Contribution of Pierre Ratcliffe to the Ceseco session 2016: Taxation

  1. Opposing goals of mining companies and state governments
  2. What are the motives of the mining company?
  3. What are the motives of the government of the hosting state?
  4. Environmental and social issues.
  5. Usual trade-offs and compromises
  6. Taxing profits versus taxing production
  7. Tax discrimination
  8. Government’s sovereignty versus credible commitment
  9. Practice of feasibility studies
  10. Impact of tax regimes on the share between mining company and host State: case studies DRC, Zambia, Peru

The purpose of my contribution is to assist in the evaluation of mining projects from the point of view of the mining company and that of the government of the hosting state. Both have opposite even conflicting motives ie. the mining company has to achieve profits and serve dividends to its shareholders who are the investors; the state has to draw taxes to finance its development and the well being of its people. Both motives hinge at the economic calculation of the mining project; both actors strive to maximize their share of the rents if mining.

My contribution aims at understanding what should the best compromise between the two, so that both parties share the mining rent fairly and sustainably, whatever the evolution of metal prices and costs of mining.

Economic calculations permit to establish the viability of a mining project. This accounts for costs and revenues. Costs are investment, cost of inputs, cost of labour; revenues are the sales of products. Investment is a "one of" cost expended before and at the beginning of the project; cost of inputs and cost of labour are expended each year of the project's lifetime; mining projects have a very long lifetime from initial studies of opportunity, through pre-feasibility and feasibility stages, detailed engineering and then exploitation of the resource until its depletion. Typically, 20 year life times apply to most mining projects. Economic calculatiosn have to make sure, as can be possible over such a length of time with many contingencies and risks, that the return is positive and worthwhile ie. yields profits to investors who have forgone present consumption for future consumption and for the state that sees its mineral resources depleted and needs to benefit from mining for the well being of its population.

Opposing goals of mining companies and state governements in reaping the benefits of mining projects

I am indebted for the following sections of my contribution, to Maria Jose Espantoso Bedoya "An Analysis of the Recent Reform to the Peruvian Mining Sector from a Tax Perspective" A thesis submitted in conformity with the requirements for the degree of the Faculty of Law University of Toronto and also to "THE TAXATION SYSTEM IN ZAMBIA" A report for the Jesuit Centre for Theological Reflection.

When deciding on the feasibility of mining projects, the investing company and the host country have a common objective: to maximize their share of revenue. Maximization of revenue is not, however, the only goal of the parties to this kind of transaction. In the case of government, for instance, the public interest should be equally or more important than revenues. In this context, it is important to keep in mind that the different participants involved in the exploitation of mineral resources have different views and may have diametrically opposed perspectives on the expectations of a mining tax regime, given that their objectives and needs are different. Ultimately, it is the government who holds the responsibility to design the fiscal regime that allows both parties to achieve, at least in some degree, their objectives.

What are the motives of the mining company?

From the perspective of the investor, the mining industry is considered to be a very risky industry, which is also very capital intensive and prone to wide commodity price fluctuations. This makes the mining industry different from other industries in ways that justifies policies that attend to these different factors, as explained below. In addition, the investor has to deal with the issue of credible commitment of the host government once the investment is sunk, given that the government may have little or no incentive to maintain the rules initially agreed upon. The various sorts of risk involved (such as the risk of not knowing what size of deposit will be found, the future changes in the price of inputs –such as capital and labour - required to exploit the mine and the risk associated with the uncertainty about the final price of the mineral at the time when it will be sold) can imply extensive investments from mining firms with the possibility of not finding anything. As a consequence of this level of uncertainty in the mining industry, when deciding among different projects to invest in, investors usually prefer the less risky alterative even when the net present value of both alternatives is the same.

Significant risks may occur in the very beginning of a mining project. The investing company may experience problems even before discovering any feasible deposits in the subsoil. This is especially problematic if we consider that the upfront sunken investments in the mining industry are always high. The requirement of large amounts of capital up front, added to the fact that there usually are long time lags between investment and production, imply in most cases a large negative cash flow for a period of time. Another reason why the mining business is known to be risky is because it is very capital intensive. This is due to the fact that the development of a mine implies a high cost of infrastructure and technology, which are needed to recover minerals in an efficient manner.

