%) Total Effective Tax Rate (%)

Lowest taxing quartile

Sweden 19.2 29.1 South Africa 18.8 32.6 Chile 18.3 36.8 Philippines 18.4 38.2 Argentina 16.6 42.5 W. Australia 15.2 43.1 Second lowest taxing quartile Peru 14.7 43.3 Zimbabwe 15.7 45.9 USA (Nevada) 15.1 49.3 Bolivia 12.2 52.4 Kazakstan 13.5 54.4 Greenland 14.7 54.9 Second highest taxing quartile Ghana 13.6 56.7 Tanzania 12.7 7.9 Indonesia (7th, COW) 11.2 61.2 Uzbekistán 11.2 62.0 México 10.4 62.9 Ontario Canada 10.7 68.3 Highest taxing quartile Ivory Coast 9.1 69.1 Indonesia (Prevailing Regime) I7.9 71.9 Papua New Guinea 8.7 72.3 China 7.1 73.9 Poland 3.0 P90.2 Burkina Faso -1.6 106.0

Note 1. Values in the table for all jurisdictions except Peru and Indonesia are extracted from: J Otto; J. Cordes and M. Betarseh, Global Mining Taxation Comparative Study, second edition, IGRPM Colorado School of Mines, March 2000. Note 2. A ranking by IRR would be different. IRR takes into account the time value of money and EFT here does not. Note 3. Treaty rates refer to withholding tax rates on loan interest and remitted

dividends.

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4.10 Non-Competitive Present Mining Fiscal Tax Regime Mining companies have many alternative nations to invest in, and jurisdictions with favorable geology and lower tax impositions have an advantage over higher taxing jurisdictions. The simulation results show that while the tax regime under the 7th COW was broadly globally competitive, the overall current mining tax system under the current law imposes a higher tax burden than in other nations that attract significant levels of mineral sector investment. This higher tax burden will be a disincentive to exploration and development of presently unidentified projects. Given that it takes 5 to 10 years to identify, develop and start production at a small to medium mine and 10 to 15 years for a large mine, delays in exploration taking place now will put back the development of a future generation of new mining projects even further into the future.

C. Making the Mining Fiscal Regime More Competitive

4.11 Main Differences between the 7th generation COW and the Prevailing Mining Tax Regime. If Indonesia desires to attract new mining investment using IUPs and PUPs, it will need to consider revising the prevailing fiscal approach to mining to make it more competitive with the tax systems in other nations. The remainder of this chapter address key issues. Fuller details are found in Annex C. The main differences between prevailing regime and the 7th generation COW largely relate to one of the state non-tax charges, namely

• higher level of production contribution (also called a “royalty”);

and to two items which are taxes namely

• provincial and local taxes.

• VAT treatment of gold, silver and coal (which differs from base metals)

4.12 Mining Royalties By comparison with other jurisdictions, the present Indonesian mining fiscal regime in Indonesia includes a royalty type tax which presently averages about 4% for non-fuel minerals significantly exceeding the rates set by most other mining nations. This places Indonesia at a serious competitive advantage to other nations seeking to attract new mining investment. In order to bring Indonesia more in line with other countries, it is recommended to reduce but not eliminate royalties completely. In the sharing of risk and reward, the use of a modest level of royalties can ensure an up-front revenue stream to government even if a project turns out not to be profitable for income tax purposes. This is consistent with the view generally held in the economic literature that a royalty can be considered as a factor payment on the extraction of a non-renewable resource owned by the state. Thus, a modest level of royalties – equivalent to say 1-2% of turnover, is considered warranted to ensure that each mine makes a minimum annual payment. Also, the use of a common rate for all minerals would help ease tax calculation and administration substantially since the same rate would be applied to all metals which means the multi-metal situation does not become a problem. Thus, in order to improve the situation, it is recommended to:

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Reduce the rates for production contribution (royalty) from the present average of 4% to a uniform rate of 2% regardless of mineral type

4.13 Value Added Tax. The imposition of non-refundable VAT for commodities such as gold bars, silver granules and coal is a major investment disincentive for mines producing those commodities and for new IUPs or PUPs . Mines are highly capital intensive and non-refundable VAT acts to raise costs. Because of this capital intensity, the imposition of non-refundable VAT is highly likely to be a barrier to the development of new ore bodies. If VAT on any mineral exported is made exempt, this is a very major disincentive to investors and it is highly likely that all exploration for that mineral will be significantly curtailed. It is strongly recommended that all mineral sales be zero-rated for VAT purposes. In order to remove this disincentive, it is recommended:

to include coal and gold dore and silver dore, (but not retail gold and silver bars), within the VAT system and zero rate them when exported (which would involve modifying Law 18/2000).

4.14 Administrative Issues – Applying VAT. Since other minerals are zero rated for VAT, there is no reason to consider that the zero rating of coal and primary gold and silver (usually in the form of dore) produced at mine sites would create any major administrative difficulties. However, it is important to draw a distinction between primary gold and silver production and retail sales of small retail gold and silver bars and gold and silver jewelry. Zero rating should be provided for mining companies with primary gold and silver production. But, there would be major administrative difficulties if the VAT authorities were to attempt to make VAT applicable to retail transactions. This would involve many hundreds, even thousands, of outlets and would likely be both administratively unmanageable and disruptive. 4.15 Administrative Issues – VAT Refunds. The reliability of tax administration is an important issue especially for projects involving large investments It is important for overall investor confidence that agreements be fully honored, refunds provided in a timely manner and all CoWs be treated in a fully consistent manner. 4.16 District and Provincial Government Taxes According to Law 25/1999, district and provincial governments are allowed to levy taxes and state non-tax fees. These include a range of taxes and fees now paid by the mining industry. For the most part, these taxes are clearly defined and rates of payments are capped in some way. But in some cases, problems have arisen regarding implementation because local officials are interpreting vague wording to increase the size of the taxable base, sometimes well beyond the original intent of the law and the implementing regulations (Regulations 65 and 66/2001). Another and even more substantial problem is the growing tendency of district and provincial governments to introduce taxes, fees and levies that are outside the scope of their authority. A possible way forward would be to revise law 34/2000, giving regional governments a closed, but possibly expanded list of taxes. In order to address this situation, it is recommended to:

modify Law 34/2000 to establish a closed (but expanded) list of district and provincial taxes and state non-tax fees and levies (which specifically excludes turnover-related) taxes.

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4.17 Impact on Tax Payments. An important potential issue is the possible impact of the proposed changes on the tax payments to individual provinces and municipalities and if there were to be any significant impacts at the sub national level, these would likely need to be addressed in order to avoid potential opposition to the proposed changes.

D. Tax Predictability and Tax Stabilization Mechanisms 4.18 Importance of Predictable Tax Regime. The predictability of the fiscal regime is an important component in the investment decision. Investors are concerned that the tax regime be predictable in order to estimate the return on investment. Lenders are also concerned about tax predictability during the period when debt is being repaid. Thus, a high degree of tax predictability can be viewed as an investment incentive. Indeed, in investor surveys, many investors indicate that they see a stable tax regime with reasonable rates as preferable to a “low” tax regime that could be changed without notice. 4.19 Tax Stabilization included in COW. Indonesia was one of the first countries to provide tax stabilization – through the Contract of Work, which stabilizes taxes for the life of the contract. More recently, the new Indonesian Petroleum law also embodies some fiscal stabilization features. A Tax Stabilization arrangement has also been available in Chile for many years. More recently tax stabilization provisions for mining operations have been adopted by a number of countries shown in Annex C. Further details for three countries (Mauritania, Madagascar and Mozambique ) who introduced mining sector tax stabilization provisions under World Bank financed Technical assistance projects are given in Annex D. 4.20 Tax Stabilization Benefits. Tax stabilization has two major benefits. First, it can help lower financing c which is especially important since mining projects are typically capital intensive and involve large initial capital investments which require substantial debt financing. Second, it can also help improve investor confidence since investors like to be assured that when they make large capital investments that they are be sure of receiving the returns that induced them to make the investment in the first place. 5.21 An effective way forward is, at minimum, to offer stabilization to the holder of a PUP for royalties and other state non-tax charges and levies for a period of ten years from the commencement of production. This would help provide a stable fiscal environment throughout the repayment period of any loans and, thereby, help to reduce the risk that tax increases could compromise the ability of a project to service its debt. As a result of stabilization, the profitability could be greater due to lower deductible financing costs, leading to higher tax payments and benefits to the State. It is recommended that:

a tax stabilization provision covering royalties and other state non- tax charges and levies be introduced into the PUP for a period of ten years from the commencement of production

4.22 The World Bank could support the Ministry of Energy and Mineral Resources and the Ministry of Finance to convene a Workshop to present these issues for more detailed examination and consideration by the key Ministries involved and other concerned parties.

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E. Other Aspects of the Fiscal regime

4.23 Ring Fencing In order to avoid possible abuse, any entity that enjoys significant tax stabilization should be ring-fenced. Entities not enjoying tax stabilization should not be ring-fenced. But, the application of ring fencing for mining projects raises two issues of concern – which typically apply to COWs which are usually ring-fenced. First, a disadvantage is that a company that wishes to undertake exploration outside its COW will be discouraged to expend money in an area outside the COW as it will not be able to deduct it as a cost against income earned in its revenue generating COWS. Second, at the time of mine closure, for plant and equipment that was imported on a tax free basis, the mine has the options of exporting, demolishing or abandoning or else it must pay the import duties. This means that mines can only transfer social assets to communities if they pay import. One solution is to pay duties on the written down value of the assets which could be very low- but it be even better if the mining fiscal regime permitted social assets, under these particular circumstances, to be transferred to government or community ownership without incurring taxes. It is recommended that:

the fiscal regime allow social assets to be transferred to appropriate social service delivery agencies at the time of mine closure without incurring tax liabilities and that this also apply to any social assets, which may have been imported duty free during the mine life, under existing COWs

4.24 Tax Holidays to be Avoided. In considering measures to make the fiscal regime more competitive, it must be strongly emphasized that this does not mean that the income tax rate should be reduced or that tax holidays should be considered. Indeed, tax holidays should be avoided as an incentive for mining, because they encourage “high grading” during the tax holiday period which results in sub economic resource development. Rather, what is needed, as outlined above, is (i) to reduce the rates for production contribution; (ii) to include all minerals within the VAT system (instead of excluding coal, gold and silver); and (iii) to establish a closed (but expanded) list of district and provincial taxes and non-tax charges (which would specifically exclude turnover-related) taxes.

4.25 Need For Broadening the Tax Base. Tax collections as a percentage of GDP, have not increased in the past two decades and are around 12%-13% of GDP in Indonesia, well below that of neighboring countries. In this situation, there is a significant need to increase tax collections and also to ensure that kabupatens and provinces have the necessary revenues to undertake the additional responsibilities and functions associated with decentralization. If the solution is not to increase the tax on mining, then what are the alternatives? The solution appears to lie, in large part, in broadening the tax base.

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4.26 Depreciation. In many jurisdictions, the most common form of tax-base incentive for mining is accelerated depreciation since mining projects are typically highly capital intensive with long capital recovery periods and accelerated depreciation reduces political risk by allowing investors to recover their capital more rapidly. This is especially important to foreign investors and lenders who are more willing to commit large amounts of capital to a developing country if the recovery period is shorter. But, Indonesia does not provide for a substantial accelerated depreciation option for mining plant and equipment in its general tax law. It is recommended that

consideration be given to allowing mining equipment to be depreciated at an accelerated rate under the prevailing law.

4.27 Loss Carry Forward. One of the most common tax incentives is to allow taxpayers the ability to carry forward losses from one year to offset taxable income in future years . Indonesia limits loss carry forward to 5 years. For capital-intensive industries, like mining, and for industries exceptionally prone to commodity price fluctuation, like mining, loss carry forward is an important issue and the 5 years period is too short. It is recommended that

the loss carry forward time limit in Indonesia be increased to a longer period – possibly 8 – 10 years.

4.28 Deductibility of Reclamation and Closure Costs. Of increasing concern to governments is the issue of mine reclamation and closure. One way to encourage companies to fund closure is to allow funds that are irrevocably set-aside for reclamation to be allowed as a cost at the time the funds were irrevocably set aside. Currently Indonesia does allow for funds deposited into a reclamation arrangement to be allowed as a cost for income tax purposes. However, such funds must be paid into specified state banks that are reportedly faced with severe financial trouble. Most companies would find placement of funds into such institutions unacceptable. It is recommended that

the current system be retained but that the list of specified banks be expanded to include international banks which have demonstrated strong financial attributes.

4.29 At closure, certain assets, such as fire trucks, ambulances, water purification infrastructure and so forth suitable for transfer to public entities and communities will be available. Under current tax law as applied to COWs such assets may be subject to transfer taxes if a mine wishes to transfer that asset, even to a public entity. In addition, if the equipment was exempted from import duty or free of VAT, additional taxes may be due. This encourages a company to consider destroying the asset instead of making it available for the public good. It is recommended that

transfers of social assets to a public entity be exempted or free from transfer and other taxes.

4.30 Deductibility of Investment in Communities and Infrastructure. There is intense interest by many stakeholders in furthering the development of communities and peoples affected by a mine. One way to foster development is to invest in communities impacted by mining so that when the mine closes, the affected communities will be able to carry-on with

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social and alternative economic activities. Thus, infrastructure and investments made in the community during the mine life can be important. The current Indonesian system does not automatically allow a deduction for such expenditures. However, costs may be allowed at the discretion of the tax office. It is recommended that

the tax law should automatically allow the deduction as a cost of certain types of investment in communities and regional infrastructure up to a prescribed limit based on the annual gross mine revenues. The types of such investment and the limit should be explicitly described by regulation or official instruction.

4.31 Import Duties. Mining is capital intensive and utilizes specialized equipment that is usually imported. Import duty is mainly paid during the construction of a mine when there are no cash flows. Thus, companies view such an input tax very negatively since it has the effect of increasing construction costs before the project starts earning income. Most nations have freed mines from import duty during construction or zero-rated most mine type equipment. In Indonesia mining companies may submit a “master list” of imported equipment and at the discretion of the government, the approved listed items may be imported free of duty – but this system results in major administrative costs and corrupt practices can creep into customs services, particularly where import duties are levied. It is recommended that

Indonesia follow the lead of most other nations and eliminate import duty on mine inputs through either an exemption or if duty category lists are sufficiently detailed, to identify mining equipment categories and zero rate such categories. The necessity to use an approved “master list” is inefficient and subject to arbitrary decision-making.

CHAPTER 5: ENVIRONMENT, SOCIAL AND FORESTRY ISSUES

A. Social

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5.01 While the original focus of this report is a licensing and fiscal review, it is also recognized that there are social, environmental, illegal mining and mining/forestry land use issues which must be addressed in order to improve the benefits of mining to local communities. The more advanced drafts of the proposed new law include important new provisions compared with Law 11/1967 that will help ensure that mining sustains and increases its contributions to the development of the local communities and the host region and respect the rights of affected people. It is recommended that the new law include provisions along the following lines that IUP and PUP holders should:

Consult with local communities on a regular basis, including disclosing project information regarding community-related impacts and informing them of the status of activities being undertaken under the IUP/PUP

assist the government in creating employment opportunities for local people, empowering the communities, helping to develop the region and the people around the mine site;

provide business opportunities for local small and medium scale entrepreneurs;

provide opportunities for local communities to take part in the environmental

management and monitoring and/or use third party monitoring;

develop a program-based skill training;

work with local government to ensure adequate provision of health, education and training facilities for local communities.

B. Environment, Health and Safety

5.02 Importance of Having Sound Policies in Place. Serious investors prefer clear, consistent and realistic environmental, health and safety policies, reflected in workable legislation. Absence of clear environmental requirements makes it more difficult for them in raising financing in international capital markets. Thus, the global nature of the markets for financing mineral resources projects facilitates enforcement of responsible environmental performance.

5.03 AMDAL Approach for Larger Projects. Indonesia has adopted a general approach to environmental management. The Ministry of Environment is the responsible leading authority for regulating and monitoring environmental aspects related to the mining sector. Each project and/or activity with major impacts on the environment must comply with the GOI Environmental Impact Analysis procedure (AMDAL), preparing an Environmental Impact Statement (ANDAL), an Environmental Management Plan (RKL) and an Environmental Monitoring Plan (RPL). The ANDAL includes provisions related to regional social and economic development. The AMDAL provides that communities affected by mining activity may play a very strong role in the ANDAL’s preparation and approval process, although implementation arrangements need to be improved. Among other things, it is necessary to ensure that construction does not start

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before the ANDAL is approved. It is important that the capabilities are in place to be sure that this is implemented.

5.04 Making Sure Smaller Projects Are Covered. While the largest operations have responded to the AMDAL requirements in a very substantive manner and provide very substantial contributions regarding local economic development, there are many smaller mining operations under local mining licenses (“KPs”) issued by the district governments which seem to fall below the AMDAL radar, are reported to cause considerable environmental harm and have little or no social development plans. While KP license holders are required to address environmental impacts including controls, community development and conservation, it seems that these are frequently ignored and AMDAL requirements cannot help to address these situations.. It is recommended that:

• The Ministry of Energy and Mines and the Ministry of Environment work together to take any necessary actions so that the necessary institutional capacities are in place at all levels of government (local, provincial and national) to ensure that all mining operations are in compliance with social and environmental requirements.

• Particular attention should be given to the adequacy of present procedures and institutional capabilities to address environmental impacts for KP license holders including controls, community development and conservation.

C Law and Order and Illegal Mining

5.05 Problems of Illegal Mining There appears to be considerable illegal mining. Reports include coal and gold in Kalimantan and tin in Bangka Island which are reportedly largely ignored by both criminal and regulatory authorities. Such illegal mining makes an unattractive environment for commercial scale mining and often causes considerable environmental harm and social stress. The choice between legal mining and illegal mining often boils down to not whether or not the deposit will be mined, but whether it will be mined in a fully taxable, orderly and environmentally responsible manner under a commercial license or whether it will be mined in an unlawful, untaxed environmentally harmful manner by small scale miners inundating the deposit. There are no easy solutions either to the problems of illegal mining or to the problems of environmental harm by irresponsible smaller scale miners. 5.06 Other Related Illegal Activities. Illegal mining is part of a larger problem facing the Government that also includes illegal logging and illegal forest clearing. A high volume of illegal activity is reported in conservation areas stemming in large part due to serious shortcomings of enforcement in the conservation areas. The situation has not improved and has probably worsened with decentralization of authority for these issues. An important task is for Government to find ways of improving its enforcement rules prohibiting all illegal and destructive activities in conservation areas. Placing restrictions on legitimate mining operations does nothing to address the more severe issue of widespread illegal mining, logging and forest clearing activities.

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5.07 Need to Address the Problem. As a first step, we recommend that an Inter Ministerial Committee be established to (a) prepare a fact finding analysis of the scale of illegal mining and logging and environmentally irresponsible small scale mining; and (b) based on the findings, work with the relevant local and provincial officials in the most effected provinces and kabupatens to identify possible measures to improve the situation. As a first step, it is recommended that:

• A broad based Inter Ministerial Committee including regional and local government representatives be established to (a) prepare a fact finding analysis of the scale of illegal mining and logging and environmentally irresponsible small scale mining; and (b) based on the findings, work with the relevant local and provincial officials in the most effected provinces and kabupatens to identify possible measures to improve the situation.

D. Overview of Forestry Issues

5.08 Mining Banned in Conservation and Protection Forest. In addition to a satisfactory licensing system and mining fiscal regime, license holders also need access to prospective land areas for exploration and mineral development. According to Law 41/2000 (Article 38, para. 4), all mining is banned in higher quality “conservation forest” which covers about 20.5 million hectares (ha) (about 10% of Indonesia’s land). Law 41/2000 also bans surface mining from “protection forest” which involves hutan lindung. Hutan lindung is typically forest and scrub land on steep slopes that is being preserved to protect watersheds from erosion, sedimentation, and disturbance to hydrologic regimes. In hutan lindung the primary concern is erosion control. Hutan lindung covers about 33.5 million ha (about 17% of Indonesia’s land area). 5.09 Impact of Law 41 Although Law 41/1999 only specifies surface mining is banned, this is tantamount to a ban on all mining, because the nature of mineral deposits in Indonesia is such, that surface mining is the only practical method for mining. The effects of the ban on mining in protection forest is twofold. Firstly, license holders are unable to get forestry permits for exploration and development for areas where licenses were issued and Contracts of Work signed in the 1980s and 1990s – in many cases before Law 41 was enacted. Secondly, some of the most highly prospective mineral land is now off limits for new licenses. IMA have made a number of representations regarding the consequences of Law 41/1999 but so far the main response has been ad hoc rather than a systemic solution. Law 41/1999 creates an absolute ban on surface mining in the protection forest with no procedure for evaluating a specific exploration or development proposal on its merits at the same time that the Government’s overall policy is to encourage development that is environmentally and socially responsible. 5.10 Need for Better Mapping. The situation is further complicated by the fact that there can be uncertainty about the exact boundaries for protection forest areas because different Ministries and agencies are not using consistent maps and because boundaries are sometimes changed. A key issue is better coordination between Mining and Forestry and other Ministries in using the same set of 1:250,000 base maps delineating boundaries. For mining, the situation would be improved if the Dept of Forestry, Planology sits down with DGGMR and the CoW holders to

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review COW overlaps with hutan lindung and conservation areas, agree the forestry maps and then jointly post the maps on a web-site. 5.11 Good Practice in Land Use Decision Making. Good practice calls for land usage decisions to be made transparently, in consultation with all stakeholders, and in consideration of all relevant information including potential environmental, social and economic impact. But such a consultative process does not appear to have been undertaken in the designation of Hutan Lindung areas as Protection Forest areas and an impasse has emerged between the Ministry of Energy and Mines who believe the Contracts of Work should be honored and the Ministry of Forestry which believes that the license holders should be denied access to Hutan Lindung. The companies have been raising this issue since the law was enacted and the Government have been grappling with it for over a year. E. Protection Forest

5.12 The Methodology to Determine Protection Forest: The following sections present an anlaysis of the impact of mining on protection forest ( hutan lindung ). Annex F provides background on the analytical approach and data sources used. Based on the GOI “Landuse of Indonesia: A National Overview”, the methodology for the classification of the Protection Forest is based upon the Consensus Forest Land Use Plans or Tata Guna Hutan Kesepakatan (TGHK). During the period of 1982-85, a series of 1:500,000 – scale maps were produced by the Directorate for Forest Inventory and Land Use Planning (INTAG) on a provincial basis. The boundaries on these maps were determined by erosion susceptibility of a given area. This is calculated by a simple formula based on the slope steepness, soil erodibility and rainfall intensity (See Table 1)

Table 1: Slope, Soil and Rainfall Intensity Classes TGHK :

Class Slope % Points Soil Erodibility Points Rainfall

intensity Points

1 0 to 8 20 None 15 <13.6 10 2 9 to 15 40 Low 30 13.6 to 20.7 20 3 16 to 25 60 Medium 45 20.8 to 27.7 30 4 26 to 45 80 High 60 27.8 to 34.8 40 5 >45 100 V. High 75 >34.8 50

5.13 The soil classes used for the above index are very general and the soil classification itself is outdated (Thorp and Smith, 1949).