Yet, an additional risk is the fact that the mineral found needs to be of a certain shape, nature and grade in order for it to be economically beneficial to the investing company to exploit it; and this information is not available before significant costs are expended ie. field and laboratory tests in specialised centers.

Also, as mentioned above, the mining industry is exposed to commodity price fluctuations as the prices of this type of resources fluctuate. This implies an additional type of risk as the investment ought to be recovered despite the price patterns or else, massive losses can occur if the price cycle is not accurately predicted.

In addition to this, it is important to bear in mind that the investing company has no choice as to the location of the mining activities as opposed to an investor of almost any other sector when deciding where to establish their business. The investing company has to establish where the mine and the minerals are. In most cases, mines tend to be located in remote or undeveloped spaces which requires that the mining company provide all facilities for its operation and its personnel: housing, schooling, food and provisions...

In the particular case of foreign companies, in addition to being subject to the risks that other domestic companies in the same industry may face, they bear the risk of a government that may change its policy towards them. The risks faced by foreign companies can be mainly classified in three different groups: expropriation risk, contract risks, and policy risks. Although direct expropriation was not a common event in the recent years (partly because direct threats to property rights are not as effective as they used to be due to the changing structure of foreign investment) some examples like Venezuela and Zimbabwe should be kept in mind.

Recent cases in Argentina and Bolivia show that expropriation, even if followed by compensation is occurring more often again. Indirect expropriation is also a risk and it occurs through interference of the government in the use or enjoyment of the benefits generated by a property, even if the property is not seized or the legal title affected. This happens when the Government imposes on the mining company to benefit a free share of equity which corresponds to a rampant privatization or expropriation.

Contract risk refers to the risk associated to the incomplete or defective fulfillment of agreements signed with either government or host country firms. Some of the reasons for this include the fact that host governments may be corrupt. Even if the governments are not corrupt, their judiciaries may be weak, hence will not protect contract rights signed between the foreign company and the government, even if there is no corruption involved.

Policy or regulatory risk refers to the modification of policies that were in force while the investor was making the decision to invest. The common reason for this modification is mainly the intention of the government to extract a higher amount of benefit from the investment through changes in regulation, tariffs, selective law enforcement, etc. Mining projects (in the same way as infrastructure ones) are sensitive to public action as governments are likely to play an important role in regulation of entry, definition of prices and other aspects referred to the particular investor. Due to the very nature of mining activities, that tend to cause social and environmental disruptions, popular protests are common to this industry, including investors' facilities becoming targets for expressions of discontent from the population. This implies that investors are not ideally positioned to protect their own interests from such risks. Even in the course of normal operations, mining projects may be subject to political opportunism aimed at pleasing public opinion moving against a mining project.

The “obsolescence bargain” model analyses the treatment of foreign investors in developing countries, with emphasis on mining investors , describes the following interaction process: investors demand from government some compensation for the contingencies, risks and uncertainties to which mining of the resources is exposed. Host authorities agree to these terms in the aim of attracting the investment competing with other countries having the same resources. But once the success of the project is evident, the government refuses to continue to compensate investors as generously. At this time, the government is prone to demand a revision of the terms of the investment. It is reasonable to question why a government would act in a way that negatively impacts their global image and reduces their possibility of attracting further foreign investment. For some, this may be explained by the fact that sometimes the short term incentives may seem more beneficial than the long term ones. An additional factor may be the political ambition of the party in office. Harming its reputation at the international level may not be as bad if the move will assure the reelection of the governing party. This happens at a higher rate in developing countries with scarce resources than in industrialized countries.

The major risks and the special characteristics detailed above explain why the mining sector requires that host country governments put in place a tax policy specifically tailored to balance and manage the huge financial commitments of investing firms, guaranteeing them a tax treatment that is fair and considers their exposure to risk, striking a balance between incentives to attract corporations and the government’s own need to retain the largest possible share of the revenues to benefit its population.