1. Alluvial Gley, Planosol, Hydromorphic, Ground Water Laterite 2. Latosol 3. Brown Forest Soil, Non Calcic Brown, Mediterranean 4. Andosol, Laterite, Grumosol, Podzol 5. Regosol, Lithosol, Organosol, Rendzina

31

The rainfall intensity index comprises the mean annual rainfall (mm) divided by mean annual rain days (a rain day having more than 1.0mm). 5.14 The classification is determined by summing the number of points attributable in respect of each of the three criteria and is used to determine the forest land category as follows:

Site Index Forest Land Category

<125 Normal Production Forest (HPB) or Conversion Forest (HK)

125 to 174 Limited Production Forest (HPT) >175 Protected Forest (HL)

In addition to the Site Index score, Protection Forest would more broadly require one of the following attributes, a slope that exceeds 45% or land with a soil class of 5 and a slope greater than 15%1. 5.15 When looking at the impact of mining on Protection Forest the real issue should be the impact on the watershed protection function. A more thorough discussion on this would require an analysis of the watershed protection provided by the various land cover and land uses that may replace the natural forest cover as a result of exploration or mining activities. This is a highly debated topic in itself as a natural and intact forest canopy is not necessarily the only (or the most effective) land cover for watershed protection. For the purpose of this analysis the following simplification is introduced:

• If the slope is more than 40%, it is considered that the optimal (and more likely) land cover is that provided by intact natural forest canopy. This means that in such areas there should not be any activity at all whether at exploration or mining phases.

• If the slope is less than 15%, that area – according to GOI formula – should

not have been Protection Forest in the first place. Any slope <15% will not have enough Site Index points to classify it as Protection forest.

5.16 To simplify classification further for the necessity of this report, the slope is divided into the following for classes:

1. Flat to gentle – less than 15% 2. Moderately steep -16 to 25% 3. Steep – 26 to 45% 4. Very Steep more than 45%

1 The Land Resources of Indonesia: A National Overview, Main Report, 1991, Government of the Republic of Indonesia, Ministry of Transmigration, Directorate General of Settlement Preparation.

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F. Findings of Protection Forest Analysis

1 The extent of mining concessions within the Indonesian forest estates:

5.17 The following results are affected by the fact that area coverage could only be obtained for mining concessions amounting to 40 million hectares1 out of the – alleged -total of 60 million (Jatam communication). These affect all of the absolute values and some of the relative values discussed below.

Finding 1: There are 11 million hectares allocated for mining inside Protection Forest [this figure is likely to increase once the data is available for the other 20 million hectares]

Table 2. Mining and Non Mining Area Outside and inside Forest Zones, Year 2000 (Area in Ha).

Forest Estate

Are

a

Prot

ectio

n

Con

serv

ati

on

Prod

uctio

n

Con

vers

ion

Sub

Tot

al

Fore

st E

stat

e

Oth

er

Tot

al

Mining 11,218,332 3,870,226 12,393,581 3,171,456 30,653,596 9,256,838 39,910,433

Non Mining 17,277,431 13,399,513 48,453,225 19,077,119 98,207,288 43,884,431 142,091,719

Total 28,495,763 17,269,739 60,846,806 22,248,575 128,860,883 53,141,269 182,002,152 Finding 2: 28% of the mining concessions area is inside Protection Forest. This makes it the most significant forest class for mining after Production Forest. Only 9.7% is inside Conservation Forest (furthermore the ban on mining in this forest class is not disputed). [these values will not change with additional data on the mission 20 million hectares, if these are proportionally distributed across the 5 land classes]

1 See list in Annex F

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Table 3: Percentage of Mining and Non Mining Area, Year 2000 (Area in Ha).

Forest Estate Area

Protection ConservationProductionConversion

Sub Total Forest Estate

Other Total

Mining 28.1% 9.7% 31.1% 7.9% 76.8% 23.2% 100.0%

Non Mining 12.2% 9.4% 34.1% 13.4% 69.1% 30.9% 100.0%

Total 15.7% 9.5% 33.4% 12.2% 70.8% 29.2% 100.0%

Finding 3: Almost 40% of Protection Forest is allocated to mining concessions. [this value is likely to increase once the data on the other 20 million hectares is available]

Table 4: Percentage of Mining and Non Mining Area Outside and inside Forest Function,

Year 2000 (Area in Ha).

Forest Estate Area

Protection ConservationProductionConversion

Sub Total Forest Estate

Other Total

Mining 39.4% 22.4% 20.4% 14.3% 23.8% 17.4% 21.9%

Non Mining 60.6% 77.6% 79.6% 85.7% 76.2% 82.6% 78.1%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Finding 4: Of the 11 million hectares allocated for mining inside Protection Forest, almost 3 million hectares have a slope lower than 15% and hence should not be classified as Protection Forest; 3.3 million hectares are on slope higher than 40% and there should be a priory that no exploration and mining activity occurs. The remaining 6 millions are in classes of slope which will require a case-by-case assessment of watershed vulnerability to forest degradation caused by

34

exploration and mining activities. [these values are likely to increase once the data is available for the other 20 million hectares]

Table 5: Mining in Protection Forest, Year 2000

Slope < 15% 16 - 25% 26 – 40% > 40% Total

Non Forest 526,488 296,825 360,263 389,650 1,573,226

Forest 2,381,044 1,851,625 2,505,681 2,906,756 9,645,106

Total 2,907,532 2,148,450 2,865,944 3,296,406 11,218,332

5.18 In relative terms, this means that as much as 26% of the mining area inside Protection Forest – by Indonesian applicable standards – should have no watershed protection limitations; on the other hand, almost 30% should not be touched at all.

Table 6: Percentage of Mining Area in Protection Forest, Year 2000.

Slope < 15% 16 - 25% 26 - 40% > 40% Total

Forest Area 25.9% 19.2% 25.5% 29.4% 100.0%

Finding 5: Also to be noted that the majority of the Protection Forest area is still forested, with the higher rate of deforested land at the lower slopes.

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Table 7: Percentage of Forest Cover in Mining Area in Protection Forest, Year 2000.

Slope < 15% 16 - 25% 26 - 40% > 40% Total

Forest Cover 81.9% 86.2% 87.4% 88.2% 86.0%

2 The impact of mining concessions on forest cover:

5.19 The following result are also affected by the fact that we could only obtain area coverage of mining concessions amounting to 40 million hectares out of the – alleged -total of 60 million (Jatam communication). Though, more important in this case - as we evaluate forest loss and forest gain across time - is the availability of information on the history of the mining concession. This is the only way to determine whether an observed forest cover change is associated to exploration and mining activities. As explained in the section “research questions” this analysis has focused on cumulated direct and indirect impacts on Protection Forest inside the mining concessions. We use the rate of forest loss/gain as an indicator of impact. The rate of forest loss/gain in a particular forest zone is calculated as follows:

The area of forest lost between 1990 and 2000

Area of forest cover in 1990 Finding 1: Based on this analysis it would appear that the rate of forest loss in Protection Forest allocated for mining is lower than in areas not allocated for mining. Furthermore, it should also be noted that there appears to be an even stronger association at slope lower than 15 – generally considered more “palatable” land. . The same appears to apply to Conservation Forest and the other forest zones.

Table 8: Rate of Forest Loss in Protection Areas

Protection Areas

Slope Percentage < 15% 16 - 25% 26 - 40% > 40%

Mining Area 6.0% 4.5% 4.6% 5.3%

Non Mining Area 14.8% 9.2% 7.3% 6.3%

36

< 15%16 - 25%

26 - 40%> 40%

0.0%

5.0%

10.0%

15.0%

20.0%

Rat

e of

For

est L

oss

Slope

Graph 1. Rate of Forest Loss in Protection Areas

Mining Area

Non Mining Area

< 15%16 - 25%

26 - 40%> 40%

0.0%

5.0%

10.0%

15.0%

20.0%

Rat

e of

For

est L

oss

Slope

Graph 2. Rate of Forest Loss in Conservation Areas

Mining AreaNon Mining Area

37

< 40%> 40%

0.0%

5.0%

10.0%

15.0%

20.0%

Rat

e of

For

est L

oss

Slope

Graph 3. Rate of Forest Loss in Production Areas

Mining Area

Non Mining Area

< 40%> 40%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Rat

e of

For

est L

oss

Slope

Graph 4. Rate of Forest Loss in Conversion Areas

Mining Area

Non Mining Area

38

< 15%16 - 25%

26 - 40%> 40%

0.0%5.0%

10.0%15.0%

20.0%25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

55.0%

60.0%

Rat

e of

For

est G

ain

Slope

Graph 6. Rate of Forest Gain in Protection Areas

Mining Area

Non Mining Area

Finding 2: The rate of forest gain appears to show an equally consistent – though less pronounced - positive association with mining areas. Thus, it appears that forest recovers at a higher rate when inside a mining concessions.

< 40%> 40%

0.0%

5.0%10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

55.0%

60.0%

Rat

e of

For

est L

oss

S lope

Graph 5. Rate of Forest Loss in Other Areas

Mining Area

Non Mining Area

39

Table 9: Rate of Forest Gain in Protection Areas

Protection

Slope Percentage < 15% 16 - 25% 26 - 40% > 40%

Mining Area 25.2% 35.2% 40.0% 43.2%

Non Mining Area 23.7% 28.0% 34.0% 42.1%

Finding 3: The areas of forest most easily accessible and interesting for land clearing are the gentle (<15% slope) and low altitudes (<1000m) forests. This class of land has suffered the highest rates of deforestation in all zones. Focusing attention to this area, a strong association can be made between the difference in rates of deforestation in mining and non-mining areas from 1990 to 2000 for each of the forest estate zones. The rate of deforestation was higher in non mining areas compared to mining areas for each of the different forest estate zones. This association raises the issue that warrants further research of whether land clearing is less likely to happen in mining concessions and whether these are more effective at protecting their forest land areas than the government or other privately owned non-mining areas.

ConservationProtection

ProductionConversion

Other

0%5%

10%15%20%25%30%35%40%45%50%55%60%

Def

ores

tatio

n R

ate

Area Classification

Graph 7. Rate of Deforestation 1990 - 2000in <15% Slope and <1000 m Altitude

Mining AreaNon Mining Area

40

Table 10: Rate of Deforestation 1990 – 2000 In <15% Slope and < 1000 m Altitude

Conservation Protection Production Conversion Other

Mining Area 5.8% 5.8% 14.0% 11.0% 41.8%

Non Mining Area 16.7% 15.5% 21.1% 28.2% 59.5%

G. Conclusions and Agenda For Further Work 5.20 Protection Forest contains a significant amount of mining concession area. Thus, the issue of the mining-forestry interface requires a systemic, not an ad hoc solution. A win-win dialogue needs to take place; 5.21 But, available data provides indications that land being licensed for mining has lower rates of forest loss and higher rates of forest gain than other forest land. A possible explanation is that mining concessions can be more reliable than other (absent) management system in securing the territorial integrity of the land under their control. The situation is further complicated by the fact that the boundaries for hutan lindung areas are subject to mapping uncertainties. It is recommended that:

• Ministry of Forestry, in partnership with Ministry of Energy and Mines and other stakeholders, undertake empirical work on the question of whether, in situations where forestry governance and law enforcement are weak, a legitimately issued, properly deigned mining concession with clear forest management prescriptions may contribute to, rather than detract from, ensuring the territorial integrity of Protection Forest and protecting its canopy cover; and

• in the meantime that the representatives of Ministry of Forestry and Ministry of Energy and Mines sit together with the COW holders to review COW overlaps with hutan lindung and conservation areas, agree the forestry maps and then jointly post the maps on a web-site

5.22 Further Empirical Work. An agenda for further work would include (i) obtaining the complete data set (boundary of concessions, history of concessions, etc):; additional statistical analysis; more detailed assessment and understanding of land clearing during mining operations; and assessment of other variables such as ownership of concession; impact outside concession; and correlation with year of activity, typology of class of mining, scale of throughput, sales and type of management; and (ii) consultation with stakeholders including

41

focused group discussions and possible workshop with various stakeholders ( including NGOs, Government, research groups and mining companies). 5.23 Unresolved Policy Conflict. The ban on surface mining in hutan lindung has created an unresolved policy conflict and an impasse between the Ministry of Energy and Mines who believe the Contracts of Work should be honored and the Ministry of Forestry which believes that mining license holders should be denied access to hutan lindung. While this has been resolved for COWs issued prior to year 2000, there remains an underlying issue of ineffective policy coordination and lack of procedures to ensure that land usage decisions are be made transparently, in consultation with all stakeholders, and in consideration of all relevant information including potential environmental, social and economic impacts. 5.24 Proposed Forestry/Mining Interface Workshop. As a way forward to resolve the policy conflict, the Donor’s Forestry Forum could be a suitable forum to convene a Policy Workshop to address the mining and forestry interface with representatives of all involved stakeholders (the relevant government ministries, affected communities, mining companies, IMA and NGOs) including representatives of main concerned provincial governments and the Association of Bupatis. This workshop could (i) provide information on procedures and practices in other countries facing a similar situation; (ii) consider the results of any further empirical work on the impact of mining on protection forest (as recommended in para 18 above); and (iii) look at procedures for evaluating alternative land uses. The resolution of this type of policy conflict would be a positive signal to both the donor community and potential investors that the Government is prepared to make the needed improvements regarding inter-agency communication and co-operation to resolve conflicts and have sound development policy and procedures. It is recommended that:

the Ministry of Forestry and the Ministry of Energy and Mineral Resources jointly request the Donor Forestry Forum to convene a multi-stakeholder workshop to address how best to address mining/forestry interface land use issue

CHAPTER 6: CONCLUSIONS

6.01 By applying good international practices and re-establishing a stable and attractive investment environment, the Government can attract new exploration and mining investment which can contribute to sustainable development in Indonesia. can take an important step towards attracting new exploration and mining investment which should provide considerable benefits at the national, provincial and local levels along the lines outlined above. But if these issues are addressed only in a partial or piecemeal manner, the desired improvements in exploration and investment may not materialize. 6.02 Proposed Improvements. The mining investment climate is in need of improvement. First, this report identifies a broad range of provisions which would help bring a new mining law in line with good international practice. Second, the report proposes measures to improve the international competitiveness and predictability of the mineral fiscal regime. Third, the report

42

notes the need to improve the mining/forestry interface. Fourth, the report notes the need for improved overall inter-government coordination and better implementation of measures to address key environmental and social issues including benefits to and respecting the rights of communities and addressing illegal natural resource exploitation. Finally, the report underscores the importance of capacity building and having in place the institutional capabilities needed to successfully implement the rules in a consistent and competent manner. 6.03 Mining Sector Sustainable Development Policy. In view of the extensive range of issues that need to be addressed, the question arises as to whether these issues are best addressed on a piecemeal basis or through some type of more comprehensive partnership approach. First, the Government needs to decide where they want to position Indonesia in global competitiveness and then develop a plan on how to get there. Does Indonesia want to be in the top 5-10 countries for mineral exploration and development? If so, then the cabinet needs to set up a process involving representatives of all the key ministries and key stakeholder groups to prepare a Mining Sector Sustainable Development Policy Statement/White Paper which would then be adopted by the Cabinet and then become the basis for developing a new law, improving the mitigation of social and environmental risks, and making other changes such as in the mining fiscal regime and the mining/forestry interface in a coordinated, holistic manner. By addressing the whole range of issues in a coordinated manner, the Government can take an important step towards (i) attracting new exploration and mining investment; and (ii) ensuring that new mining investment contributes to sustainable development for Indonesia. But if these issues are addressed only in a partial or piecemeal manner, the desired improvements in exploration and investment may not materialize and mining development not contribute to poverty alleviation and sustainable development.

45

Annex A

Comments and Recommendations Regarding the

Draft of a New Indonesian Mining Law Dated September 25, 2002

A Introduction

1. By applying good international practices and re-establishing a stable and attractive investment environment, the Government can attract new exploration and mining investment which should provide considerable benefits including increased state and local revenues, education, employment and community and business development. But investors will likely only be willing to commit large investments if the law adequately addresses the role of Government and decentralization, arrangements for the mining cadastre, the characteristics of the mining business agreement, equal treatment for foreign and local investors, mine closure and reclamation, and transition provisions from the old law to the new law. It is also important that the law provide predictability and non-interference in commercial and operational decisions for investors which involves allowing investors to take commercial decisions regarding partnerships and marketing and to be protected from possible expropriation. The law also needs to provide good access to prospective land for exploration and to provide investors with sound security of title.

2. In light of the above a number of improvements are presented which would help improve the proposed new Mining Law: For purpose of better understanding, the improvements are placed within an unofficial English translation of a draft of the proposed new law dated September 25, 2002 - which is the latest to have been received by the World Bank. The improvements do not relate to the legal language used in drafting of the law. Rather they relate to the underlying policies and concepts that shape the law and instruments to be included in the law. The recommended improvements are summarized below and presented in the Section B that follows:

• Role of Government: full clarity and consistency about the role and authority of different levels of government; (Articles 4 and 19)

• Mining Cadastre: a centrally coordinated register recording all agreements relating to mining tenements; (Articles 4, 24 and 41)

• Mining Business Agreement (PUP): that provides for collective approval, tax stabilization and international dispute resolution. (Articles 9 and 14)

• Level playing field: a level playing field for local and foreign investors; (Article 19)

• Mine Closure: ensuring sound mine closure procedures and post closure monitoring (Articles 31 and 33)

46

• Transition Provisions: ensuring the authority of the initial issuing authority continues to apply to licenses issued under the previous law (Article 62)

• Non-interference: non-interference in commercial and operational decisions; (Articles 3, 4, 5, 6, 45, 50)

• Licensing Rules: clarity regarding the rights and obligations of different license holders and certainty regarding security of tenure including minimizing the risks of overlapping license areas (Articles 3, 9, 11, 13, 15, 19, 24, 39, 50)

3. Mobilizing new investment will require not only a sound and carefully drafted national mining law, but also consistency with other laws such as the foreign investment law, and consistent and standardized provincial and local level perdas and regulations. This will be no easy task.

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B Comments and Suggested Improvements Draft September 25, 2002

DRAFT OF LAW THE REPUBLIC OF INDONESIA

NUMBER: …… OF YEAR ……

REGARDING

GENERAL MINING

BY THE GRACE OF THE ONE SUPREME GOD

THE PRESIDENT OF THE REPUBLIC OF INDONESIA,

Considering : a. that all minerals are natural resources that are controlled by the state and play

a very important role for the national economy, as such they shall be managed in such a way that they will provide the maximum benefits and prosperity for the people;

b. that general mining activities especially mineral mining of non oil and gas play a very important role in providing added values to the national economic growth and regional development in a sustainable manner;

c. that by considering national and international development, it is necessary to revise laws and regulations on in the field of general mining to create independent, reliable, transparent, competitive, efficient, environmentally-oriented general mining activities and encourage sustainable regional and national development;

d. that Law No. 11 of 1967 on Basic Provisions on Mining is no longer appropriate with the current development of general mining now and in the future;

e. that based on the consideration as referred to in letters a, b, c, and d, , and to provide legal foundations for reformed steps and management of general mining operations, it is necessary to stipulate a Law regarding General Mining;

In view of : 1. Article 5 paragraph (1), Article 18, Article 20 paragraphs (1), (2), (4), and

(5) and Article 33 paragraphs (2) and (3) of the 1945 Constitution as amended by the third amendment.;

2. TAP MPR RI No. XV/MPR/1998 on Regional Autonomy; Management,

Division, and Use of National Resources in a Fair Manner; and Financial Proportion between the Central Government and Regional Administration within the Unitary State of the Republic of Indonesia.