What are the motives of the government of the hosting state?

In order to determine the needs and objectives of the government, it is useful to start by understanding the role of government in modern societies. Among the most relevant economic purposes of modern governments are:
(i) to address market failures, which in some cases may require a need to subsidize some goods or services or to provide directly some goods or services such as may be the case of transportation or communication,
(ii) to allocate some types goods and services, such as is the case of public health and public education, which should certainly be delivered based on need and not market demand,
(iii) to redistribute economic resources on the basis of need, moderating the market natural outcome and,
(iv) to apply fiscal and monetary policies in such a way as to achieve price stability, full employment and economic growth.

From these roles stems the observation that governments require significant funding to finance the cost of their activities and public services. Taxation is one of the alternatives of government to fund its activities, Other alternatives are borrowing and printing money. Finally, with regards to the third role of government exposed above (income redistribution), it is important to mention that redistribution as a function of taxation has been debated extensively over time. In fact some theories of distributive justice have been used to advocate for or to refuse its legitimacy.

The degree of equality that redistribution should provide is also contested in the literature. For some, a certain degree of equality needs to be provided by the government since otherwise governments face a risk of undermining their accomplishment of other social and economic objectives. For others, some amount of inequality of income is not bad because it provides low income workers with incentives to work harder. It rests on the government to decide what constitutes an acceptable level of inequality and to moderate this amount. In the specific context of developing countries, some additional objectives of government may be considered. In developing economies, there is a higher expectation that taxation will help government to support valuable functions, such as the provision of public goods. Within this function of government, taxation is expected to address mainly, three types of problems:
(i) the need to address short term problems of human development such as those arising from the lack of food, housing, clothing and emergency medical treatment,
(ii) the need to invest in education and preventive medicine and to improve economic potential and
(iii) the creation and maintenance of institutions that guarantee quality of life and further development.

It is important to keep in mind that these objectives may not be exclusive to developing countries. Redistribution of income and wealth allowing for a more equal distribution than the one that results from the regular operation of a market-based economy is also relevant in the context of developed economies. As mentioned before, the role that taxation might play in addressing the problem of income and wealth inequality in developing countries and the way in which governments should redistribute income respecting “equality” has never been fully agreed upon by policymakers, whose opinions range from the far left Marxist/socialist ideology all the way to the laissez faire, free market model.

If one accepts that tax systems should redistribute wealth, then the question becomes how to design optimal tax structures to achieve fair redistribution of government revenue in particular, in the context of mining taxation. Should the central government collect all tax revenues and then re-distribute by means of the periodical budgeting? Or should this revenues collection role be delegated to local authorities? There is a trend towards decentralization of tax revenues collection among some developing economies, where local authorities have received increased or new taxing powers. Some other countries are leaning towards payments (of royalties for example) being made directly to the provincial government and finally some others have inter-governmental transfers in place. The decentralization is a model adopted in Congo Kinshasa (Katanga).

Environmental and social issues.

Two other important trends in the mining industry are the growing concern with environmental and social aspects and the pressure of local communities aided by NGOs such as RAID and Global Witness5.10 with Corporate Social Responsibility (CSR) at stake5.11. This reflects in many places with unrest of local populations against mining operations. An example is the Las Bambas Peru protests against Glencore-Xstrata which is believed to having led the company to sell the mine to a chinese consortium5.15-17. Similar unrest occurred in Zambia 3.11 and in the DRC which contribute to Governments wanting to revise mining codes and agreements. The unrest is thought to deter investors, but because the trend is global, mining companies will have to adapt. This video shows how Glencore-Xstrata is addressing the issue:

Usual trade-offs and compromises

As discussed above, there is a fundamental conflict between the investing party and the government negotiating a mining contract, since both parties intend to maximize their share of mining revenues.