48

With the joint approval between

HOUSE OF REPRESENTATIVES OF THE REPUBLIC OF INDONESIA

HEREBY DECREES:

Enacting : LAW REGARDING GENERAL MINING

49

CHAPTER I

GENERAL PROVISIONS

Article 1

In this Law the definition of:

1. General Mining, shall be the mining of minerals beyond natural oil and gas;

2. Minerals are variety of chemical, mineral, mineral group, boulder, stone/kernel, including coal, peat moss, solid bitumen, underground water, earth heat, and radioactive mineral elements which naturally occur and having economic value.

3. Associated minerals will be minerals or variety of mineral which naturally occur or exist together with the main mineral so that in the mining and processing or purifying process they are unwillingly taken as associated products.

4. The General Mining Operation, hereinafter referred to as mining operation will be any activity in the framework of mining operation (exploitation) which covers General Investigation, Exploration, Feasibility Study, Construction, and Production Operation activities.

5. General Investigation will be the stage in mining operation to know regional geological condition and indication of mineralization or mineral sediment existence and quality overview, estimated resources of sediment which is carried out by means of geological, geo-physical, geo-chemical investigation on regional basis and sampling at random.

6. Exploration will be the stage of mining operation activity to obtain detail and careful information on location, form, dimension, spreading, quality and measured resources, from minerals of geological, geophysical investigation outcome, and sampling, ditch or test or drilling wells and detailed construction of exploration tunnel.

7. Feasibility study will be the stage of mining operation activity to obtain detailed operation on all related aspects to determine mining operation feasibility including research/study on total reserve which can be mined using method of mining and processing/purification, infrastructure plan, investment and Analysis on Environmental Impact or Environmental Management Effort and Environmental Monitoring Effort which can be conducted by inserted drilling and spill sampling.

8. Construction is a phase of mining operation activities to perform the construction of all facilities for Production Operation, including preparation of lands, roads, processing and purification facilities, mining test and processing or purification test.

9. Production Operation is a phase of mining operation activities to perform mining, processing, purification, transportation or sale of mining materials

10. Mine Closure is permanent discontinuation to a mining operation because of the end of Mining Production License (IUP) and or Mining Business Agreement (PUP) or mining activities discontinuation for more than 1 (one) year.

11. Mining Production License or IUP shall be the permit to conduct mining operation;

50

12. Mining Business Agreement or PUP is an agreement between the Government and/or Regional Government and an Indonesian corporate body in performing mining operation.

13. Smallholding Mining License or IPR is a permit granted to individual or local cooperative which conducts mining operation using simple device.

14. Indonesian Mining Jurisdiction, shall be the entire Indonesian land and waters territories and Indonesian continent base;

15. Mining Operation Territory shall be the territory designated in the Mining Production License and/or Mining Business Agreement for conducting mining operation.

16. Another Party’s Mining Service shall be the service activities related to the implementation of Mining Production License and/or Mining Business Agreement the relevant support activities.

17. Reclamation, shall be efforts to rehabilitate or restore the land and/or vegetation, quality of the environment, and public facilities and infrastructure both natural and man-made disturbed as a direct result of mining operations to a state where they can function optimally according to their designation.

18. Dead rent is fees paid to the State as in return to the opportunity for General Investigation, Exploration, Feasibility Study, Construction and Production Operation at an IUP or PUP area.

19. Royalty is a sum of money paid to the State for the results generated from Production Operation mining operation over one or more mining materials.

20. Each Person is an individual, including legal entities.

21. Central Government or Government, is an apparatus of Unitary State of the Republic of Indonesia consisting of President and its cabinet ministers.

22. Regional Government is head of Region along with its other apparatus of Autonomous Region as Regional Executive Board.

23. Minister, shall be the Minister whose field its duty and responsibility includes activity of mining operation;

Definitions In order to strengthen the provisions of the draft law regarding mine closure and community development, it is recommended that the following definitions be included in Article 1

• Mine Closure Plan (see comments on Article 31) - which is a plan prepared during the feasibility stage, progressively updated during the production operation phase, with the final version approved by relevant authority, that provides the basis for mine decommissioning and reclamation and post closure monitoring and supervision;

• Local Business Development Plan (see comments on Article 34) - which is a plan mutually agreed at the mine feasibility stage, between the IUP or PUP holder, local community and the regional government regarding initiatives to support local business development);

51

• Land Use Agreement (Article 31) - which is an agreement made between the IUP or PUP holder and the title holder regarding the reclamation and use of ex-mining land;

• Post Closure Monitoring. (see comments on Article 31) - which is the phase following completion of mine closure

• Reclamation Guarantee and Mine Closure Fund (see Article 33) - which is a fund to cover the cost of decommissioning, reclamation and post closure environmental protection in accordance with the Mine Closure Plan, plus any costs for monitoring or further expenditures needed during the Post Closure Monitoring stage.

CHAPTER II

CONTROL OF MINERALS

Article 2

(1) All minerals found in the Indonesian mining jurisdiction as natural resources shall be the property of the Indonesian People and shall therefore be controlled by the State to be used for the maximum benefit of Indonesian people.

(2) Control over mining materials as referred to in paragraph (1) shall be conducted by Government and Regional Government through inventory, investigation and research, regulation, permit issuance, guidance and supervision of mineral development in the Indonesian Mining Jurisdiction.

Article 3

(1) For national interest, President can stipulate:

a. reserve of certain minerals for the state in part of Indonesian mining jurisdiction by referring to the National Spatial Layout Plan;

Licensing Rules. Article 3(1)a allows for land to be reserved for state mining. This restricts access of private investors to such land. As a first best it is recommended that the law should not include such a provision. However, if the provision remains then it is recommended that the law stipulate that public notification will be provided in the event that any such reserved lands shall be released and an international competitive tendering processes will be used for licensing purposes in any cases where particular minerals are considered to be of interest to investors.

b. domestic market prioritization;

Non Interference. Article 3(1)b allows for Government to intervene in the marketing decisions of private companies. Such intervention is detrimental to the optimal allocation of resources and is no longer appropriate in a modern mining framework and it is recommended that the priority to domestic marketing be eliminated from the law.

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(2) In determining reserve of minerals as referred to in paragraph (1) letter a President shall consult with House of Representatives.

CHAPTER III

GENERAL MINING EXPLOITATION AUTHORITY

Article 4

Role of Government. One of the most important issues for the mining sector is the supervision of environmental, health and safety aspects of mining operations. Mining operations are typically much more complex and often very much larger than manufacturing and services activities and this means that mining operations generally require a considerable amount of technical supervision to ensure that operations are in compliance with license conditions and health, safety and environmental criteria.

While environmental, heath and safety supervision would be part of the government functions that are due to be decentralized according to the provisions of Law 22, careful consideration is needed as to whether this is the best course of action in the mining sector at the present time given that these capabilities do not exist at the provincial level in many places – but do exist at the central level. Modern mining laws generally specify that in a decentralized system the national government has the responsibility for overall mining policy and law making as well as for supervising mine health and safety through regional or local offices in accordance with the prevailing laws.

By keeping such functions centralized, it helps ensure that highly specialized expertise can be brought to bear at mines in different regions as needed and that there can be a high degree of learning and information sharing between offices regarding conditions at mines in different regions. In addition, it helps smooth out employment patterns because when necessary staff can be re-allocated from offices in regions where mines are closing to offices where new mines are opening.

If these functions are decentralized too early it will lead to a situation where the responsible Government authorities lack the necessary capabilities to fulfill important supervisory and monitoring responsibilities which will be not only be highly unsatisfactory for companies and communities alike but also irresponsible. Investors look for certainty about the authority of different institutions to administer and regulate the mining industry and mining companies are presently concerned that it is not clear in practice who has supervising authority regarding mine health and safety, environment and other inspections. The experience of mining companies is that the necessary skills and capabilities simply do not exist in many local and regional authorities. This has been confirmed at Training Workshops for Provincial Governments environmental officials being conducted under an Australian assistance program.

It is recommended that the law stipulate that the national government should have the responsibility for overall mining policy and law making and should also be responsible for supervising mine health and safety conditions through regional or local offices of a national agency (Article 4 and Article 32). This would involve modifying Law 22/2000 accordingly.

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(1) The Authority of the Government in general mining processing covers:

a. Formulation of national policies;

b. Formulation of laws and regulations in the field of mineral mining;

c. Formulation and stipulation of national standardization in the field of mineral mining;

d. Formulation and stipulation of national general mining licensing system;

Mining Cadastre. The Mining Cadastre is the national Register which records all matters related to each exploration and mining tenement granted within Indonesia, including ownership, transfers, encumbrances, joint ventures, etc. It also registers any other agreement relating to the tenement including approvals from relevant authorities and land use or compensation agreements. Indonesia presently has one of the best mining cadastres and national mining data bases. But, decentralization now places the responsibility for licensing to more than 90 and possibly as many as 300 Kabupatens and Provinces, only a minority of which will have reliable databases or good security of licenses. For new investment to be mobilized, new investors will need (i) timely and accurate access to mineral data and licensing information regarding which areas are already licensed and which are available for license application and also (ii) an ability to overlay other land uses with the mineral licensing and geological information. The successful establishment of a decentralized mining cadastre is absolutely critical to the successful implementation of any modern mining law. It is recommended that there be a separate Mining Cadastre Chapter in the law. This chapter should establish the principles upon which the applications process will be based (i.e. first come - first served) as well as all processes associated with the licensing process. This chapter should also identify who is the authority to hold and manage the cadastre (register) – if it is the same authority that grants the license or a separate one - and the law should state that the register is the final arbiter in any dispute and that no agreement or document has any legally binding force or effect unless entered on the register. The law should stipulate that the mining cadastre will be decentralized, but coordinated centrally, including reference to the nature and legal status of the register of mineral licenses. The cadastre should be a nationally standardized system of management and the register should be centrally coordinated and maintained. The law should stipulate that the register is a physical book that spells out the criteria for grant of a license or agreement (PUP) as well as the application and approvals process and who has the authority to issue and sign licenses or agreements on behalf of the State. There must be an official mining cadastre Register Book and Map Index maintained in every established regional mineral licensing registration office- which is open to the public and which records all transactions relating to mining licenses. The register should be open to the public for title searches. The law should also outline an appeal process in the event that an application is declined, revoked or cancelled.

e. Management of operation and supervision of mineral mining in the cross-

province areas and marine areas beyond 12 sea miles;

f. Performing issuance of permits and mining supervision of minerals in the cross-province areas and marine areas beyond 12 sea miles;

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g. Stipulation of marketing, utilization, and conservation policies;

h. Stipulation of cooperation and partnership policies;

Non Interference. Article 4(1)j gives authority to the National Government to stipulate partnership policies relating to mining. The elucidation indicates that in this case partnership relates to artisanal/small scale and large scale mining operation. This could be highly problematic because it is normally better to keep commercial scale and small scale mining separate. It is recommended that the law make no reference to partnerships

i. Stipulation of criteria for general mining area;

j. Formulation and stipulation of dead rent and royalty Tariff, and utilization of Government share of coal production;

k. Guidance and supervision of the implementation of the management and formulation of Regional Regulation in the general mining;

k. Management of information on geology, potential minerals, and national mining information.

l. Preparation of mining resources balance at national level.

Article 5

(1) The Authority of the Provincial Government in general mining management cover:

a. Stipulation of cooperation and partnership policies in the field of mining of mineral

Non Interference. Article 5(1)a gives authority to the Provincial Government to stipulate partnership policies relating to mining. The elucidation indicates that in this case partnership relates to artisanal/small scale and large scale mining operation. This could be highly problematic because it is normally better to keep commercial scale and small scale mining separate. It is recommended that the law make no reference to partnerships

b. Formulation of regional laws and regulations in the field of mining of

mineral

c. Management on the development and supervision of mineral mining in the cross-regency / municipality territory and sea territory beyond one third of the sea boundary of the Province Area;

d. implementation permit issuance and supervision of mineral mining in the cross-regency / municipality and sea territory beyond one third of the sea boundary of the Province Area;

e. Management of information on geology, mineral potential in the cross-regency / municipality territory and information on mining in the regency / municipality territory;

f. Preparation of provincial level mineral resource balance.

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(2) The authority of the provincial government as intended in paragraph (1) shall be executed in accordance with the prevailing laws and regulations.

Article 6

(1) The authority of the Regency / Municipality Government in the management of general mining includes :

a. Stipulation of cooperation and partnership policies in the field of mining of mineral;

Non Interference. Article 6(1)a gives authority to the Regency/Municipal Government to stipulate partnership policies relating to mining. The elucidation indicates that in this case partnership relates to small scale and large scale mining operation. This could be highly problematic because it is normally better to keep commercial scale and small scale mining separate. It is recommended that the law make no reference to partnerships

b. Formulation of laws and regulations in the field of mining of mineral;

c. Management and supervision on development of mineral mining in the Regency / Municipality area and sea territory up to one third of the sea boundary of the Province Area;

d. Issuing permit and supervising

e. mineral mining in the Regency / Municipality area and sea territory up to one third of the sea boundary of the Province Territory

f. Management of information on geology, mining material potentials and mining in the Regency/Municipality;

g. Preparation of mining material resources balance at the Regency/Municipality level.

h. Empowering the community in and around mine operation areas;

i. Stipulating spatial layout plans.

(2) The authority of the Regency / Municipality government as intended in paragraph (1) shall be executed in accordance with the prevailing laws and regulations.

CHAPTER IV

DEVELOPMENT AND CATEGORIZATION OF MINING OPERATIONS

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Article 7

Development of minerals shall be conducted by State-Owned Enterprises / Region-Owned Enterprises, Indonesian Limited Liability Companies, Cooperatives and Individuals based on business development permit.

Article 8

(1) Mining operations are classified into 5 groups:

a. Radioactive Mineral Mining;

b. Metal Mineral Mining;

c. Non-Metal Mineral Mining;

d. Coal, Peat Moss, and Solid Bitumen Mining;

e. Geothermal Mining;

(2) The classification as referred to in paragraph (1) shall be provided for further by Government Regulation.

CHAPTER V

FORM OF MINING OPERATION

Article 9

Mining Operations shall be executed in the following forms::

a. Mining Production License (IUP);

Licensing Rules. The underlying principle appears to be of “first come first served” which is a sound principle used by many jurisdiction but it is not stipulated in the law. It is recommended that Article 9 be expanded to specifically stipulate that the IUP shall be granted on a first come first serve basis following receipt of an application.

b. Smallholding Mining License (IPR); c. Mining Business Agreement (PUP)

Mining Business Agreement (PUP). Article 9 c provides for a Mining Business Agreement (PUP). Good practice calls for the purpose and structure of the PUP to be stipulated in the law. If the main function of the PUP is to provide additional assurances needed to help attract the financing required for large scale or mega projects, then three main characteristics of the PUP are needed:

• First, the PUP should be a “bankable” document. This can be accomplished by providing “collective approval. The PUP can be based on a model agreement that is approved by all 3 levels of Parliament and then each PUP would be signed by the designated

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representative of each level of authority. The standard contract should be approved by the National DPR at the same time as the draft law.

• Second, the PUP can be used as an instrument to provide stabilization provisions which are of importance to both investors and lenders, especially for very large and mega scale investments.

• Third, the PUP can provide for dispute resolution to take place in an international venue which is also of great importance to both foreign investors and international lenders.

In light of the above, it is recommended that the law elaborate the nature and structure of the Mining Business Agreement (PUP) to include collective approval, tax stabilization and international dispute resolution.

Another function that the PUP could fulfill is to address community-related aspects such as

• Disclosure of information regarding project-related activities and impacts on the community so that communities are properly informed about relevant project activities and their rights are respected;

• Consultation between the IUP holder and the affected communities;

• Provisions to ensure that environmental and social risks are adequately identified, monitored. Managed and mitigated

• Provisions are in place that communities benefit from the mining activities including for example providing employment and business opportunities to local small and medium enterprises

• Provisions to ensure that mine closure plans and procedures are in place and that post-closure monitoring and, if necessary, correction takes place with the community fully informed

Based on the above it

It is also important to harmonize the draft Mining Law and the draft Investment Law. The draft Investment Law (Section 19) states that a joint agreement or similar (which would presumably include the Mining Investment Agreement (i.e. the PUP)) would be considered as meeting the requirements of the draft Investment Law for a “Letter of Approval for Investment.” It also appears that the IUP would meet the requirements for a Business License (Draft Investment Law Section 18, para 3). But it would also seem that IUP/PUP holders would also need an implementation permit (draft Investment Law Section 18, para 2) which would be issued by an institution authorized as a “one stop shop” (draft Investment Law Section 21). Any specific requirements that would be covered by the implementation permit would be better included in the PUP which would mean it would not be necessary for a project with a PUP to also have to go to the “one stop shop” as outlined in the draft Investment Law. In view of the above, it is recommended that the draft law stipulate that in the case of mining the PUP will fulfill the requirements for the implementation permit (which is in the draft investment law). This would also require cross referencing in the draft Investment Law.

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Article 10

(1) Mining production license (IUP) for mining operation as referred to in Article 8 paragraph (1) letters a may be issued by the Minister to

a. Government Agencies;

b. State Owned Enterprises/Region Owned Enterprises;

c. Indonesian Limited Liability Companies;

(2) Mining production license (IUP) for mining operation as referred to in Article 8 paragraph (1) letter b, letter d, and letter e may be issued by the Governor to:

a. State Owned Enterprises/Region Owned Enterprises;

b. Indonesian Limited Liability Companies;

c. Cooperatives

(3) Mining Production License (IUP) for mining operation as referred to in Article 8 paragraph (1) letter c and letter f is issued by the Regent / the Mayor to :

a. State Owned Enterprises/Region Owned Enterprises

b. Indonesian Limited Liability Companies

c. Cooperatives

d. Individuals

(4) Provision on the requirements and procedure for the IUP issuance shall be provided further with Government Regulation.

Article 11

(1) Mining operation can commence after an IUP from the Minister or the Governor or the Regent/Mayor as per their authority is obtained.

(2) IUP shall be issued for one type of mining mineral and its associated minerals.

Licensing Rules. Article 11.2 gives a priority to the IUP holder to obtain IUPs for other minerals in the event they are found within in the area covered by the initial IUP. In order to provide greater certainty for the license holder, it is recommended that the law stipulate that the license grant the title holder exclusive rights to explore for and develop any and all minerals that are found by the IUP holder within the categories of minerals specified by the license (according to Article 8 - namely radioactive minerals; metal minerals; non-metal minerals; coal and bitumen) rather than just for one specified mineral.

(3) The Mining Production License holder as referred to in paragraph (2) discovering

other minerals in the mining operation territory may be given priority and has the right to reject IUP to exploit such other minerals.

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(4) If the IUP holder as referred to in paragraph (3) rejects it, the IUP holder is obligated to save such minerals.

(5) Mining operations at water sources shall take into account the function conservation and carrying capacity of the water sources in question in accordance with the applicable laws and regulations.

Article 12

(1) The territory that has been issued with Mining Production License (IUP), may be issued with another IUP for the development of other minerals whose availability differs.

(2) The issuance of the Mining Production License (IUP)as referred to in paragraph (1) shall be carried out after the opinions from the first IUP holder have been considered.

Article 13

(1) The Regent/Mayor shall stipulate public mining territories in a Regent / Mayor decree pursuant to the criteria stipulated by the Minister.

(2) The Regent/Mayor shall issue an IPR to an individual holding Indonesian citizenship or a local cooperative within the local mining area;

(3) The Regent/Mayor shall provide guidance with regard to the public mining operation.

(4) Provisions on the procedure for stipulation, cancellation, area size, term, rights and obligations of an IPR holder shall be regulated by Regional Regulation.

Licensing Rules. Article 9(a) provides for the small holder mining license (IPR) and Article 13 stipulates that the IPR will be issued by the Regent /Mayor. The use of both the IUP and the IPR creates the potential problem of overlapping licenses. Good practice would give the IUP holder firm title and would not allow a Regent/Mayor to grant an IPR directly over the discovery zone of an ore deposit in an existing IUP or PUP license creating substantial conflict. In the event consideration is being given to granting an IPR over land the subject of an existing IUP or PUP, then the IPR should only be granted with the prior consent of the IUP/PUP holder who would then relinquish that part of their concession. Where an IPR exists prior to an IUP then the area of the pre-existing IPR can only be included in the IUP or PUP with the prior consent of the pre-existing IPR holder who would need to be compensated. It is recommended that the law should stipulate that an IPR should not be granted over land in an IUP or PUP unless that land is relinquished by the IUP /PUP holder. It should also stipulate that or IUP/PUP cannot be granted over an area held by an IPR. The law should also stipulate the rights, obligations of the IPR and should provide for it to be transferable, convertible to an IUP and subject to termination for due cause.

Article 14

(1) Exception from the Provision as referred to Article 9, The Minister, the Governor, the Regent/Mayor according to their respective authority may appoint an Indonesian Limited Liability Company to execute mining operation in the form of

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PUP (Mining Business Agreement) which gives more advantages for the interests of the State and the public.

Mining Business Agreement (PUP). Article 14(1) provides for the Minister, the Government or the Regent/Mayor to appoint the PUP holder. Collective approval in the case of a PUP is a good thing that will signify support at all levels of government and increase the Bankability of the PUP. However, according to the draft law the PUP can be signed by either the Minister, the Governor or the Mayor/Regent with the approval of the other two parties. The possibility of three different authorities signing the PUP may lead to uncertainty and confusion and the PUP may not be considered bankable unless it is signed by the Minister. In order to ensure full bankablity and an efficient process, it is recommended that the PUP should be signed by the Minister following collective approval of the Governor and the Bupati/Mayor. Tax Stabilization Importance of Predictable Tax Regime. The predictability of the fiscal regime is an important component in the investment decision. Investors are concerned that the tax regime be predictable in order to estimate the return on investment. Lenders are also concerned about tax regime predictability – especially during the period when debt is being repaid. Thus, a high degree of tax predictability can be viewed as an investment incentive. Indeed, in investor surveys, many investors indicate that they see a stable tax regime with reasonable rates as preferable to a “low” tax regime that could be changed without notice.

Tax Stabilization included in COW. Indonesia was one of the first countries to provide tax stabilization – through the Contract of Work, which stabilizes taxes for the life of the contract. More recently, the new Indonesian Petroleum law also embodies some fiscal stabilization features. A Tax Stabilization arrangement has also been available in Chile for many years. More recently tax stabilization provisions for mining operations have been adopted by a number of countries shown in Table 1 below.

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Table 1 Availability of Tax Stabilization in Selected Jurisdictions Country

Some Form Description of tax stabilization available?

Argentina Yes 30 yrs, provincial & municipal taxes, import duties, foreign exchange rules.

Burkina Faso Yes During the term of the contract; except mining taxes and fees

Chile (42%) Yes 10 yrs, if mine elects a higher income tax rate Indonesia Yes COW – most taxes stabilized for life of mining

agreement; without COW, taxes are not stabilized. Kazakhstan Yes Taxes stabilized for life of mining agreement. Madagascar Yes Taxes stabilized for life of mining permit. Mozambique Yes Taxes stabilized for 15 years from start of

exploration or 10 years from granting of mining title. Mauritania Yes Taxes stabilized for life of mining permit. Peru Yes Two optional systems of tax stabilization: mining

contracts (10-15 yrs tax stabilization), and 10 yrs Legal Stability Agreements that fix the income tax regime and certain other fiscal imposts; 2% additional rate income tax is applied.

Uzbekistan Yes Most major taxes may be frozen for 10 yrs from date of establishment; tax experts warn that there may be difficulties with the practical implementation.

Source: J. Otto, J. Cordes and M. Batarseh, Global Mining Taxation Comparative Study, second edition, IGRPM Colorado School of Mines, March 2000; World Bank Reports. Tax Stabilization Can Help Lower Financing Costs. Large initial capital investments require substantial debt financing. Financial institutions will require higher cover ratios where fiscal terms are not fixed in order to reduce the risk of debt service default in the event that governments attempt to impose higher taxes once the project starts production, but before the debt has been repaid. This may compromise the project’s capacity to service its debt. This may in some cases limit the capacity of developers to finance project debt. In addition the potentially lower level of risk associated with the project due to the fixed fiscal terms can also result in more attractive interest rates and lower the cost of political risk insurance. This ultimately makes the project more profitable and which, in turn, results in higher tax collections to the government.

Tax Stabilization Can Help Improve Investor Confidence. Investors like to know that when they make large capital investments that they are assured of the returns that induced them to make the investment in the first place. While taxes that apply across the economy as a whole tend to be reasonably stable and even declining over time as is the case of income tax in Indonesia, investors are often concerned that changes in non state tax charges such as royalties that are specific to the sector can mean that the “goal posts” move for the investors during “the game”. Fiscal stabilization can thus be considered a risk mitigation measure for investment promotion. Investors will consider the risk profile of a jurisdiction which offers fiscal stabilization as generally lower than those that do not.

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A Range of Possible Options. For the future, there are several different options for the structuring of fiscal stabilization. The following presents some of the options which may be considered for implementation as part of the proposed PUP.

• Life of project fixed fiscal terms, negotiated rates. The concept introduced in Indonesia for the Contract of Work under Law number 11 of 1967 was one of “cradle to grave” stabilization of fiscal terms by the inclusion of all fiscal terms into a legally binding contract between the developer and the government. This had the effect of locking in negotiated fiscal arrangements, including the types of fiscal measures and rates to be applied, for the term of the contract.

• Fixed fiscal terms for fixed periods, negotiated rates. A variation of the above is to provide fixed fiscal terms for a fixed period of time in order to give the investor confidence in his ability to meet debt servicing requirements, especially during the payback period of the project. These rates may be negotiated and included in the project agreement.

• Fixed fiscal terms for fixed periods, prevailing rates. Another variation of the above is to provide fixed fiscal terms for a fixed period of time in order to give the investor confidence in his ability to meet debt servicing requirements, especially during the payback period of the project. These rates are fixed at the rates prevailing at the time the investment decision is made by inclusion of the rates in a schedule attached to the project agreement.

• Fixed fiscal terms at a premium to prevailing rates. In some nations, such as Chile and Peru, stabilization is available but carries an additional stabilization premium (for example, in Peru, the normal income tax rate is increased). A further variation of the above is the Chilean model which provides fixed fiscal terms for either the project life or a fixed period of time at rates which are fixed at a premium to the rates prevailing at the time the investment decision is made. This provides the investor with the choice of paying higher rates in return for guaranteed fiscal terms, or accepting the risk of variable terms. This can be viewed in a similar manner to the investor paying political risk insurance on his debt, where he pays a higher interest rate in return for a transfer of the political portion of project risk to the bank. In the Chilean model, at the time of project approval, the investor elects either (i) to accept the prevailing tax rates, or (ii) to use the fixed rates option. The investor is also allowed to change the selection one time during the project life.

Multiplicity of Tax Regimes. If taxes are stabilized for various mines at prevailing rates at different points in time, then an administrative challenge can arise over time. As the underlying tax laws change, each stabilized mine will have a tax regime dating to the time the stabilization arrangement was entered into. This means that over time there will be many tax regimes, and the government agency charged with tax administration will increasingly face a more complicated situation monitoring and enforcing each. This entails costs. At the present time in Indonesia, there are many COWS with stabilization arrangements containing many different tax regimes. Thus, the COW approach has enhanced the potential for mineral sector investment, but has also complicated the tax system and raised administrative challenges.

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An effective way forward is to offer stabilization to the holder of a PUP for a period of ten years from the commencement of production, in order to provide a stable fiscal environment throughout the repayment period of any loans. This will assist the developer to finance the project and will reduce the risk profile thereby resulting in lower debt financing charges, and lower political risk insurance premiums. As a result of stabilization, the profitability will be greater due to lower deductible financing costs, leading to higher tax payments and benefits to the State. To reduce the risk that tax increases could compromise the ability of a project to service its debt, it is recommended that a tax stabilization provision covering royalties and other non- tax state charges and levies be introduced into the PUP for a period of ten years from the commencement of production

(2) The IUP holder as referred to in Article 9 letter a may change its license into a

PUP after completing the general investigation stage.

(3) Provisions on the requirements and the procedure for PUP issuance as referred to in paragraphs (1), and (2) shall be provided further with Government Regulation.

Article 15

(1) The Minister, the Governor, the Regent/Mayor in accordance with their respective authority in issuing IUP, IPR and signing PUP as referred to Article 11, Article 13, and Article 14 recognize the existence of traditional public mining activities.

(2) The traditional public mining activities as referred to paragraph (1) are conducted

by local residents for generations whose criteria are regulated further by Regional Regulation.

Licensing Rules. Article 15 stipulates that traditional mining activities by local residents can be recognized within an IUP, IPR or PUP license area. This creates the risk of conflict between the traditional mining activities by local residents and the IUP, IPR, PUP holder. It also opens the door for mining to take place by individuals who are not really traditional small holder miners. In order to improve the situation, it is recommended that the law should stipulate that traditional mining activities by local residents can only be legitimately carried out by registered individual local residents using non-mechanized means. The traditional local resident miners should be registered and issued with identification cards (or authorizations) specifying the location of their workings to avoid any conflict with IUPs and PUPs or confusion over the rights of traditional local resident miners. The Regent/Mayor should be required to develop a map, which identifies the areas of traditional mining and advise applicants for IUP/PUP of the existence of any such areas. This measure is also needed to assist in combating illegal mining activity.

Article 16

IUP and PUP shall not be used for other purposes other than the purposes of the issuance of the IUP and / or as per content of the PUP.

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Article 17

(1) In the event that the Mining Production License (IUP) holder or Mining Business Agreement (PUP) holder uses another party’s services to conduct its mining operation, the responsibility of mining activities will continue to fully rest with the IUP or PUP holder..

(2) Another party’s services as referred to in paragraph (1) shall meet requirements for the classification and qualification stipulated by the Government.

Article 18

The Government or the Regional Government in accordance with their respective authorities shall guarantee the rights of the IUP holder, IPR holder and PUP holder in conducting mining operation based on the prevailing laws and regulations.

CHAPTER VI

CAPITAL INVESTMENT IN THE MINING OPERATION

Article 19

(1) The IUP or PUP in connection with foreign investment shall be carried out in the form of a joint-venture between a foreign investor and/or Indonesian Limited Liability Company.

Level Playing Field. The requirement in Article 19, section (1) that foreign investment must take place in a partnership with a local investor, presents one of the most critical obstacles to major new investment in the draft of the mining law. It constrains foreign investors from being fully in control of decisions regarding ownership and funding of new ventures – which are essential considerations for investments which can typically run into the hundreds of millions and sometimes billions of dollars for world class mining projects. While local investors and domestic mining companies can undertake small or medium size projects, few if any have the ability to raise the financing needed for mega projects – at least without a foreign partner. But international mining companies will want to be free to decide when to take and when not to take a local partner – and not be obligated in this regard.

Furthermore, the requirement is a backward step from the provisions of the 7th generation Contract of Work (COW) which does not require local equity participation. It is also inconsistent with the rules for foreign investment in the Foreign Investment Law. The next round of foreign investment in mining is likely to take place under COWs which already exist or for which applications have already been made, so it is probable that this requirement will not be a hindrance in these cases. However, the requirement will be a major obstacle to new investment taking place once PUP’s start to be issued. Few, if any other countries, have such a requirement for local partnerships, This will put Indonesia at a competitive disadvantage in attracting foreign investment since international mining companies have many geologically attractive jurisdictions to choose from when considering exploration and mining investment targets.

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If the Government wishes to encourage new foreign investment, then foreign investment should be on the same terms as domestic investment (equal treatment) and mandatory local partnerships should not be required. This issue should be left to the provisions of the Foreign Investment Law and not be mentioned in this law. Instead of requiring local partnership, the law could provide that an IUP or PUP involving a foreign investors may be implemented in the form of a joint venture between foreign investor and Indonesian Citizen and/or Limited Liability Company of Indonesian corporate consistent with the Foreign Investment Law. It is recommended that foreign investment under the PUP should be on the same terms as domestic investment (equal treatment) and that the law should not stipulate a requirement for mandatory partnerships with domestic investors should not be required.

(2) The Minister as per his/her authority as set forth in Article 4 item e signs IUP or

PUP in connection with foreign investment as referred to paragraph 1 after obtaining approval from the Mayor / Regent and the Governor.

(3) The Governor as per his/her authority as set forth in Article 5 paragraph 1 item c signs IUP or PUP in connection with foreign investment as referred to paragraph 1 after obtaining approval from the Mayor / Regent and the Minister.

(4) The Mayor/Regent as per his/her authority as set forth in Article 6 paragraph 1 c signs IUP or PUP in connection with foreign investment as referred to paragraph 1 after obtaining approval from the Governor and the Minister.

Role of Government. Article 19(4) stipulates that the Mayor/Regent must obtain the approval from the Government and the Minister before issuing a IUP. This creates a very slow and cumbersome process. The IUP is a fairly simple license and it would be better if it could be issued promptly upon request. Thus, for IUP applications for areas within the boundary of the Municipality or the Kabupatan, it is recommended that the law stipulate that the Mayor/Regent should have full authority to issue an IUP according to the provisions of the law (Article 19 para (4)).

(5) The signing of PUP in connection with domestic investment shall follow the

procedures as referred to paragraphs 2, 3, and 4.

Article 20

The requirements and procedure for mining investment shall be in accordance with the prevailing laws and regulations.

CHAPTER VII

RIGHTS of IUP HOLDERS AND PUP HOLDERS

Article 21

Holders of IUP or PUP may execute all stages of mining business activities as follows:

a. General investigation;

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b. Exploration;

c. Feasibility study;

d. Construction;

e. Production operation.

Article 22

Provisions on the term period of IUP or PUP are regulated further by Government Regulation.

Article 23

(1) The size of the territory that can be possibly provided for one IUP or PUP of metal mineral shall not exceed 100,000 (one hundred) hectares at the maximum for the general investigation or exploration stage and the size of the territory that can be retained in the production operation stage shall not exceed 20,000 (twenty thousand) hectares.

(3) The size of the territory that can be possibly provided for one IUP or PUP of non metal mineral shall not exceed 25,000 (twenty five thousand) hectares at the maximum for the general investigation or exploration and the size of the territory that can be retained in the production operation stage shall not exceed 5,000 (five thousand) hectares

(4) The size of the territory that can be possibly provided one IUP or PUP of solid bitumen, peat moss, and coal mineral shall not exceed 50,000 (fifty thousand) hectares for the general investigation or exploration stage and the territory size that can be retained in the production operation stage shall not exceed 10,000 (ten thousand) hectares.

(4) The size of the territory that can be provided one IUP or PUP of geothermal shall not exceed 200,000 (two hundred thousand) hectares for the general investigation or exploration stage and the territory size that can be retained in the production operation stage shall not exceed 40,000 (forty thousand) hectares.

Article 24

Provisions concerning with the territorial size and territorial size changes at every stage of mining business for each IUP and PUP existing in the production forest territory or the protected forest territory, and revision to IUP and PUP territorial size as referred to Article 23 paragraphs (1), (2), (3), and (4), in any mining stage shall be further regulated by Government Regulation.

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Mining Cadastre. Article 23 specifies the size of IUP and PUP tenements and Article 24 stipulates that this can be further regulated by Government Regulations. However, there is no reference to recording the licenses, is noted previously, it is a matter of great importance that the kabupatans and Provinces keep accurate records (in a physical book or register as well as in computerized form) and provide the national mining data base with changes in licensing information in a timely and complete manner so that the national data base remains up to date and accurate. This will be one of the most critical challenges if a decentralized mining licensing system is to operate successfully. It is recommended that the law stipulate that Districts, Municipalities and Provinces should be obliged to provide the national government in a timely manner with information relating to all mineral licenses previously issued or in the process of being issued by them so that a linked national records index of all license transactions can be maintained in a central agency in Jakarta. Licensing Rules. Articles 23 and 24 do not specify any relinquishment requirements. IUPs and PUPs can cover very large land holdings which enable the license holders to undertake exploration activities to find mineral targets for detailed exploration and possibly subsequent mine development. In order to avoid tying up very large areas of land for very long periods of time, it is recommended that the law stipulate exploration permits granted within the IUP or PUP should be approved for a defined term with any renewals made based on approval of an advanced exploration program. There are a number of mechanisms that relate to relinquishment of land and the law should specify whether this will be by mandatory relinquishment provisions down to a certain minimum size or by licensee holding fees that progressively increase. The detailed procedures can then be included in the regulations.

It is probably better to address the issue of incentive to develop or drop a license area by the size of the land holding by way of a progressively escalating rental fee based on by increasing the rates of the rental fee up until development, the company will have the incentive to speed up the process of exploration and development. If the mandatory relinquishment approach is taken then it is suggested that the minimum size beyond which relinquishment is no longer required should be equal to the maximum size of a production license.

Article 25

(1) Holders of IUP and PUP are entitled to use any infrastructure and public facilities and use water for mining activities after meeting the applicable laws and regulations.

(2) During the execution of Production Operation mining stage activities , holders of IUP and PUP can cut and use the plants and use buildings existing on the area to be used for mining activities and the area where infrastructure facilities will be built up subject to the fulfillment of the applicable laws and regulations.

Article 26

1. Holders of IUP and holders of PUP have the right to own the minerals and their associated minerals that have been produced, provided that all dead rent and royalty from the sales price of such minerals have been paid or for PUP holders, results of coal production of Government portions have been submitted...

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Article 27

Holders of IUP and PUP may assign IUP and PUP to another party after satisfying the requirements in accordance with the prevailing laws and regulations.

CHAPTER VIII

OBLIGATIONS OF IUP HOLDERS AND PUP HOLDERS

Article 28

Holders of IUP and PUP are obliged to meet any obligations related to the following issues: application of good engineering principles, finance, environmental management, mine safety, territorial and community development around the mine site, enhancement of added value

Article 29

IUP holders and PUP holders shall guarantee the application of standards and quality in accordance with the prevailing laws and regulations and apply good engineering principles.

Article 30

(1) Holders of IUP and PUP are obliged to pay to the state taxes, non-tax state

revenues in compliance with the prevailing laws and regulations .

(2) State revenues in the form of taxes as referred to in paragraph 1 shall be :

a. Taxes;

b. Import duty and other fees on import and excise;

c. Regional taxes and regional retributions.

3. Non-tax state revenues as referred to in paragraph 1 shall be:

a. Dead rent;

b. Royalty;

c. Coal Development Fund

4. Coal PUP holders are obligated to submit results of Government portion coal production in cash which constitute Non Tax State Revenues.

5. Provisions on the procedure for the submission and use of coal products as intended in paragraph (4) shall be regulated further by Government Regulation.

6. Holders of IUP and PUP are not subject to the regional taxes and regional retributions as referred to in paragraph 2 item c and the royalty as referred to in paragraph 3 item b on the land/rocks existing on, between or around the minerals

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mined purposefully or unpurposefully during mining activities unless they are utilized.

7. Non tax state revenues as referred to in item 3 shall constitute the revenues of the Central Government and Regional Government, where the sharing is determined in accordance with the prevailing laws and regulations.

Article 31

(1) In executing mining activities, IUP and PUP holders are obliged to execute provisions on health and occupational safety, mining environmental monitoring and management including reclamation activities, conservation efforts, management of waste produced from an activity or process in the form of solids, liquid or gas as a result of mineral mining processes and processing/purification..

.

2.Reclamation of ex-mine site, mine closure and area conservation efforts shall be executed in compliance with the ex-mining area use as stipulated by the regulatory authority by involving the communities and land owners.

(2) The ex–mining area use as intended in paragraph (2) shall be stated in the Land Use Agreement between the holder of PUP or IUP with the right holder of the land in compliance with prevailing laws and regulations.

(3) The activities as intended in paragraphs (1) and (2) shall be executed in accordance with the applicable laws and regulations.

Mine Closure. Article 31(2)(2) stipulates that reclamation of the mine site will take place according to the Land Use Agreement between the PUP /IUP holders and the land holder. While this is a step in the right direction it is not sufficient. A modern mining law will specifically cover (i) “Decommissioning and Rehabilitation” which is a phase of the mining business when plant and equipment are decommissioned and removed, secured or handed over to new owners; and when mine impacted areas are stabilized and returned to the agreed final landform and land use; and (ii) “Post Closure Monitoring” which is a phase following completion of decommissioning and rehabilitation when monitoring and repair of the rehabilitated mining areas may be required. Article 62 section C refers to a mine closure plan as part of the transition requirements. It is recommended that the law stipulate that mine closure will take place according to the Mine Closure Plan (which is a plan prepared during the feasibility stage, progressively updated during the production operation phase, with the final version approved by relevant authority, that provides the basis for mine decommissioning and reclamation and post closure monitoring and supervision and that specifies the agreed final landform and land use). The law should also stipulate that the Mine Closure Plan will be consistent with the ex-mining land use set forth in the Land Use Agreement made between the IUP Holder or PUP Holder and the title holder of the land.

Article 32

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(1) The environmental management and monitoring and mining safety as regulated by Article 28 paragraph (1) shall be executed during the mine life and post-mine period in compliance with the prevailing laws and regulations.

(2) Stipulations on the requirements and procedure for the post-mine will be regulated further with Government Regulation.

Article 33

(1) Holders of IUP and holders of PUP shall deposit a Reclamation Guarantee and Mine Closure Fund to the account of the Government Bank or the Regional Government bank as financial security to execute reclamation and mine closure.

Mine Closure. Article 33 specifies that the Reclamation Guarantee and Mine Closure Fund should be deposited with a Government Bank or Regional Government Bank. Mine closure requirements can only be properly implemented if the required funds are available to implement the closure. Thus, a very important task is to address the funding of mine closure. This is usually done through a Reclamation Guarantee and Mine Closure Fund, which is a fund to cover the cost of decommissioning, reclamation and ongoing chemical treatment in accordance with the Mine Closure Plan, plus any costs for monitoring or further expenditures needed during the Post Closure Monitoring stage. Good practice would call for the reclamation funds or bond be placed with a financially sound commercial financial institution. This should not be limited to a state or regional bank (as is presently required by MOF Decree 89/KMK.04/1995) but should also include commercial banks with good financial standing. All funds deposited to the account should be tax deductible as though an operating expense. The funds should be managed subject to a trust deed to maximize the value of the fund with features such as multiple signatures required to prevent possible misuse. It is recommended that the law stipulates that provision should be made for Reclamation Guarantee and Mine Closure Fund to be placed with any financially sound commercial financial institution, not just a state or regional bank. This would also require that MOF Decree 89/KMK.04/1995 be modified.