Taxing profits versus taxing production
Mining investors generally prefer profits-based taxes, since these types of taxes help reduce their financial risk. In some cases, for example, profit-based taxes allow investors to delay the disbursement of the tax payment until the moment in which up-front costs have been recovered (depending on country specific tax and accounting rules). This will likely not be the preferred alternative to host governments, since the use of these types of taxation implies that government will receive very little to none revenues for a period of time. Both parties agree on the fact that funds received today are more valuabler than those received in the future. This is the preference for the present instead of the future, which is the basis for interest rate payments and discounting factors which we shall discuss in the next section.

Conversely, production-based taxation allows governments to ensure some tax revenues, and brings with it some political advantages such as earmarking those revenues. For mining investors the main disadvantage of using production-based taxation is that it may imply the payment of taxes even when the investor may be in a loss position. Production-based taxes may also lead mining companies to cut back production on sites that have higher unit costs.

The payment of taxes is not the only dimension to this tradeoff. The design of tax policy may also include tax incentives. Accelerated depreciation and tax holidays granted in the early years of a project are the two most common ways in which governments provide time-sensitive tax incentives.

Tax discrimination
Tax discrimination is another aspect of the trade-off. It is a common practice throughout the world. The three most common tax discrimination practices are based on the type of mineral being mined, the scale of the operation, and the "nationality" of the miner. Discrimination by type of mineral may be achieved, for instance, by the use of higher royalty rates for a specific type of mineral or class of minerals, for minerals that compete in a global market, and/or for minerals that generate higher profits than others. Discrimination by size of operation usually takes into account the profit-potential of the investment and provides exemptions from certain taxes for a period of time.

Finally, discrimination by nationality of the miner is common in developing countries and it is usually achieved by means of providing special tax terms to foreign investment through specially negotiated agreements.

The subject of tax discrimination is highly contested in the literature with regards to the way in which these types of provisions should be interpreted. The fact that a local versus foreign party or a large versus small company implies different uses of government services may justify differences in their tax treatment. In this sense, arriving to the conclusion that a tax is discriminatory requires an understanding of the values being promoted by the non-discrimination principles. The analysis of these principles is beyond the scope of my contribution, but nonetheless, it is important to keep in mind the perspectives and usual trade-off that tax discrimination may imply for governments and foreign investors.

In this sense, we should keep in mind that from the government’s perspective, tax discrimination allows for an increase in tax revenues but may reduce competitiveness as compared to other jurisdictions. Conversely, from the investor’s point of view, (depending on the specific situation such as the size of the operation for instance), risk compensation, volatility of mineral prices in the global market and lack of neutrality are situations that may need to be addressed by government. The challenge is to determine how much tax can be extracted from the investment while providing mining companies with reassurances that the investment is worthwhile.

Government’s sovereignty versus credible commitment
This section will discuss the trade-off between a government’s sovereignty versus credibility. In a country where political risk is perceived as high, companies are usually attracted by the incentives provided by host government, such a reduced tax burden, that allows companies to potentially increase the rate of return on the investment. The government, on the other side, is enticed by the projected revenues, the jobs created for local population and the investment in new technology associated with foreign investments.

However, in cases where the mining investment is expected to contribute immediately to the economic development of the country, mining companies should be aware that the fact that the host government needs to wait longer to receive the tax revenue increases the political risk. The balance tilts towards the host government once the investment is sunk since, at this point, the government has little incentive to maintain the rules that favor the investor, placing the investor in a very vulnerable position with regards to the change to the fiscal terms once the production stage has started. Changes in political leadership may also cause a change in the tax regime.

With the intention of, among others, protecting the foreign investment against political risk, most investors rely on International Investment Agreement (IIA). More generally, IIA are treaties signed between two or more countries in order to address cross-border investment issues95. IIA usually contain stabilization clauses, which aim to committing the host government not to change the legal framework that applies to a project without the consent of the investor. The intention is to reduce the non-commercial (i.e. fiscal, regulatory or political) risk associated with the investment.

However, in cases where the fiscal regime is not set in statute but negotiated between the parties, uncertainty tends to be greater.98 As a consequence, investors are more likely to require stability clauses in such cases.99A stability clause is an agreement signed between the host government and the investor, in which the government guarantees the investor that the regulatory framework of a particular regime will not be altered throughout the investment term100. Alterations to the fiscal regimes are not restricted to increases in tax rates; pressure for mining investors to make “voluntary” contributions towards what would be normally considered as public expenditures is an example seen recently in Tanzania and Peru.