(2) In the event that holders of IUP and PUP do not execute reclamation and mine

closure after the post mining period, the Minister, the Governor, the Regent / Mayor in accordance with their respective authority may appoint a third party to execute reclamation and mine closure activities using the guarantee fund as intended in paragraph (1)

(3) The reclamation guarantee and mine closure guarantee as referred to in paragraph (1) including the interests shall be returned to the holders of IUP and PUP after they perform the reclamation and mine closure in accordance with the applicable laws and regulations.

(4) Matters pertaining to the amount, the procedure for payment and release and reporting of the use of the guarantee fund as referred to in paragraph 1shall be further regulated by Government Regulation.

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Article 34 Holders of IUP and holders PUP executing mining activities shall prioritize the use of the local manpower, goods and services procured at home in a transparent and competitive manner.

Article 35

(1) Holders of IUP and holders PUP in the mining territory shall assist the government’s tasks in developing the region and the people around the mine site, creating employment opportunities for Indonesians, empowering the communities and developing local small and medium scale businesses conducted jointly with the Government and Regional Government and local communities.

(2) To implement the provision as intended in paragraph (1), holders of IUP and PUP shall assist the government and the regional government in their efforts to:

a. Increase the performance of the local community’s businesses;

b. Provide opportunities for local small and medium scale entrepreneurs to do supporting business activities;

c. Provide opportunities for local communities to take part in the environmental management and monitoring;

d. Develop a program-based skill training;

e. Provide health, education and training facilities for local communities;

f. Develop settlements and their supporting infrastructure and facilities;

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(3) The implementation of the stipulations of paragraphs (1) and (2) shall be adjusted with the business scale and on the basis of mutual agreement between the community and the Regional Government and holders of IUP and PUP.

(4) The implementation of stipulations as intended in paragraphs (1), (2), and (3) shall be further regulated by Government Regulation.

Article 36

The Government and the Local Government shall endeavor to create business partnerships between Holders of IUP or PUP and the community or local small and medium entrepreneurs on the basis of principles of mutual need and mutual benefit.

Article 37

(1) Business partnerships as intended in Article 36 may take the form of the following:

a. Purchasing products from people’s mining businesses;

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b. Serving as a foster parent of people’s mining businesses;

c. Providing guidance with regard to technical and managerial aspects on people’s mining businesses .

2) The implementation of the stipulation as intended in paragraph (1) shall be further - regulated by Government Regulation.

Articles 38

(1) Holders of IUP and PUP are obliged to do research and development to enhance added value as optimally as possible in the implementation of mining, processing / refinery and use of minerals

(2) Priority for the implementation of the processing / refinery as intended in paragraph (1) shall be given to areas around the mine site.

Article 39

(1) Holders of IUP and PUP shall be obliged to provide a written report on a periodical basis of the work plan and the implementation of general mining activities to the Minister, the Governor and the Regent/Mayor in accordance with their respective scope of authority

(2) Provisions on the form, type, time and procedure of the reporting as intended within paragraph (1) shall be further regulated by Government Regulation.

Licensing Rules. Article 39 specifies that IUP/PUP holders be required to provide written reports to the relevant authorities. It is recommended that the law specifies that IPU/PUP holders will be required to provide reports at all stages of activity (general survey, exploration, development, operation, closure and post closure) that address all aspects of activities including but not limited to exploration results, production, financial results, and social and environmental impacts. The frequency and content as well as the conditions of confidentiality of data and periods of such confidentiality of information should be specified in the regulations.

CHAPTER IX

USE OF LAND FOR MINING ACTIVITIES

Article 40

(1) Mining operation activities as referred to in Article 8 shall be conducted in Indonesian Mining Jurisdiction.

(2) Rights over the Mining Operation Territory shall not include rights over surface lands.

(3) Mining operation activities shall not be conducted at the following areas:

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a. graveyard, places considered holy, public places, public facilities and infrastructure, lands owned by customary communities;

b. fields and buildings of the state’s defense and areas surrounding them; c. historical buildings and state symbols; d. buildings, residence and factories along with the yard around them,

unless with a permit from the government’s institution, the community’s approval, and individual’s approval on the matter concerned; or

e. Other places forbidden for conducting business activities according to the applicable laws and regulations.

(4) Holders of IUP or holders PUP intending to carry out their activities must first

obtain a permit from the authorized institution, including in removing the buildings, public buildings, public facilities and infrastructure as referred to in paragraph (3) letter (a) and letter (b).

Article 41

(1) In the event that holders of IUP and PUP will use right lands and state lands in their Mining Operation Territory, the IUP or PUP holders in question shall first settle matters with holders of land right or users of state lands in accordance with the prevailing laws and regulations.

(2) The settlement as referred to in paragraph (1) shall be conducted amicably by way of sales, swap, reasonable compensation, recognition or such other form of compensation to holders of right or users of state lands.

Mining Cadastre. Articles 41-43 stipulate procedures for compensation and other arrangements with land holders and land users. It is recommended that the law stipulates that any agreements and permits in this regard should be registered in the cadastre in order to give them legal force and effect.

Article 42 Holders of land right are obliged to allow holders of IUP or PUP to conduct mining activities on such lands, if: a. prior to commencement of the activities, holders of IUP or PUP first show the

IUP or PUP or legal copies of them and inform of the intent and places of activities;

b. holders of IUP or PUP first settle or provide settlement guarantee approved by holders of land right or uses of state lands as referred to in Article 41.

Article 43

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(1) In the event that holders of IUP or PUP have been granted with Mining Operation Territory, the lands directly to be used for mining operation and safety areas will be granted with use rights in accordance with the applicable laws and regulations and shall be maintained properly. (2) In the event that the granting of the Mining Operation Territory as referred to in paragraph (1) includes a vast state-owned area, portions of the area not yet used for mining activities may be given to other parties by the Minister in charge of agrarian or land affairs with local communities being given the priority after receiving a recommendation from the Minister and obtaining approval from the holder of IUP or PUP.

Article 44

Provisions on the procedure of the settlement of right land or state land use as referred to in Article 41 will be further regulated by Government Regulation.

CHAPTER X

GUIDANCE AND SUPERVISION

Article 45 (1) The Responsibilities for guiding and supervising the work and implementation of

mining operation activities in regard to the compliance with the prevailing laws and regulations rest with the Minister, the Governor, the Mayor/Regent according to their scope of authority.

Non Interference. Article 45(1) gives the Minister, the Government and the Mayor/Regent authority to guide and supervise the implementation of mining activities. This use of the terms “guidance and supervision” could be perceived as a risk by the investor since it could be misconstrued by the authorities that they can intervene in the commercial affairs of the company. While this can be addressed in the regulations (as stipulated in Para 47 section 2) it is recommended that that to avoid any such uncertainty, the law stipulate instead that the Minister, Governor, Regent/Mayor pursuant to their respective authority should be responsible for “Monitoring and Oversight” of the implementation of the mining business activities and the observance of the provisions as referred to in the prevailing rules and regulations.

(2) Without prejudice to the Governor, the Regent / Mayor as intended to Article 5

and Article 6, the Governor, the Regent / Mayor are obligated to report the implementation of their general mining activities in their respective areas every 6 (six) months to the Government.

Article 46

The guidance and supervision as meant by Article 45 include as follows:

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a. exploration; b. production operations c. marketing d. finance e. processing of mineral data f. mineral conservation g. mine safety h. environmental management and reclamation i. use of domestic goods, services, technology, engineering design and design j. development of Indonesian manpower k. development of local environment and community l. mastery, development, and application of mining technology m. other activities in the fields of mining operation activities as long as they are

related to public interest n. management of minerals o. application of good engineering principles p. type and quality of mineral processing results

Article 47

Provisions concerning with the guidance and supervision as intended in Article 45 and Article 46 shall be further regulated with Government Regulation.

CHAPTER XI

TERMINATION OF IUP AND PUP

Article 48

IUP or PUP shall terminate if it :

a. Is returned;

b. Is cancelled and / or revoked ;

c. expires;

Article 49

(1) Holders of IUP may return the IUP by a written statement to the Minister, the Governor, the Regent/Mayor in accordance with their respective authority along with clear reasons.

(2) PUP holders may propose a PUP termination to the Governor, the Minister, the Regent/Mayor in accordance with their respective authority along with clear reasons.

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(3) The return of PUP or IUP as stipulated within paragraphs 1 and 2, shall be deemed legitimate after the Minister, the Governor and the Regent/Mayor issue their approval in accordance with their respective authority.

Article 50

(1) IUP may be annulled and PUP may be voided by the Minister or the Governor, the Regent/Mayor in accordance with their respective f authority if:

a. The IUP and Pup holder doesn’t meet the obligations as stipulated in the IUP and PUP;

b. The IUP or PUP holder commits any crime acts as intended in this law.

Licensing Rules. Article 50 stipulates that IUPs and PUPs may be canceled for failure to meet the obligations in the IUP/PUP. This opens the possibility that a severe penalty (license cancellation) could be imposed for a minor infringement (e.g. late submission of a report). License cancellation should occur only for serious, repeated infractions not minor offences. Even though there may be certain protections and requirements for due process in other laws, investors will be more willing to invest if they see that cancellation only applies to the most serious offences and if there is a clearly stated process of warnings and appeals included in the law. It is recommended that the law stipulate procedures and processes that ensure that minor infringements are not abused in order to justify cancellation or revocation of licenses.

c. The Government can annul IUP and void PUP for the state interest by giving compensation according to the prevailing laws and regulations.

Non Interference. Article 50(c) stipulates that licenses can be cancelled for state interest Even with a provision for compensation, the possibility of the state canceling a license for its own interest (which is essentially expropriation with compensation) represents a significant risk to the investor. It is recommended that the provision for license cancellation for state interest be excluded from the law.

Article 51

In case of the expiry of PUP and IUP, or no application of the promotion or extension of activity stages is made or if the application submitted does not meet the requirements, The IUP or PUP concerned shall be deemed to have been terminated by law.

Article 52

(1) In the event of the terminated IUP and PUP due to the reasons as intended in Articles 46, 47, and 48, the IUP and /or PUP holders shall fulfill and settle their obligations in accordance with the prevailing laws and regulations..

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(2) The obligations of the IUP and PUP holders as intended in paragraph 1 shall be deemed to have been fulfilled after the approval of the Minister, the Governor, the Regent/Mayor in accordance with their respective authority has been obtained.

CHAPTER XII

TEMPORARY DISCONTINUATION OF MINING OPERATION ACTIVITIES

Article 53

(1) Temporary discontinuation of mining operation activities may apply to any PUP or IUP holder due to force majeure and/or any condition which causes the stoppage of part or all of mining operation activities for a period of minimum 3 (three) months.

(2) The temporary discontinuation, as intended in paragraph 1, shall not reduce the expiry period of an IUP or PUP.

(3) The application of temporary discontinuation of mining activities shall be submitted to the Minister, the Governor, the Regent/Mayor in their respective authority by mentioning such force majeure or/and condition that causes any partial or full discontinuation of mining operations.

(4) The Minister, the Governor, the Regent/Mayor in their respective authority shall issue a written decision on the application as intended by paragraph (3) not later than 30 days from the application acceptance day.

(5) In the event that the temporary discontinuation of mining operations is caused by force majeure, the obligations assumed by PUP and IUP holders to Government shall no longer apply.

(6) In the event that the temporary discontinuation of mining operations is caused by the condition which prevents mining activities from operating, the obligations assumed by IUP and PUP holders to Government shall remain in force.

CHAPTER XIII

INVESTIGATION

Article 54

(1) In addition to the Police of the Republic of Indonesia, certain Civil Servants in a department circle whose scope and responsibilities of work cover mining operations shall be granted with special authority to act as an investigator as referred to in Law No. 8 of 1981 on Procedure of Criminal to conduct crime investigation in mining activities..

(2) Investigators with a status as Civil Servants as referred to in paragraph 1 are authorized to:

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a. conduct an investigation on the truth of the report or information received in relation to the crime committed in mining operation activities.

b. Conduct an investigation on any individual or body suspected to have committed crime in mining operation activities;

c. Summon people to hear their testimonies and to be investigated as witnesses or suspects in the crime committed in mining operation activities;

d. Check any places and/or facilities suspected to be used for committing crime in mining operation activities;

e. Conduct an investigation on facilities and buildings of mining operation activities and stop the use of the equipment suspected to be used to commit crime;

f. Seal and/or seize mining operation activities equipment used to commit crime as evidence;

g. Invite experts for the purposes of the investigation of the crime committed in mining operation activities;

h. Stop investigation of the crime committed in mining operation activities.

(3) Investigators with a status as Civil Servants as referred to in paragraph (1) shall notify of the commencement of the investigation of crime to the Police l of the Republic of Indonesia in accordance with the prevailing laws and regulations.

(4) The investigators as referred to in paragraph 1 shall stop the investigation in the

event that the case as referred to in paragraph 2 item a lacks evidence and/or the case is not a crime.

(5) The authority as referred to in paragraph 2 shall be executed in accordance with

the prevailing laws and regulations.

CHAPTER XIV

CRIMINAL PROVISIONS

Article 55

Holders of IUP or PUP that intentionally report untrue or false information as intended in Article 3 paragraph (1) shall be imprisoned for a maximum term of 5 (five) years and fined at a maximum amount of Rp 1,000,000,000.00 (one billion rupiah).

Article 56

(1) Anyone who does not have IUP as intended in Article 11 or PUP as intended in Article 14 or IPR as intended in Article 13 or statement letter to do research from the Government or the Regional Government as intended in Article 2 paragraph (2) conducting the General Investigation or Exploration shall be subject to a maximum imprisonment term of 1 (one) year and a maximum fine of Rp. ,200,000,000 (two hundred million rupiah).

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(2) Anyone who does not have IUP as intended in Article 11 or PUP as intended in Article 14 or IPR as intended in Article 13 or IUP or PUP for the Production Stage as intended in Article 21 item a, item b, item c and item conducting the Production Operation stage shall be subject to a maximum imprisonment term of 5 (five) years and a maximum fine of Rp. 1,000,000,000 (one billion rupiah).

Article 57

Any individual who purchases or accommodates and utilizes the minerals produced from any mining business activities that have no IUP as intended in Article 11, that have no IPR as intended in Article 13, or have no PUP as intended in Article 14 shall be subject to a maximum imprisonment term of 5 (five) years and a maximum fine of Rp. 1.000.000.000,00 (one billion rupiah).

Article 58

(1) Anyone who hinders or disrupts general investigation, exploration or feasibility study of the IUP and PUP holders that have fulfilled the requirements as set forth in articles 41 and 429 shall be imprisoned for a maximum term of 1 year or fined for a maximum amount of Rp 200,000,000.00. (two hundred million rupiah)

(2) Anyone who hinders or disrupts the construction activities or production operation of the IUP and PUP holders who have fulfilled the requirements as stipulated in Articles 418 and 429 shall be imprisoned for a maximum term of 5 years and fined for a maximum amount of Rp 1.000,000,000.00 (one billion rupiah).

Article 59

In the event that the crime as intended in this Chapter is committed by a Legal Entity, the claims and suits filed against the Legal Entity in question and/or the its Board of Management shall be the a fine with a maximum crime fine provisions plus 1/3 (one third) of the fine.

Article 60

1. The crime as intended in Article 56 paragraph (1) and Article 58 paragraph (1) shall constitute an offence.

2. The crime as intended in Article 55, Article 56 paragraph 2, Article 57 and Article 58 paragraph 2 shall constitute a crime.

Article 61

Other than the provisions as stipulated in Articles 55, Article 56 and Article 57, anyone found committing crime will be subject to additional crime charges as followed:

a. Expropriation of goods used in the crime committed;

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b. Profit expropriation as acquired as a result of the crime committed;

c. Obligation to pay any expenses arising from the crime committed;

CHAPTER XV

TRANSITIONAL PROVISIONS

Article 62

When this Law is valid:

a. The Mining Concession (KP), Contract of Work (KK), and Coal Mining Operation Work Agreement (PKP2B), Regional People’s Mining Permit (SIPD), and People’s Mining Permit (SIPR) issued based on Law Number 11 of 1967 on Basic Provisions of Mining (State Gazette of 1967 Number 22, Supplementary State Gazette Number 2831) and the implementation regulations, shall remain in effect until the expiration of the period.

Transitional Provision. Article 62 stipulates that existing licenses and agreements will remain in effect but it does not specify who has authority over those licenses and agreements. When canceling one mining law and enacting another, a transitional provision needs to be inserted to extend the authority of the initial issuing authority to manage licenses issued under the old law. This is needed to give the MoEMR authority to manage the ongoing COW’s until their expiry or surrender. It is recommended that the law should include a transitional provision which will extend the authority of the initial issuing authority to manage licenses issued under the old law. This would be consistent with PP 75 of 2001 but would imply a change to Ministerial Decree 1453 of 2000. Transitional provisions should also cover the issue of the transformation of local coordinates on locally issued licenses to the national coordinate system or in the chapter on cadastre. It is recommended that the law include transitional provisions to transform local coordinates on any locally issued licenses to the national coordinate system. In order to promote standardization of mineral licensing and also to help encourage the development of land presently held but not being actively explored or mined under existing COWs, a transitional provision should also be included whereby the holder of an existing COW can elect to convert (i) the whole of an existing COW or (ii) any undeveloped parts of the COW to a PUP. In cases where COWs are suspended or exploration is being held up because the COW holders face unattractive conditions or uncertain situation, promising land is not being explored. This is to the detriment of the country. If transition to a PUP will resolve the unattractive conditions or remove the uncertainty, then it is better to transfer to a PUP so that work will be started rather than to leave the status quo in which the COW holder is entitled not to undertake any exploration activities. The transfer to a PUP would thus be a “win win” action since it is in both the national interest and the license holder’s interest. But this option should be granted only to those portions of COW’s which are not the subject of an existing production permit. Existing production operations should be required to retain their existing provisions and tax rates. It is recommended that the law include a transitional provision that stipulate that the holder of an existing COW can elect to convert the COW or any undeveloped areas in an existing COW to a PUP.

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There are presently a number of unprocessed COW applications. Transition provisions will need to specifically address how these applications will be treated. Since COWs will not be available under the new law, one approach would be to give the COW applicants first right to an IUP for the area which was covered by the COW application. It is recommended that the law include transition provisions to specifically address how these existing applications for COWs will be treated.

b. The Contract Agreement on Geothermal Operations signed prior to the enforcement of this law shall remain in effect until the expiration of the period.

c. The Mine Closure Plan submitted by holders of the Mining Concession, Contract of Work, and Coal Mining Operation Work Agreement, Regional People’s Mining Permit, and People’s Mining Permit issued based on Law Number 11 of 1967 on Basic Provisions of Mining (State Gazette of 1967 Number 22, Supplementary State Gazette Number 2831) and the implementation regulations, shall be adjusted with the provisions of this law in 2 (two) years time prior to the performance of the mine closure approved by the Minister, the Governor, the Regent / the Mayor according to their respective authorities..

CHAPTER XVI

CLOSING PROVISIONS

Article 63

(1) As a result of the enactment of this Law, Law No. 11 of 1967 regarding the Basic Mining Provisions (State Gazette of 1967 Number 22, Supplementary to State Gazette Number 2831) shall be declared null and void.

(2) All implementation regulations originating from Law Number 11 of 1967 regarding Basic Mining Provisions (State Gazette of 1967 Number 22, Supplementary to State Gazette Number 2831) and other provisions shall remain in effect insofar as they have not been contradictory or amended under this law.

Article 64

This Law shall take effect on the date of legislation. To ensure that everyone is aware to this Law, it is hereby instructed that this Law be legislated by placing it in the State Gazette of the Republic of Indonesia.

Enacted in Jakarta On the date of……………

PRESIDENT OF THE REPUBLIC OF INDONESIAN,

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MEGAWATI SOEKARNOPUTRI Legislated in Jakarta

On………………………

SECRETARY OF STATE (……………………………)

STATE GAZETTE OF THE REPUBLIC OF INDONESIA, YEAR……… NO……

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Annex B

More Detailed Comments on the Mining Cadastre

A. Titles Administration and National Mining Cadastre (License Database).

1. Licensing Information The Mining Cadastre is the national Register which records all matters related to each exploration and mining tenement granted within Indonesia, including ownership, transfers, encumbrances, joint ventures, etc. It also registers any other agreement relating to the tenement including approvals from relevant authorities and land use or compensation agreements. Indonesia presently has one of the best mining cadastres and national mining data bases. But, decentralization now places the responsibility for licensing to more than 90 and possibly as many as 300 Kabupatens and Provinces, only a minority of which will have reliable databases or good security of licenses. For new investment to be mobilized, new investors will need (i) timely and accurate access to mineral data and licensing information regarding which areas are already licensed and which are available for license application and also (ii) an ability to overlay other land uses with the mineral licensing and geological information.

2. Further Elaboration Needed. The new law should have a full elaboration of the mining cadastre and should specify that it will be decentralized, but coordinated centrally, including reference to the nature and legal status of the register of mineral licenses. The cadastre should be a nationally standardized system of management and the register should be centrally coordinated and maintained. The new law should stipulate that the register is a physical book that spells out the criteria for grant of a license (IUP) or agreement (PUP) as well as the application and approvals process and who has the authority to issue and sign licenses or agreements on behalf of the State. The register should be a physical book or register which records all matters related to each tenement granted within Indonesia, including ownership, transfers, encumbrances, joint ventures, etc and also registers any other agreement relating to the tenement including approvals from relevant authorities and land use or compensation agreements to give them legal force and effect. The register should be open to the public for title searches. The cadastre should also outline an appeal process in the event that an application is declined, revoked or cancelled. 3. Preferred Approach The successful establishment of a decentralized mining cadastre is absolutely critical to the successful implementation of any modern mining law. The preferred approach would be to have a separate Chapter of the new law. This chapter should establish the principles upon which the applications process will be based (i.e. first come - first served) as well as all processes associated with the licensing process. This chapter should also identify who is the authority to hold and manage the cadastre (register) – if it is the same authority that grants the license or a separate one - and the law should state that the register is the final arbiter in any dispute and that no agreement or document has any legally binding force or effect unless entered on the register. With this background, it is recommended that

• The national government should maintain and coordinate a decentralized national mining cadastre, which is open to the public and which registers all agreements

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relating to the license. There must be an official mining cadastre Register Book and Map Index maintained in every established regional mineral licensing registration office- which is open to the public and which records all transactions relating to mining licenses.

4. National Mining Data Base It is thus a matter of great importance that the kabupatens and Provinces keep accurate records (in a physical book or register as well as in computerized form) and provide the national mining database with changes in licensing information in a timely and complete manner so that the national data base is can remain up to date and accurate. This will be one of the most critical challenges if decentralized mining licensing system is to operate successfully. It is recommended that

• Districts, Municipalities and Provinces should be obliged to provide the national government in a timely manner with information relating to all mineral licenses previously issued or in the process of being issued by them so that a linked national records index of all license transactions can be maintained in a central location.

B. Mine closure regulations including mine closure plan and post closure monitoring 5. Coverage A modern mining law will specifically cover (i) “Decommissioning and Rehabilitation” which is a phase of the mining business when plant and equipment are decommissioned and removed, secured or handed over to new owners; and when mine impacted areas are stabilized and returned to the agreed final landform and land use; and (ii) “Post Closure Monitoring” which is a phase following completion of decommissioning and rehabilitation when monitoring and repair of the rehabilitated mining areas may be required.

6. New Instruments. The decommissioning and rehabilitation should take place according to a Mine Closure Plan. This is a plan which should initially be prepared during the feasibility stage, progressively updated during the production operation phase, with the final version approved by relevant authority, that provides the basis for that provides the basis for mine decommissioning and reclamation and post closure monitoring and supervision and that specifies the agreed final landform and land use. While this can be included in the regulations, it would have stronger force if the definition and the instrument are included in the new law itself. The law should also include provision for Land Use Agreement (which is an agreement made between the IUP or PUP holder and the title holder regarding the reclamation of ex-mining land); and a Reclamation Guarantee Fund (which is a fund to cover the cost of decommissioning, reclamation and ongoing chemical treatment in accordance with the Mine Closure Plan), plus any costs for monitoring or further expenditures needed during the Post Closure Monitoring stage. It is recommended that

• The law should stipulate the preparation and use of a Mine Closure Plan.

7. Mine Closure funding Mine closure requirements can only be properly implemented if the required funds are available to implement the closure. Thus, a very important task is to address the funding of mine closure. This is usually done through a Reclamation Guarantee Fund, which is a fund to cover the cost of decommissioning, reclamation and ongoing chemical treatment in accordance with the Mine Closure Plan, plus any costs for monitoring or further expenditures needed during the Post Closure Monitoring stage. Good practice would call for the reclamation bond be placed with a financially sound

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commercial financial institution. This should not be limited to a state or regional bank (as is presently required by MOF Decree 89/KMK.04/1995) but should also include commercial banks with good financial standing. All funds deposited to the account should be tax deductible as though an operating expense. The funds should be managed subject to a trust deed to maximize the value of the fund with features such as multiple signatures required to prevent possible misuse. It is recommended that

• Provision should be made for Reclamation Funds to be placed with any financially sound commercial financial institution, not just a state or regional bank. (This would also require that MOF Decree 89/KMK.04/1995 be modified accordingly).

C. Transition Provisions. 8. Carryover of Authority When canceling one mining law and enacting another, a transitional provision needs to be inserted to extend the authority of the initial issuing authority to manage licenses issued under the old law. This is needed to give the MoEMR authority to manage the ongoing COW’s until their expiry or surrender. Thus, the new law should include a transitional provision which will extend the authority of the initial issuing authority to manage licenses issued under the old law. This would be consistent with PP 75 of 2001 but would imply a change to Ministerial Decree 1453 of 2000. Transitional provisions should also cover the issue of the transformation of local coordinates on locally issued licenses to the national coordinate system or in the chapter on cadastre. It is recommended that

• Transitional provisions need to be stipulated to extend the authority of the initial issuing authority to manage licenses issued under the old law and to transform local coordinates on locally issued licenses to the national coordinate system.

9. Approach to Existing COWs In order to promote standardization of mineral licensing and also to help encourage the development of land presently held but not being actively explored or mined under existing COWs, a transitional provision should also be included whereby the holder of an existing COW can elect to convert (i) the whole of an existing COW or (ii) any undeveloped parts of the COW to a PUP. In cases where COWs are suspended or exploration is being held up because the COW holders face unattractive conditions or uncertain situation, promising land is not being explored. This is to the detriment of the country. If transition to a PUP will resolve the unattractive conditions or remove the uncertainty, then it is better to transfer to a PUP so that work will be started rather than to leave the status quo in which the COW holder is entitled not to do anything. The transfer to a PUP would thus be a “win win” action since it is in both the national interest and the license holder’s interest. But this option should be granted only to those portions of COW’s which are not the subject of an existing mining operation license. Existing operations should be required to retain their existing provisions and tax rates. It is recommended that

• A transitional provision should also be included for the holder of an existing COW to elect to convert the COW or any undeveloped areas in an existing COW to a PUP.

10. Unprocessed COW Applications. There are presently a number of unprocessed COW applications. Transition provisions will need to specifically address how these applications will be treated. Since COWs will not be available under the new law, one

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approach would be to give the COW applicants first right to an IUP for the area which was covered by the COW application. it is recommended that

• Transition provisions be included to specifically address how these existing applications for COWs will be treated.

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Annex C

Some Detailed Comments on the Enabling Regulations

1. At the same time as finalizing the law, it will be important to move quickly to prepare the associated Government Regulations and in particular the Government Regulations relating to (i) the Standardization of mining licensing system, (ii) the function and content of the PUP. To the extent possible, implementation of the law should be through Government Regulations rather than Ministerial Decrees (as the latter are more at risk for rapid cancellation and amendment). Until national regulations and standards are in place for issuing IUPs and IPRs, there is a risk that provincial and local governments will prepare perdas that lack uniformity and which will then prove an impediment rather than a positive step towards attracting new investment in mining. 2. Smallholder Mining License (IPR). There is a need to clearly spell out in the law and the regulations full details of the rights, obligations and termination /cancellation of the IPR and should provide for it to be transferable, convertible to an IUP and subject to termination for due cause. The use of both the IUP and the IPR creates the potential problem of overlapping licenses. In the event consideration is being given to granting an IPR over land the subject of an existing IUP or PUP, then the IPR with the prior consent of the IUP/PUP holder. Where an IPR exists prior to an IUP then the same should apply, that the area of the pre-existing IPR can only be included in the IUP or PUP with the prior consent of the pre-existing IPR holder. Good practice would give the IUP holder firm title and would not allow a Regent/Mayor to grant an IPR directly over the discovery zone of an ore deposit in an existing IUP or PUP license creating substantial conflict. 3. Mining Business Agreement (PUP) The key elements of the PUP need to be elaborated in the regulations (including the form of the agreement and procedures for signing the PUP collective approval, tax stabilization and international dispute resolution). The regulations should also specify community-related aspects if desired. This is an important matter and urgent attention should be given to the formulation of this regulation in order to give effect to this article, since (with the exception of existing COWs) the future of investment in the sector will to a large degree hinge on the nature and provisions of this agreement. 4. Traditional Small-holder Mining The regulations should clearly stipulate that traditional small-holder mining can only be legitimately carried out by registered small-holder miners and be by non-mechanized means. The traditional miners should be registered and issued with identification cards (or authorizations) specifying the location of their workings to avoid any conflict with IUPs or confusion over the rights of small-holder traditional miners. The Regent/Mayor should be required to develop a map, which identifies the areas of traditional mining and advise applicants for IUP/PUP of the existence of any such areas. This measure is also needed to assist in combating illegal mining activity.

5. License Area Relinquishment. It is probably better to address the issue of incentive to develop or drop a license area by means which will not result in conflict between the investor and the State. This could be by way of a progressively escalating rental fee (or Permanent Contribution). By increasing the rates of the Permanent Contribution up until development the company will have the incentive to speed up the process of exploration and

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development. Any exploration permits granted within the IUP should be approved for a defined term with any renewals made based on approval of an advanced exploration program. There are a number of mechanisms that relate to relinquishment of land and the regulations should specify whether this will be by (i) have mandatory relinquishment provisions down to a certain minimum size beyond which no further relinquishment is required, or both. It is suggested that if the mandatory relinquishment approach is taken then the minimum size beyond which relinquishment is no longer required should be equal to the maximum size of a production license. Any exploration permits granted within the IUP should be approved for a defined term with any renewals made based on approval of an advanced exploration program. It is probably better to address the issue of incentive to develop or drop a license area by other means which will not result in conflict between the investor and the State. (ii) Having a fiscal incentive to relinquish either by progressively increasing expenditure requirements or by increasing Permanent Contribution,

6. Land Reclamation. The regulations should stipulate that that the ex-mining land designation shall be consistent with the mine closure plan and shall be set forth in the land use agreement made between the IUP Holder or PUP Holder and the title holder of the land, pursuant to the provisions as referred to in the prevailing rules and regulations. Also the obligations of the license holder during the post closure monitoring phase need to be stipulated

7. Reporting Requirements. The reporting requirements of license holders needs substantial elaboration in terms of both content and periods for submission. During the general survey and exploration phase technical reports should be submitted annually including all technical data in raw form as well as interpretation of results. These should be in both hard copy and digital form in order to facilitate direct entry into the national mineral occurrence database. Reports of production should also specify the quantities mined as well as grades, recoveries and net mineral production as well as sales values, in order to facilitate audit of payments of royalties etc. Reports should also be submitted for all areas relinquished from IUP’s or PUP’s in order for the data to be made immediately available for new investors. The conditions of confidentiality of data and periods of such confidentiality of information should also be included in the regulations. Also, there has been a very active dialogue over the past two years between DGGMR and the mining industry regarding mine closure and the preparation of draft Mine Closure Regulations is well advanced. Given the impending closure of the Kelian gold mine in Kalimantan, as well as other smaller mines elsewhere, it is very important that the process be brought to completion and the draft Mine Closure Regulations be finalized and issued in the near future – if necessary even under Law 11/1967 initially and then transferred to the new law once it is enacted.

8. Registration of Agreements. All such agreements and permits should be registered on the cadastre in order to give them legal force and effect

9 Examples of articles where regulations are needed.

Licensing rules and National mining licensing cadastre

Dispute resolution between the Kabupaten and Provincial levels

Details of five groups of minerals

Requirements and Procedures for Issuing IUPs

Exploration on first come first served basis

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Mining operations at water sources

Stipulate Public Mining areas (Regional/Local Regulations)

Conditions for Small Holding Mining License (Regional/Local)

Requirements and Procedures for Issuing PUP

Traditional small-holder mining

Term of IUP and PUP

Land Area of IUP and PUP and Relinquishment of Land

Use of Infrastructure, Water and Public Facilities

Assignment of IUP and PUP

Application of standards and quality and good engineering practice

Payment of taxes and state non-tax charges

submission and use of coal products

Requirements and procedures regarding the post-mining period

Reclamation Fund and Guarantee

Local and Regional Economic Development

Business partnerships

Reporting Requirements

Areas where Mining is Prohibited

Compensation to holders of rights regarding state lands

Use of State Land

Guidance and Supervision by State Authorities

Annulment of IUP and PUP with compensation

Termination of IUP and PUP

Investigation of Crimes

Mine Closure regulations 19. It is recommended that the following improvements be made to some of the more important regulations which relate to:

National Regulations and Standards. National Regulations and uniform national standards regarding criteria and procedures for granting licenses; land access agreements and compensation; relinquishment rules; reporting requirements; and

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reclamation fund requirements, dispute resolution etc. should be prepared in advance and put in place as a matter of priority following enactment of the law.

• Smallholding Mining License (IPR). An IPR should not be granted over land in an IUP or PUP. The IPR should be transferable, convertible into an IUP and subject to termination/cancellation provisions.

• Mining Business Agreement (PUP). The key elements of the PUP need to be elaborated in the regulations (including collective approval, tax stabilization and international dispute resolution.

• Traditional Small-holding Mining Activities. Traditional small-holding mining should only be legitimately carried out by registered small-holder miners and be by non- mechanized means. The traditional miners should be registered and issued with identification cards (or authorizations) specifying the location of their workings to avoid any conflict with IPRs, IUPs and PUPs.

• Relinquishment of Parts of License Areas. Any exploration licenses granted within the IUP or PUP should be approved for a defined term with any renewals made based on approval of an advanced exploration program. There are a number of mechanisms that relate to relinquishment of land and the regulations should specify whether this will be by mandatory relinquishment provisions down to a certain minimum size or by licensee holding fees that progressively increase.

• Mine Closure and Reclamation The obligations of the license holder during the closure and post closure phases needs to be more fully elaborated. The ex-mining land designation should be consistent with the mine closure plan and set forth in the Land Use Agreement made between the IUP Holder or PUP Holder and the title holder of the land, pursuant to the provisions as referred to in the prevailing rules and regulations stipulated.

• Reporting Requirements The reporting requirements of license holders needs substantial elaboration in terms of content, periods for submission and public release of data.

• License cancellation License cancellation should occur only for serious, repeated infractions not minor offences and the regulations should provide procedures and processes in order to ensure that minor infringements are not abused in order to justify cancellation or revocation of licenses.

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`Annex D

More Detailed Comments on Mining Fiscal Regime

A Introduction

1. Main Differences between the 7th generation COW and the Prevailing Mining Tax Regime. If Indonesia desires to attract new mining investment using IUPs and PUPs, it will need to consider revising the prevailing fiscal approach to mining to make it more competitive with the tax systems in other nations. The main differences between prevailing regime and the 7th generation COW largely relate to one of the state non-tax charges, namely

• higher level of production contribution (also called a “royalty”);

and to two items which are taxes namely

• provincial and local taxes.

• VAT treatment of gold, silver and coal (which differs from base metals)

B Production Contribution (Mining Royalty)

2. Mining Royalties compared with Profits based taxes. Governments often like to impose a combination of profit-based taxes with other taxes that are not based on profits but based instead on volume of production or value of inputs or outputs (turnover). The Production Contribution is such a tax. These taxes are generally referred to as Royalty type taxes. Royalty type taxes have the benefit that they are typically easier to measure and collect than profit based taxes. They are also more stable than profits based taxes and provide a certain level of payments when a mine does not produce a profit (although royalties rise and fall with changes in production volumes and/or commodity prices and thus are not as stable as say license fees and property taxes).

3. Royalties are Regressive. But royalty type taxes are very regressive – the ratio of tax paid to profitability rises as profitability falls. This is problematic, especially for companies in the mining industry, which is a highly cyclical industry due to the volatility of commodity prices. First, companies in any sector, including mining, prefer taxes based on profits rather than taxes charged irrespective of the taxpayer's profit or loss because in this way the tax collector shares in both the upside and down side of mining activities. The need to pay taxes during commodity price slumps when many mines will only break even or make losses, makes a difficult situation even worse for the company and creates a disincentive for new mining investment. Second, the impact of royalties effectively raises the production costs for a given ore body. The result of this is to reduce the size of the deposit that is economically recoverable, which in the case of high royalties (3-4% or more) can even result in turning a marginally viable ore deposit into a non-viable deposit.

4. International Trend To Reduced Royalties. Over the past century, there has been a general trend to de-emphasize tax systems based on royalties and to instead implement systems that rely on tax mechanisms that are based on “ability to pay”, i.e., profit-based

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taxes. This reflects two factors. First, is recognition to the disincentive that royalty type taxes create for new investment, Second, is the improved capability of Governments to more carefully monitor the financial recoding keeping of companies to ensure that income statements and tax filings represent a true picture of the company’s business and prevent profits (and hence taxes) from being underestimated. In fact, some important mining nations, for example Chile, Mexico, South Africa and most states and provinces in the United States and Canada respectively, do not impose mineral royalties entirely, while other jurisdictions have reduced their importance.

5. Royalties in Indonesia. By comparison with other jurisdictions, the present Indonesian mining fiscal regime in Indonesia includes a royalty type tax which presently averages about 4% for non-fuel minerals significantly exceeding the rates set by most other mining nations. This places Indonesia at a serious competitive advantage to other nations seeking to attract new mining investment. In addition, the rate is variable depending on the mineral type in Indonesia. This complicates tax administration and causes compliance challenges. Many minerals are produced for sale in a multi-metal product. For example, mined gold is often sold in a dore form that contains silver, copper and nickel concentrates often contain zinc and lead.

6. Proposed Approach. In order to bring Indonesia more in line with other countries, it is recommended to reduce but not eliminate royalties completely. In the sharing of risk and reward, the use of a modest level of royalties can ensure an up-front revenue stream to government even if a project turns out not to be profitable for income tax purposes. This is consistent with the view generally held in the economic literature that a royalty can be considered as a factor payment on the extraction of a non-renewable resource owned by the state. Thus, a modest level of royalties – equivalent to say 1-2% of turnover, is considered warranted to ensure that each mine makes a minimum annual payment. Also, the use of a common rate for all minerals would help ease tax calculation and administration substantially since the same rate would be applied to all metals which means the multi-metal situation does not become a problem. Thus, in order to improve the situation, it is recommended to:

• Reduce the rates for production contribution (royalty) from the present average of 4% to a uniform rate of 2% regardless of mineral type

C. VAT Treatment of Different Minerals

7. Value Added Tax. This type of tax, called a goods and services tax in some jurisdictions, is becoming more common worldwide. In nations where such a tax is in use, it is commonly applied to most purchases, both in terms of capital goods as well as services. Because it is a “consumer” tax and export minerals must compete globally, almost all mineral exporting nations (see Table 1 following) have chosen to eliminate the impact of the tax in one way or another on both export mineral sales and imported equipment used to produce the exports. The means to achieve this involve varying degrees of complexity and government administration. The simplest form of negation for qualifying exports is to zero rate for VAT purposes all mining inputs and outputs. More complex schemes involve rebates, crediting, refunds, deferrals, and a host of other mechanisms. While many nations negate the effect of VAT on exported products, the normal practice is to apply VAT to mining products that serve domestic markets.

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8. Gold and Coal Treated Differently From Other Minerals. Indonesia levies a VAT on goods and services purchased. When the VAT system was introduced (Law 8/1983), all minerals were included, with exported minerals typically being zero rated with the result that production-related VAT payments were refunded following sale and export of the mineral. However, the situation was changed (by Law 18/2000 Article 4 A Section 2 (d)) when coal, gold and silver were changed to VAT tax exempt status. The exact rationale for this change is not known for certain, but local tax experts described it as being for revenue raising purposes rather than for tax administration purposes. The implementation of the VAT is reported not to take place on a consistent basis with some COWs being changed to tax exempt and others remaining VAT applicable. The effects of becoming VAT exempt is quite significant for non COW mining operations and for those COWs (which are not subject to tax stabilization through the COW). The effect of this change is to increase production costs (because VAT payments are no longer refunded) and thereby reduce the rate of return for a given project. Good fiscal practice is to treat all minerals alike and include them in the VAT tax scheme as zero rated for exports.

9. Disincentive for Foreign Investment in Gold and Coal Mining. The imposition of non-refundable VAT for commodities such as gold bars, silver granules and coal is a major investment disincentive for mines producing those commodities and for new IUPs or PUPs . Mines are highly capital intensive and non-refundable VAT acts to raise costs. Because of this capital intensity, the imposition of non-refundable VAT is highly likely to be a barrier to the development of new ore bodies. If VAT on any mineral exported is made exempt, this is a very major disincentive to investors and it is highly likely that all exploration for that mineral will be significantly curtailed. It is strongly recommended that all mineral sales be zero-rated for VAT purposes. In order to remove this disincentive, it is recommended:

• to include coal and gold dore and silver dore, (but not retail gold and silver bars), within the VAT system and zero rate them when exported (which would involve modifying Law 18/2000).