Based on the information provided above, the main point is that the interests of the main negotiating parties to a mining investment agreement (the government and the investor) are diametrically opposed given that both parties will always try to maximize their revenues and minimize their level of risk in order to meet their different needs. Government, on one side needs to balance the reception of tax revenues to fund its activities, while keeping the public interest as a priority. On the other side, investors require a tax policy specifically tailored to balance and manage the huge financial commitments of investing firms.

To sum up this piece, the mining industry is a highly capitalistic activity that requires massive investments in plant and equipment, extensive know how for exploration, access to reserves, extraction of ore and its beneficiation, to meet quality standards for markets and commercial uses. At all stages of a mining project there are risks of failure and loss of rare capital ivestment. These risks have to be taken into account. Moreover, the resource that is mined is a non renewable resource; once depleted it has to be renewed somewhere else in the host country or in another geologically rich part of the world. The price paid by the global market must cover the costs of these risks and of the renewal of the resource.

At the same time, the global market must pay the true cost of the product that contributes to the global economy. That cost must include a fair payment to the personnel employed: both expatriates and locals with their families, a payment which naturally has to be commensurate with the state of development of the host country, but also has to provide decent conditions of living. This means road and communications infrastructure, water supply and disposal, housing, food and provisions supplies, schooling for the children, health and medical services, retirement schemes, community and social centers. This can be provided directly by the mine in remote areas being newly developed, or/and by the State - through taxes - because the state has to improve the well-being of its people through development. In both cases the cost has to be borne by the price paid by the market. If not, mining companies are considered to be benefiting from the resource more than they should for the benefit of their owners and shareholders, notably because of cheap labour which I consider akin to a modern form of slavery.

Price fluctuations affect mining projects seriously. When prices rise because of high demand due to growth of economic activity worldwide, profits soar and the state and local communities, because they are aware of this, demand to have their share of the boon. But when prices plummet because demand slackens, operating mines with the highest technical costs have to reduce production, layoff personnel It is up to Governments to impose true market prices by appropriate taxation regimes, and imposition of EITI and CSRor even close down altogether. In reality, there is a mean price of the product on the market, which reflects the structure of supply to meet demand over medium or long term. The mining company should make reserves in the boon periods so as to absorb the shock of the poor years without having to layoff and shut down operations. This is effectively a practice that major mining companies adopt. The host state has to understand this.

All of this can be dealt with efficiently by imposing full transparency of costs and benefits (EITI)5.12 and corporate social responsibilty (CSR)5.11to mining companies. And to enable state officials to better understand, monitor and control the challenges of the industry. There is no justification that some people in the mining companies and in the government should reap enormous profits at some times, put in tax havens to purchase luxury yachts or paradise islands.

It is up to Governments to impose true market prices by appropriate taxation regimes, and imposition of EITI and CSR.