10. Administrative Issues – Applying VAT. Since other minerals are zero rated for VAT, there is no reason to consider that the zero rating of coal and primary gold and silver (usually in the form of dore) produced at mine sites would create any major administrative difficulties. However, it is important to draw a distinction between primary gold and silver production and retail sales of small retail gold and silver bars and gold and silver jewelry. Zero rating should be provided for mining companies with primary gold and silver

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Table 1: VAT on Imported Goods and Services in Selected Jurisdictions

Country

VAT on goods and services paid for by a mineral

enterprise

Mechanism* to negate Or offset VAT on goods and services if mine production is exported

Argentina Yes yes

Bolivia Yes yes

Burkina Faso Yes yes

Canada Yes yes

Chile Yes yes

China Exempt -

Ghana exempt -

Indonesia yes depends on commodity

Ivory Coast yes none

Kazakhstan yes yes

México yes yes

P.N.G. yes yes

Peru yes yes

Poland yes yes

South Africa yes yes

Sweden yes yes

Tanzania exempt -

Uzbekistan exempt

W. Australia yes yes

*credits, refunds, exemptions, drawback or deferral available to at least some types of mines for at least some types of purchases

Source: derived from Global Mining Taxation Comparative Study, 2nd edition 2000

production. But, there would be major administrative difficulties if the VAT authorities were to attempt to make VAT applicable to retail transactions. This would involve many hundreds, even thousands, of outlets and would likely be both administratively unmanageable and disruptive. 11. Administrative Issues – VAT Refunds. The reliability of tax administration is an important issue especially for projects involving large investments It is important for

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overall investor confidence that agreements be fully honored, refunds provided in a timely manner and all CoWs be treated in a fully consistent manner. D. District and Provincial Government Taxes

12. District and Provincial Government Taxes According to Law 25/1999, district and provincial governments are allowed to levy taxes and state non-tax fees. These include a range of taxes and fees now paid by the mining industry. For the most part, these taxes are clearly defined and rates of payments are capped in some way. But in some cases, problems have arisen regarding implementation because local officials are interpreting vague wording to increase the size of the taxable base, sometimes well beyond the original intent of the law and the implementing regulations (Regulations 65 and 66/2001).

13. Taxable Base Expanded Beyond Original Intent. The tax base on which they are assessed. This arises mainly where local officials are interpreting vague wording to increase the size of the taxable base, sometimes well beyond the intent of the regulation. This has and is resulting in legal cases brought by taxpayers to the appropriate courts which have typically ruled in favor of the investor. In particular, difficulties have arisen for some mines with regard to: street lighting tax, tax on mining of category C minerals, and the tax on the exploitation and utilization of underground water and surface water.

14. Taxes Imposed Outside Scope of Authority. Another and even more substantial problem is the growing tendency of district and provincial governments to introduce taxes, fees and levies that are outside the scope of their authority. The Ministry of Home Affairs (MoHA) is responsible for supervising the activities of local and provincial governments (Law 22/2000, Article 114). While it is important that districts and provinces are adequately funded, it is also important that taxes be within the criteria specified in the law.

15. A possible way forward would be to revise law 34/2000, giving regional governments a closed, but possibly expanded list of taxes. This would be in accordance with the provisions of Law 8/1986 and should help resolve any uncertainty about which taxes are valid – while, at the same time, providing adequate taxing authority at the local and regional levels. If the list is to be expanded, it will be important to stay in line with the types of taxes included in Ordinance 65 and 66 of Year 2001 and exclude turnover and asset based taxes, since these could become excessively burdensome for industries with very large turnovers such as mining, oil and gas. Equally, if not more importantly, there are many levies and fees that are perhaps more damaging to investment than taxes. Most of these are quasi-taxes, but there seems to be little oversight. Because of this Law 20/1997 would need similar adjustment to that proposed for Law 34/2000. In order to address this situation, it is recommended to:

modify Law 34/2000 to establish a closed (but expanded) list of district and provincial taxes and state non-tax fees and levies (which specifically excludes turnover-related) taxes.

16. Impact on Tax Payments. An important potential issue is the possible impact of the proposed changes on the tax payments to individual provinces and municipalities. For example, the allocation of mining royalty payments provided for in the “Fiscal Decentralization Laws” is 32% to the producing region; 32% to other regions in the same province as the producing region; 20% to the state; and 16% to the Province where production takes place. Thus, a reduction in the average royalty from 4% to 2% could have

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potentially important implications for sub-national revenues. This would need to be examined once specific proposals were on the table. Given that most mines operate under COWs the impact of the proposed tax changes would likely be fairly modest at least until such time as any large new operations start up using IUPs and PUPs. However, if there were to be any significant impacts at the sub national level, these would likely need to be addressed in order to avoid potential opposition to the proposed changes.

E. Tax Predictability and Tax Stabilization Mechanisms

17. Importance of Predictable Tax Regime. The predictability of the fiscal regime is an important component in the investment decision. Investors are concerned that the tax regime be predictable in order to estimate the return on investment. Lenders are also concerned about tax predictability during the period when debt is being repaid. Thus, a high degree of tax predictability can be viewed as an investment incentive. Indeed, in investor surveys, many investors indicate that they see a stable tax regime with reasonable rates as preferable to a “low” tax regime that could be changed without notice.

18. Tax Stabilization included in COW. Indonesia was one of the first countries to provide tax stabilization – through the Contract of Work, which stabilizes taxes for the life of the contract. More recently, the new Indonesian Petroleum law also embodies some fiscal stabilization features. A Tax Stabilization arrangement has also been available in Chile for many years. More recently tax stabilization provisions for mining operations have been adopted by a number of countries shown in Table 2 following. Further details for three countries (Mauritania, Madagascar and Mozambique ) who introduced mining sector tax stabilization provisions under World Bank financed Technical assistance projects are given in Annex D.

19. Tax Stabilization Can Help Lower Financing Costs. Large initial capital investments require substantial debt financing. Financial institutions will require higher cover ratios where fiscal terms are not fixed in order to reduce the risk of debt service default in the event that governments attempt to impose higher taxes once the project starts production, but before the debt has been repaid. This may compromise the projects capacity to service its debt. This may in some cases limit the capacity of developers to finance project debt. In addition the potentially lower level of risk associated with the project due to the fixed fiscal terms can also result in more attractive interest rates and lower cost political risk insurance. This ultimately makes the project more profitable and which, in turn, results in higher tax collections to the government.

20. Tax Stabilization Can Help Improve Investor Confidence. Investors like to be assured that when they make large capital investments that they are assured of the returns that induced them to make the investment in the first place. While taxes that apply across the economy as a whole tend to be reasonably stable and even declining as is the case of income tax in Indonesia over time, investors are often concerned that changes in state non tax charges such as royalties that are specific to the sector can mean that the goal posts move for the investors during the game. Fiscal stabilization can thus be considered a risk mitigation measure for investment promotion. Investors will consider the risk profile of a jurisdiction which offers fiscal stabilization as generally lower than those that do not.

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21. A Range of Possible Options. For the future, there are several different options for the structuring of fiscal stabilization and the following presents some of the options which may be considered for implementation as part of the proposed PUP.

• Life of project fixed fiscal terms, negotiated rates. The concept introduced in Indonesia for the Contract of Work under Law number 11 of 1967 was one of “cradle to grave” stabilization of fiscal terms by the inclusion of all fiscal terms into a legally binding contract between the developer and the government. This had the effect of locking in negotiated fiscal arrangements, including the types fiscal measures and rates to be applied, for the term of the contract.

• Fixed fiscal terms for fixed periods, negotiated rates. A variation of the above is to provide fixed fiscal terms for a fixed period of time in order to give the investor confidence in his ability to meet debt servicing requirements, especially during the payback period of the project. These rates may be negotiated and included in the project agreement.

• Fixed fiscal terms for fixed periods, prevailing rates. Another variation of the above is to provide fixed fiscal terms for a fixed period of time in order to give the investor confidence in his ability to meet debt servicing requirements, especially during the payback period of the project. These rates are fixed at the rates prevailing at the time the investment decision is made by inclusion of the rates in a schedule attached to the project

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Table2: Availability of Tax Stabilization in Selected Jurisdictions Country

Some Form Description of tax stabilization available?

Argentina Yes 30 yrs, provincial & municipal taxes, import duties, foreign exchange rules.

Burkina Faso Yes During the term of the contract; except mining taxes and fees

Chile (42%) Yes 10 yrs, if mine elects a higher income tax rate Indonesia Yes COW – most taxes stabilized for life of mining

agreement; without COW, taxes are not stabilized. Kazakhstan Yes Taxes stabilized for life of mining agreement. Madagascar Yes Taxes stabilized for life of mining license. Mozambique Yes Taxes stabilized for 15 years from start of

exploration or 10 years from granting of mining title. Mauritania Yes Taxes stabilized for life of mining license. Peru Yes Two optional systems of tax stabilization: mining

contracts (10-15 yrs tax stabilization), and 10 yrs Legal Stability Agreements that fix the income tax regime and certain other fiscal imposts; 2% additional rate income tax is applied.

Uzbekistan Yes Most major taxes may be frozen for 10 yrs from date of establishment; tax experts warn that there may be difficulties with the practical implementation.

Source: J. Otto, J. Cordes and M. Batarseh, Global Mining Taxation Comparative Study, second edition, IGRPM Colorado School of Mines, March 2000; World Bank Reports.

• Fixed fiscal terms at a premium to prevailing rates. In some nations, such as Chile and Peru, stabilization is available but carries an additional stabilization premium (for example, in Peru, the normal income tax rate is increased). A further variation of the above is the Chilean model which is to provide fixed fiscal terms for either the project life or a fixed period of time at rates which are fixed at a premium to the rates prevailing at the time the investment decision is made. This provides the investor with the choice of paying higher rates in return for guaranteed fiscal terms, or accepting the risk of variable terms. This can be viewed in a similar manner to the investor paying political risk insurance on his debt, where he pays a higher interest rate in return for a transfer of the political portion of project risk to the bank. In the Chilean model, at the time of project approval, the investor elects either (i) to accept the prevailing tax rates, or (ii) to use the fixed rates option. The investor is also allowed to change the selection one time during the project life.

22. Multiplicity of Tax Regimes. If taxes are stabilized for various mines at prevailing rates at different points in time, then an administrative challenge can arise over time. As the underlying tax laws change, each stabilized mine will have a tax regime dating to the time the stabilization arrangement was entered into. This means that over time there will be many tax regimes, and the government agency charged with tax administration will increasingly face a more complicated situation monitoring and enforcing each. This entails costs. At the present time in Indonesia, there are many COWS with stabilization arrangements containing

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many different tax regimes. Thus, the COW approach has enhanced the potential for mineral sector investment, but has also complicated the tax system and raised administrative challenges.

23. An effective way forward is, at minimum, to offer stabilization to the holder of a PUP for royalties and other state non-tax charges and levies for a period of ten years from the commencement of production. This would help provide a stable fiscal environment throughout the repayment period of any loans and, thereby, help to reduce the risk that tax increases could compromise the ability of a project to service its debt. This would also assist the developer to finance the project and may well help reduce the risk profile thereby resulting in lower debt financing charges, and lower political risk insurance premiums. As a result of stabilization, the profitability could be greater due to lower deductible financing costs, leading to higher tax payments and benefits to the State. It is recommended that:

a tax stabilization provision covering royalties and other state non- tax charges and levies be introduced into the PUP for a period of ten years from the commencement of production

24. The World Bank could support the Ministry of Energy and Mineral Resources and the Ministry of Finance to convene a Workshop to present these issues for more detailed examination and consideration by the key Ministries involved and other concerned parties.

F. Ring Fencing

25. Ring Fencing Applies to COWs. Ring fencing is a concept which is applied to COWs in Indonesia. If a mining company wants to undertake exploration and mining under COWs, it must set up a distinct taxable entity for each COW. (in the case where a company mines and explores without a COW, such as with KPs, there is no ring- fencing). The accounts of different COWs cannot be combined for tax purposes. In effect, the taxes for each COW are ringed by an accounting fence. The advantage of this approach is that administrative tax agencies do not have to sort out a host of different combined tax systems for each company. The disadvantage is that a company that wishes to undertake exploration outside its COW will be discouraged to expend money there as it will not be able to deduct it as a cost against income earned in its revenue generating COWS.

26. Perverse Impact For Handover of Social Assets at Mine Closure. In order to avoid possible abuse, any entity that enjoys significant tax stabilization should be ring-fenced. Entities not enjoying tax stabilization should not be ring-fenced. But, the application of ring fencing for mining projects cannot help but create a major issue regarding the treatment of social assets at the time of mine closure. This is demonstrated with the advent of the closure of the first large scale mine under a COW (the Kelian gold mine). For plant and equipment that was imported on a tax free basis, the mine has the options of exporting, demolishing or abandoning or else it must pay the import duties. The mine is willing to transfer social assets (such as schools) to the local government or community. But because the plant or equipment involved was imported on a tax free basis, it must pay those taxes in order to transfer them. Companies cannot reasonably be expected to make tax payments in order to hand over social assets – yet it would be a terrible situation for these assets to be destroyed or exported and not given to the community simply because of the tax rules. While levying taxes at a reduced, depreciated value may provide a possible solution, there would be an overall positive developmental value if the mining fiscal regime permitted such

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assets, under these particular circumstances, to be transferred to government or community ownership without incurring taxes. It is recommended that:

the fiscal regime allow social assets to be transferred to appropriate social service delivery agencies at the time of mine closure without incurring tax liabilities and that this also apply to any social assets, which may have been imported duty free during the mine life, under existing COWs

G. Other Aspects of Fiscal Regime

27. Tax Holidays to be Avoided. In considering measures to make the fiscal regime more competitive, it must be strongly emphasized that this does not mean that the income tax rate should be reduced or that tax holidays should be considered. Indeed, tax holidays should be avoided as an incentive for mining, because they encourage “high grading” during the tax holiday period which results in sub economic resource development. Rather, what is needed, as outlined above, is (i) to reduce the rates for production contribution; (ii) to include all minerals within the VAT system (instead of excluding coal, gold and silver); and (iii) to establish a closed (but expanded) list of district and provincial taxes and non-tax charges (which would specifically exclude turnover-related) taxes.

28. Need For Broadening the Tax Base. Tax collections as a percentage of GDP, have not increased in the past two decades and are around 12%-13% of GDP in Indonesia, well below that of neighboring countries. In this situation, there is a significant need to increase tax collections and also to ensure that kabupatens and provinces have the necessary revenues to undertake the additional responsibilities and functions associated with decentralization. If the solution is not to increase the tax on mining, then what are the alternatives? The solution appears to lie, in large part, in broadening the tax base. Among the initial steps that would help improve the overall situation are improved personal tax legislation and regulation (including better separation of corporate and personal tax legislation and regulations), simplification of the tax system and tax forms (for example the VAT form has 18 pages whereas most countries use a simpler often single-page form), capacity building to strengthen the tax administration, modernization of collection and reporting systems (such as online payments), and reform of audit policy and procedures and tax collection functions. With a more diversified tax base, there would be less pressure for the tax authorities to maximize the short term taxation of sector such as mining, and by encouraging investment, the tax authorities can encourage growth of the industry and future tax payments. Indonesia’s income tax rate is similar to rates in other nations. It is recommended that

the mining sector be assessed at the same rate as other types of corporate activity.

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Table 3: Income Tax Rates Applied to Mining Projects in Selected Jurisdictions

Country Corporate Income Tax Rate

______________________________________________________________________________

Argentina 35%

Bolivia 25% (a surtax may also apply in some cases)

Burkina Faso 35%

Canada (Newfoundland) federal: effectively 29.12% including 4% surtax); Prov 4%

Chile 15% (or 42% for a stabilized tax regime)

China 33% (30% to central gov’t., 3% to provincial gov’t.)

Ghana 35%

Greenland 35%

Indonesia 30% (COWS range from 22½ - 48%)

Ivory Coast 35%

Kazakhstan 30% (excess profits tax may apply)

Mexico 35%

P.N.G. 35% for large (SML) mines, 25% for most other mines

Peru 27% (29% for taxpayer with stabilization agreement)

Poland 2000, 30%; 2000-2001, 28%; 2003, 24%; 2004+, 22

South Africa 30% for other than gold; formula > 30% for gold mines

Sweden 28%

Tanzania 30%

USA-Arizona progressive based on income (profit level)

Uzbekistan 33%

W. Australia 2000/2001, 34; 2001+, 30%

Zimbabwe 35%

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29. Depreciation. In most of the surveyed nations, tax policy is mainly implemented through adjustments to the tax base rather than through the tax rate. The tax rate is commonly uniform for all tax-payers, or for all tax payers at a given level of profit. The most common form of tax-base incentive for mining is accelerated depreciation. Most nations provide the mining industry with some sort of accelerated depreciation (see Table 4) which it is understood has been used in some COWs. Mining projects are typically highly capital intensive with long capital recovery periods and accelerated depreciation reduces political risk by allowing investors to recover their capital more rapidly. This is especially important to foreign investors and lenders who are more willing to commit large amounts of capital to a developing country if the recovery period is shorter. Indonesia does not provide for a substantial accelerated depreciation option. For example, category 3 equipment, which includes machinery for general mining, provides for either 12.5 % declining balance or 6.25% straight-line for assets with a beneficial life of 16 years. The concept of depreciation is that a taxpayer should be able to over the life of a piece of physical plant (equipment or building) deduct the full cost of that plant. Governments in almost all major mining countries provide an acceleration of depreciation for mine equipment as an incentive to reduce the risk that capital may not be recovered in a timely manner. Indonesia does not provide acceleration. It is recommended that

consideration be given to allowing mining equipment to be depreciated at an accelerated rate under the prevailing law.

30. Loss Carry Forward. One of the most common tax incentives is to allow taxpayers the ability to carry forward losses from one year to offset taxable income in future years (Table 5). Indonesia limits loss carry forward to 5 years. For capital-intensive industries, like mining, and for industries exceptionally prone to commodity price fluctuation, like mining, loss carry forward is an important issue and the 5 years period is too short. It is recommended that

the loss carry forward time limit in Indonesia be increased to a longer period – possibly 8 – 10 years.

31. Deductibility of Reclamation and Closure Costs. Of increasing concern to governments is the issue of mine reclamation and closure. During the last years of a mine substantial closure costs will be incurred. Because production revenues will have ceased or been reduced, the company may receive no useable tax deduction for these important and essential costs of business. Thus, companies may not recover the costs involved with closure unless the tax system is adjusted to take these into account while cash flows are still being generated. It is in the government's interest to see that the company does plan and set aside funds for this activity, for at the end of the mine life, funds will not be generated and a failed company could result in the need for the government to pay for reclamation. One way to encourage companies to fund closure is to allow funds irrevocably set-aside for reclamation to be allowed as a cost at the time the funds were irrevocably set aside. Currently Indonesia does allow for funds deposited into a reclamation arrangement to be allowed as a cost for income tax purposes. However, such

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Table 4: Depreciation Applied to Typical Mining Equipment in Selected Jurisdictions

Country Accelerated Method Example

______________________________________________________________________________

Argentina Yes 3 yr straight-line

Bolivia Yes 8 yr straight-line

Burkina Faso Yes useful life minus one year

Canada Yes variety of options: up to 100% in yr incurred for

new mine or 25% declining pool balance

Chile Yes 3 yr straight-line

China Yes 10 years

Ghana Yes 75% in 1st yr, then 50% declining balance

Greenland Yes the company may decide the rate and period

Indonesia No 12.5 % declining balance or 6.25% straight-line

Ivory Coast Yes method of acceleration depends on life of equipment

Kazakhstan Yes 25% declining balance method

P.N.G. Yes 150% declining balance over 7 years

Peru Yes 5 yrs straight-line (20%)

Philippines Yes twice the normal straight-line rate

Poland Yes 5 yrs straight-line (20%)

South Africa Yes expensed in 1st year of production

Sweden Yes 5 yrs straight-line (20%)

Tanzania Yes 12.5% straight-line

W. Australia Yes prime cost or diminishing value methods

Zimbabwe Yes expensed in year incurred or 1st year of production

Source: derived from derived from Global Mining Taxation Comparative Study, 2nd edition 2000

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Table 5: Loss Carry Forward/Back Policy in Selected Jurisdictions Country Loss limit carry

forward available? (yrs)

Time carry-back available? (yrs)

Loss limit Time

Argentina Yes 5 No - Bolivia Yes None No - Burkina Faso Yes 5 No - Canada (Ont) Yes 7 Yes 3 Chile Yes None Yes None China Yes 5 No - Ghana Yes None No - Greenland Yes None Yes 5 Indonesia Yes 5 No - Ivory Coast Yes 5 No - Kazakhstan Yes 7 No - México Yes 10 Yes None PNG Yes 7 No - Peru Yes 4 No - Philippines Yes 5 No - Poland Yes 5 No - South Africa Yes None No - Sweden Yes None No - Tanzania Yes None No - USA-Arizona Yes 15 Yes 3 W. Australia Yes None No -

Zimbabwe Yes None No - funds must be paid into specified state banks that are reportedly faced with severe financial trouble. Most companies would find placement of funds into such institutions unacceptable. It is recommended that

the current system be retained but that the list of specified banks be expanded to include international banks which have demonstrated strong financial attributes.

32. At closure, certain assets, such as fire trucks, ambulances, water purification infrastructure and so forth suitable for transfer to public entities and communities will be available. Under current tax law as applied to COWs such assets may be subject to transfer taxes if a mine wishes to transfer that asset, even to a public entity. In addition, if the equipment was exempted from import duty or free of VAT, additional taxes may be due. This encourages a company to consider destroying the asset instead of making it available for the public good. It is recommended that

transfers of social assets to a public entity be exempted or free from transfer and other taxes.

33. Deductibility of Investment in Communities and Infrastructure. There is intense interest by many stakeholders in furthering the development of communities and peoples

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affected by a mine. One way to foster development is to invest in communities impacted by mining so that when the mine closes, the affected communities will be able to carry-on with social and alternative economic activities. Thus, infrastructure and investments made in the community during the mine life can be important. The current Indonesian system does not automatically allow a deduction for such expenditures. However, costs may be allowed at the discretion of the tax office. It is recommended that

the tax law should automatically allow the deduction as a cost of certain types of investment in communities and regional infrastructure up to a prescribed limit based on the annual gross mine revenues. The types of such investment and the limit should be explicitly described by regulation or official instruction.

34. Import Duties. Mining is capital intensive and utilizes specialized equipment that is usually imported. This means that an import duty on equipment has a direct impact on project economics in the project’s early years. Project feasibility studies calculate various projections of profitability, such as internal rate of return, and such measures are very sensitive to large costs in the early years of a project. Even modest levels of equipment import duties can sink a marginal project. Competition for mineral sector investment worldwide is fierce, and many countries have either eliminated import duties on mine equipment or have found ways to exempt projects or their equipment from such duties. Table 7 lists typical import and export duties in a cross-section of mining nations around the world. As can be seen in the table, most of the sample nations impose no or low duty, and those with higher duty usually have some means of exempting mines. 35. Import Duties. Indonesia imposes import duties, and the rates vary according to the item. However, a mining company may submit a “master list” of imported equipment and at the discretion of the government, the approved listed items may be imported free of duty. Import duty is mainly paid during the construction of a mine when there are no cash flows. Thus, companies view such an input tax very negatively since it has the effect of increasing construction costs before the project starts earning income. Most nations have freed mines from import duty during construction or zero-rated most mine type equipment. The imposition of customs duty carries with it substantial burdens and costs for government in terms of the manpower and time required for tax collection. Most countries are in the process of reducing import duties to values of zero or close thereto. Many nations find that over time, corrupt practices can creep into customs services, particularly where import duties are levied. It is recommended that

Indonesia follow the lead of most other nations and eliminate import duty on mine inputs through either an exemption or if duty category lists are sufficiently detailed, to identify mining equipment categories and zero rate such categories. The necessity to use an approved “master list” is inefficient and subject to arbitrary decision-making.

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Table 7: Typical Import Duties on Mine Equipment Country Typical Import Duty

Argentina None* *1% control fee applies Bolivia 5% Now under review Burkina Faso Exempt * *during development Canada 0.5% Chile 10%* *deferred and amortized China None Ghana Exempt* *during development Greenland None Indonesia None Ivory Coast 0.75% Kazakhstan None México Exempt* *during development PNG None Peru 12%* *depreciated Poland 9% South Africa None Sweden None* *1% control fee Tanzania None USA-Arizona Rates vary Uzbekistán Exempt* *mines usually exempt W. Australia 5% Zimbabwe 5% Source: derived from Global Mining Taxation Comparative Study, 2nd edition 2000 36. Dividend Withholding Tax. Many nations impose a dividend withholding tax. The tax can be appreciable. Table 8 lists rates for a number of countries. The general rates described in the table must be used with some caution. Although many governments define a high dividend withholding tax rate, perhaps with the objective of promoting reinvestment or providing national mining companies with an advantage over foreign firms, they often enter into bilateral investment treaties (or dual tax treaties) that lower or eliminate such taxes for companies headquartered in key trading partner countries. It is recommended that

Indonesia imposes a dividend withholding tax of 20%. However, it has established treaty provisions with most nations where mining investors are headquartered that reduce withholding rates to 10 to 15%.

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Table 8: Dividend Withholding and Similar Taxes in Selected Jurisdictions Country

Dividend Withholding Tax Rate *

Argentina 0% (35% on the excess of the accumulated taxable net income) Bolivia 12.5% Burkina Faso 12.5% Canada 25% Chile 35% (but 15% income tax is credited against the W/H tax) China None Ghana 10% (mines usually exempt by negotiated agreement) Greenland 35% Indonesia 20% (treaty rates in the 10 to 15% range) Ivory Coast 12% Kazakhstan 15% México 35% P.N.G. 17% Peru 4.1% (assessed as an additional income tax rate on remitted dividends) Poland 20% South Africa 12.5% (Secondary Tax on Companies is levied on dividend basis) Sweden None Tanzania 10% USA 30% Uzbekistán 15% W. Australia 30% (in practice 0% through dividend “franking”)

Source: Derived from Global Mining Taxation Comparative Study, 2nd edition, 2000

Note: The rate given in the table is the non-treaty general rate. Many nations have a host of bilateral investment or tax treaties that may reduce this rate for investors from countries entering into such a treaty.

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Annex E

Recent Examples of Mining Fiscal Stabilization in Other Countries

MOZAMBIQUE

Country

Mozambique

Date of Mining Law

April 2002

Tax Stabilization in Mining Law

Yes

Tax Stabilization in Tax Law

No

Tax Stabilization is

Optional

Tax Stabilization covers - all taxes If No – which taxes are covered

Yes

Are taxes fixed or capped ?

Fixed

Is there an agreement ?

Yes

Are taxes specified in agreement ?

No; reference is made to Mining Law

Rates are set out at prevailing levels If not - they are:

No Lower

Length of stabilization period

15 years from the granting of the exploration permit or 10 years from the granting of the mining title (optional).

Start of stabilization period

From the granting of exploration permit or the mining permit (optional); stability granted on the exploration title can be transferred to the mining title.

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Annex E

MADAGASCAR

Country

Madagascar

Date of Mining Law

Mining Code : August 1999 Special Regime on large scale mining investments : April 2001


Yes


No


Optional


Yes


National taxes fixed, local taxes capped

Is there an agreement ?

Yes


No; reference is made to Special Regime on large scale mining investments

Rates are set out at prevailing levels

Yes


Validity of mining permit


Certification of eligibility required after granting of mining permit

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Annex E

MAURITANIA

Country

Mauritania

Date of Mining Law

Mining Law : June 1999 Law with a Special Fiscal Regime for Mining approved on December 2001


Yes


No


Optional


Yes


Fixed

Are there an agreement ?

Yes


No; reference is made to the Law with Special Fiscal Regime for Mining

Rates are set out at prevailing levels If not - they are:

No Lower


Validity of permit


From the granting of exploration permit or the mining permit (optional); stability granted on the exploration title can be transferred to the mining title.

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Annex F

Mining and Forestry Interfaces

A Introduction 1. This Annex analyzes the effect on forest cover of surface mining inside Protection Forest (Hutan Lindung). The Indonesian term Protection Forest refers to areas requiring management practices compatible with watershed protection and is not to be confused with the term Protected Area or Protected Forest used elsewhere (i.e. IUCN) which encompass also biodiversity protection. In Indonesia this latter forest zone is referred to as Conservation Forest. 2. Maintaining an intact forest cover for watershed protection is just one of the several issues of the environmental and social aspects to be considered when analyzing mining impacts. This Annex intends, by design, to look at environmental effects of mining only through the narrow lenses of forest cover changes inside Protection Forest. As such it represents a starting point for the comprehensive discussion of all social and environmental impacts that is required for an informed and relevant policy debate. The Annex aims to provide traceable facts on which a constructive and informed discussion among the various stakeholders can start. B. Issues in the Mining Forestry Interface

3. There are four main “perspectives” that frame the significance, extent and relevance of the mining/forest interface:

(i). The “Area Perspective”: • Indonesia’s land surface amounts to 182 million hectares1. • Indonesia’s “Forest Estate” (Kawasan Hutan) extends over 129 million hectares. • This means that 70% of Indonesia’s land area is - de jure - subject to management

prescriptions aiming at achieving a determined forest function (social, economic or environmental) and under the control of Ministry of Forestry .

• Forest Estate does not equate with forest cover (i.e. actual presence of a tree canopy): 37 million hectares (i.e. 27% of the Forest Estate) do not have a forest on it.

• Indonesia’s land mining concessions, according to Jatam2, cover about 66 million hectares, i.e. 36% of Indonesia’s land area.

• We could only obtain the boundaries of mining concessions for a total land area of approximately 40 million hectares, i.e. 60% of the area indicated by Jatam (or only 22% of Indonesia’s land area)3.

1 There are several figures on Indonesia’s land surface. This one is by no means to be considered the official one. It is simply the one we were able to calculate directly from the GIS dataset we assembled and as such is consistent with all other are calculations presented in this Annex. 2Jatam is the major Indonesian NGO on mining issues. This information was provided through personal communications on 27 August 2004 and 10 September 2004; During a workshop with WRI on GIS datasets on 10 September 2004 Jatam had agreed to provide its database to WRI; we were subsequently informed that the dataset could no longer be made available. Despite several attempts it has been impossible to date to obtain the dataset.

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(ii). The “Legal Perspective”:

• The Indonesian Constitution of 1945 (Article 33): provides the State, on behalf of the

people of Indonesia, with powers of control of forest lands and the harvesting of their resources. Acting on the constitution the GOI has the authority to control, manage and administer the nation’s forests.

• Forestry Law (UU) 5/1967: the Basic Forestry Law established that the Ministry of Forestry has management jurisdiction over all land designated as Forest Estate .

• Forestry Law (UU) 41/1999: is the Forestry Act of Indonesia replacing the Basic Forestry Law 5/1967. Article 38 outlaws all mining in Conservation Forest and open pit mining in Protection Forest.

• Government Regulation (PP) 34/2002: is the first implementing regulation of the Forestry Act 41/1999. Chapter VI section 2 (Use of Forest Area) allows for “strategic” area use of Protection Forest. Mining is included in the list of strategic uses. It stipulates that an ensuing Presidential Decree should regulate such strategic uses.

• Presidential Decree […]/July 2004: well known recent history …13 mining concessions are allowed to resume operations inside Protection Forest. A list is presented in Section E to this Annex. Section F gives a list of reference materials

• From a procedural point of view, the holder of a mining permit needs to obtain from Ministry of Forestry a permit for “Area Utilization” as well as a permit for “Forest Utilization”. The latter is required to fell trees and clear the land to prepare for explorations and mining site development.

(iii). The “Forest Functions Perspective”:

• The Forest Estate: is the key concept - the portion of Indonesia’s land area under the control of the Ministry of Forestry and subject to management prescriptions aiming at achieving a determined forest function (social, economic or environmental).

• The Government Regulation (PP) No 33 of 1970: established the guidelines to delineate the area of the Forest Estate and the purpose for which it is to be used. As such, this implementing regulation is about planning and zonation. It granted the then Ministry of Agriculture and Forests with the authority to prepare forest land use plans.

• The TGHK (Forest Land Use Planning by Consensus) of 1984: was the result of the planning exercise launched by PP 33/1970. The TGHK determined the portions of Indonesia’s land which constituted the Forest Estate: 144 million hectares or 72% of the (then) land area of Indonesia. The TGHK also recognized and delineated the areas of four functional categories:

o Protection – 30.3 million hectares or 15.1% of the land area of Indonesia; o Conservation – 18.8 million hectares or 9.4% of the land area; o Production – 64.4 million hectares 32.4% of the land area o Conversion – 30.5 million hectares or 15.1% of the land area

• The RTRWP (Provincial Spatial plans) were the result of the Spatial Use Management Law (UU) No 24 of October 1992, whereby Provinces and District were

3 As discussed in the dataset section, it is important that we obtain the official dataset it this analysis is to provide any policy-discussion relevant information. I assume that Jatam affirmation is correct and that our dataset is incomplete.

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entrusted with (some level of) authority to redraw the boundaries of the forest functions.

• The Paduserasi (Synchronization) was the subsequent attempt by the Ministry of Forestry to synchronize the RTRWPs for the various provinces with the TGHK.

• The Penunjukan (Recalculation) of 2001 was the conclusive determination and zonation of the Forest Estate carried out by the Ministry of Forestry. As per the Decree of Minister of Forestry [No…] of August 2004, the Penunjukan has been concluded for all provinces except North Sumatra, Riau and Central Kalimantan. For the latter 3 Provinces the Decree stipulates that the TGHK constitute the applicable zonation of the Forest Estate until the Penunjukan is completed. All data used in this paper refer to the Penunjukan 2001 forest area and are determined as follows:

• Forest Estate: 129 million hectares – 70% of Indonesia’s land area • Protection Forest: 28.5 million hectares – 15.7% of the land area. The purpose of this

forest zone is solely to provide watershed protection. This is the key issue in the current mining/forest debate. As such a more detailed discussion of Protection Forest is provided in a specific section below.

• Conservation Forest: 17.2 million hectares - 9.5% of land area. The purpose of this forest zone is mainly to provide biodiversity protection. The ban on mining in this forest zone is not disputed by mining concessions holders; hence it is not discussed in this Annex.

• Production Forest: 60.8 million hectares – 33. 4% of the land area. The purpose of this forest zone is mainly to provide a sustainable supply of timber. Legal mining in this forest zone has not emerged as a specific forest issue; hence it is not discussed in this Annex.

• Conversion Forest: 22.2 million hectares – 12.2 % of land area. This forest zone is not permanent, as it has been assigned for conversion to other non-forest uses (agriculture, infrastructure, etc). Legal mining in this forest zone has not emerged as a specific forest issue; hence it is not discussed in this Annex.

• Other Land: 53.1 million hectares 29% of land area. This is the land outside the Forest Estate, consisting of urban areas, agriculture, infrastructure, etc. Legal mining in this forest zone has not emerged as a specific forest issue (there are 9 million hectares of forested land of which 2.3 million hectares are allocated to mining concessions; but they are not subject to forest functions management prescriptions), hence it is not discussed in this Annex.

(iv) The “Mineral Extraction Perspective”:

• Although Law 41/1999 only specified surface mining was banned, this was considered tantamount to a ban on all mining, because the nature of mineral deposits in Indonesia is such, that surface mining is the only practical method for mining. The effects of the ban on mining in protection forest is twofold:

• Firstly, holders of licenses and CoW issued in the 1980s and 1990s are unable to obtain from Ministry of Forestry the permits to fell trees and clear the land to prepare for exploration and development of mining areas;

• Secondly, some of the most highly prospective mineral land has been placed off limits for new licenses. [Law 41/1999 creates an absolute ban on surface mining in the protection forest with no procedure for evaluating a specific exploration or development proposal on its merits and effects on the environmental function for which the specific forest regime had initially been created.]

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• The situation is further complicated by the fact that there can be uncertainty about the exact boundaries for protection forest areas because different Ministries and agencies are not using consistent maps, because boundaries are sometimes changed and also as the result of general mapping inaccuracies4.

C. Research Questions

4. Within the scope of analyzing the effect on natural forest cover of surface mining inside Protection Forest, two questions are addressed in this Annex:

1 What is the extent of mining concessions within Indonesian forest estates?:

5. This has 5 subsets, of which the first one is the focus of this Annex:

a. area covered by mining concessions inside Protection Forest b. area covered by mining concessions inside Conservation Forest c. area covered by mining concessions inside Production Forest d. area covered by mining concessions inside Conversion Forest e. area covered by mining concessions outside the Forest Estate

2 What is the impact of mining concessions on the forest cover?: 6. These can be categorized as follows:

a. Direct: the forest cover change that occurs directly as a result the installation of the physical infrastructure (roads, buildings, etc), digging the pit and disposing of the overburden. According to earlier World Bank research, this impact is likely to be marginal in terms of relative forest loss (EASES paper November/2000 page 10: 450 Ha for pit and dam), and no attempt is made to disaggregate this type of forest loss from the one discussed under point b. below, which is of greater magnitude.

b. Indirect- inside the concession: the forest cover change that occurs as a result of improved access (or perceived so) to an area inside the mining concession, either through the construction of physical infrastructures, by attracting people to an area, or by triggering local claims on land. This impact is the main subject of analyses in this Annex as it can be measured and is within the control and responsibility of the mining concession.

c. Indirect- outside the concession: the forest cover change that occurs as a result of improved access to an area outside the mining concession but affected by the increased access that the concession brings about, either through the construction of physical infrastructures, by attracting people to an area, or by triggering local claims on land. This impact is likely to be the most significant one in terms of forest loss but as it is difficult to measure with the current dataset (we would require more information on the history of the

4 AN immediate and pragmatic next step would be to carry out a review of existing maps bringing together MoFr Baplan, DGGMR and the CoW holders to review COW overlaps with hutan lindung and conservation areas, synchronize the various maps and then make those maps publicly available ie. by jointly posting on a web-site.

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COW and on access roads) and is not under the responsibility of the concession, it is not discussed in this Annex.

d. Indirect- through macroeconomic processes: The forests cover change that occurs as a result macroeconomic changes triggered by income generated from oil and mineral production. These issues have recently been discussed in the CIFOR’s study “Oil Wealth and the Fate of Forest – Swen Wunder, 2004”. Given the many “degrees of separation” between the mining revenues and the impact on forest and the amount of assumptions required to establish some sort of correlation, it is not discussed in this Annex.

D. Datasets and Sources

• As there was not a reliable and single-source forest dataset, data used in this Annex have been derived from various sources and compiled and harmonized into a single database for elaboration. At this stage, the data obtained and generated through this work have to be considered more as illustrative of a process rather than as fully representative of reality. In other words, the accuracy and reliability needs to be verified if the elaboration has to be used for policy guidance and decision making. While more work need still to be done the dataset that has been compiled is the best available at the moment.

• As the available dataset has only 2 classes of land cover (Forest and Non-Forest) it is possible to discuss only the process of deforestation and not forest degradation.

• Also as there is one dataset for 1990 and one for 2000 it is possible only to look at deforestation that has occurred between those two years: i.e. areas that had a forest cover in 1990 and have no forest in 2000.

• The two above limitations do not allow observation of finer (but likely significant) changes in forest cover degradation and hence are likely to underestimate absolute values of impacts on forest. Though, as this is true also for the forest outside mining concessions, relative comparison are likely to be still relevant.

E List of CoWs for Which Forestry Permits Were Granted in 2003 7. Presentation to the Commissions III and VIII of the House of Representative meeting on Discussion in Altering the Classification of Protected Area for Mining Purposes, 2003: list of the thirteen mining companies that are currently being evaluated by the House of Representative of Indonesia5

No Company Province Area CoW (Ha)

Overlap ping With PAs (Ha)

Proposed Alteration area (Ha)

Eco- system area

% over lapping

area

% Reduc- tion of

PAs

1 PT Freeport Indonesia Co

Papua 399,732 119,435 42,617 3,616,000 3.3% 1.18%

2 PT Karimun Granit

Riau 2,761 1,160 1,160 2,767 41.92% 41.92%

5 The above data need to be confirmed

116

3 PT Inco Tbk

South and central Sulawesi

219,529 74,890 49,561 829,548 9.31% 6.16%

4 PT Indo minco Mandiri

East Kalimantan

25,121 4,520 2,210 23,340 19.37% 9.47%

5 PT Aneka Tambang

North Maluku

39,040 8,660 7,090 77,330 11.20% 9.17%

6 PT Natarang Mining

Lampung 12,790 9,593 40 215,800 0.02 % 0.02%

7 PT Nusa Halmahera Minerals

North Maluku

29,622 9,350 213 25,540 36.61% 0.83%

8 PT Pelsart Tambang Kencana

South Kalimantan

201,000 20,370 3,223 382,300 5.33% 0.84%

9 PT Interex Sacra Raya

East and South Kalimantan

15,650 7,200 2,717 434,290 1.66% 0.63%

10 PT Weda Bay Nickel

North Maluku

76,280 35,155 9,954 159,900 21.99% 6.23%

11 PT Gag Nickel

Papua 13,136 6,060 4,721 6,060 100% 77.92%

12 PT Sorikmas Mining

North Sumatra

66,200 34,830 632 251,630 13.84% 0.25%

13 PT Aneka Tambang

Sulawesi Tenggara

14,570 6,531 979.19 26,144 7.69% 1.27%

1,110,660 337,754 125,118 6,054,175 5.58% 2.07% GLOSSARY Hutan Lindung- Protection Forest Kawasan Hutan- Forest Estate Tata Guna Hutan Kesepakatan (TGHK) - Consensus Forest Land Use Plans

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Annex G

Literature References BAKOSURTANAL, Land Resources Department, ODA Foreign and Commonwealth Office-England, Direktorat Bina Program, DG Penyiapan Pemukiman-DEPTRANS. (1990). The Land Resources of Indonesia: A National Overview, By Regional Physical Planning Programme for Transmigration (RePPProT). Boccucci,M and Walton, T, Firmansyah, D, Dore, G. (2003). Decentralization of the Forest Governance System: An Analytical Framework. Bruner, A, Gullison R.E, Rice E.R, da Fonseca G.A.B, (2001). Effective Of Parks In Protecting Tropical Biodiversity. Departemen Kehutanan Indonesia. (2001). Statistik Kehutanan Indonesia 2000 & 2001. GFW. & FWI. (2001). State of the Forest Indonesia. Holmes, D.A. (2002). Indonesia Where Have All the Forests Gone?. A Discussion Paper. McMahon G, Subdibjo E.R, Aden J, Bouzaher A, Dore G, Kunanayagam R, (2000). Mining and the Environment in Indonesia: Long-term Trends and Repercussions of the Asian Economic Crisis, East Asia Environment and Social Development Unit. Sunderlin, W.D, Between Danger And Opportunity: Indonesia’s Forests In An Era Of Economic Crisis And Political Change. The World Bank Group, (Draft: February 4, 2003). Indonesia: Mining Licensing and Fiscal Review.

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