  1. Strategic metals and statistics
    1. Copper
    2. Cobalt
    3. Zinc
    4. Coltan columbite and tantallite
    5. Copper statistics 2014 (pdf)
    6. World production of copper 2004-2014 (xls)
  2. DRC Congo Kinshasa
    1. Etude comparative du code minier
    2. La fiscalité minière
    3. Rapport de consultant international
      PROMINES Projet d’Appui au Secteur Minier Revue et amélioration du cadre légal et règlementaire du secteur minier congolais
    4. Code minier 2002
      et Règlement minier 2003
    5. Projet de révision du Code Minier 6 février 2014
    6. Synthèse des travaux sur le code minier
    7. Comparaison de codes miniers d'Afrique
    8. Nécessité de poursuivre la révision du Code minier`| Chambre des mines AllAfrica 17/7/2014
    9. Site du Ministère des Mines
    10. Promines Ministère des Mines Projet d’Appui au Secteur Minier
    11. Chambre des Mines, membre de la FEC Fédération des entreprises du Congo
    12. ITIE Initiative pour la Transparence des Industries Extractives en RDC
    13. Katanga: le ministre de l’Energie déplore un déficit électrique préoccupant
    14. Le déficit en énergie électrique plombe le secteur minier | Pierre Goosens
    15. Ça gronde: le boom minier au Katanga ne profite pas aux communautés locales (sous traitance)
    16. Critiques de transactions de vente d'actifs de Gecamines de 2010 à 2012: chiffrement des sous-évaluations et pertes pour la RDC
    17. Rapport de Koffi Annan "Equité et Industries Extractives en Afrique | Rapport 2013 sur les progrès en Afrique
    18. Extrait: Annexe 1 de ce rapport: pertes estimées pour la RDC de 5 transactions de ventes d'actifs de 2010 à 2012
    19. Congo's mining and oil codes | Global Witness
    20. Global Witness’s recommendations for the Democratic Republic of Congo’s new Mining Code
    21. Transparency and anti-corruption in Congo Kinshasa
    22. Congo Kinshasa: les réformes du commerce de minerais sapées par l’impunité dans l’armée
    23. Chambre des mines: rapport d'activités 1er trimestre 2014
    24. Comparaison entre l’attractivité du Pérou et celle de la République du Congo avant et après la révision de leurs Codes Miniers respectifs
    25. DRC: situation dans l'initiative pour la transparence des industries extractives (ITIE) Extractive industries transparency initiative (EITI)
    26. The mineral resources of Katanga; a development strategy | John Holloway
    27. Empowering locals: Black empowerment experience in South Africa
  3. Zambia
    1. Zambia: Country guide
    2. Zambia: Mining sector profile
    3. Zambia: Mining tax
    4. Zambia: The Mines and Minerals Development act, 2008
    5. Zambia: Mines and Minerals Development (Amendment)
    6. Zambia: Mining legislation SADC comparison Africa (full)
    7. Zambia: Overview of tax changes
    8. Zambia to More Than Triple Royalties for Copper Miners Royalties to Rise to 20% for Open-Pit Copper Mines
    9. Zambia Mining: Tax Regime and Incentives
    10. Fiscal guide Zambia | KPMG
    11. Caught in a Trap: Zambia’s Mineral Tax Reforms David Manley ICTD International Center for Tax and Development
    12. The 2012 revised tax regime | Robert F Conrad ICTD
    13. THE TAXATION SYSTEM IN ZAMBIA A Technical report for the Jesuit Centre for Theological Reflection
    14. Extract of this report on the mining industry
  4. Peru
    1. Peru: LEGISLACIÓN
    2. Peru: Peru Mining law
    3. Peru: Mining taxation recent trends
    4. Peru: Analysis of the recent reform of the mining sector (taxes)
    5. Changes in mining taxes and regulations |
    6. Peru: Country Mining Guide
    7. Peru: Analyse de la réforme minière | Deloitte
    8. Peru: Mining and metals investment guide 2014-2015
    9. Peru: Mining taxes and royalties | PWC
    10. Peru: Other intersestin aspects
    11. An Analysis of the Recent Reform to the Peruvian Mining Sector from a Tax Perspective
    12. Are the current mining investment conditions in Peru as attractive as they were in the 1990s?
  5. Other references
    1. Africa Review Report on Mining - Executive Summary
    2. Africa Mining Vision
    3. Africa Mining Vision
    4. Joseph Stiglitz
    5. Ha-Joon Chang
    6. Ha-Joon Chang "the bad samaritans"
    7. CIA factbook, Democratic Republic of the Congo
    8. USGS Country surveys Africa 1997-2012
    9. Mining Codes in Africa Towards a fourth generation
    10. Global witness
    11. Corporate social responsibility CSR
    12. Extractive Industries Transparency Initiative EITI
    13. Windfall taxes
    14. Consensus de Washington
    15. The Las Bambas mine deal needs to recognize local discontent
    16. Local Communities Still Weary of Conga Project, Peru
    17. Anti-mining sentiment in Peru main barrier to sector’s growth – S&P

Put online for Ceseco 2015