The Technical File “Fiscal Regime and Management of Revenue from Mining” Basic concept for valuation of common gemstones in Malawi” featured below was initially published in Malawi’s Mining & Trade Review Issue Number 29, September 2015.
The Technical File series is written by a leading Mineral Resouces and Environmental Management Expert, Grain Malunga (FIMMM).
Malawi needs to come up with a fiscal regime that that comes with a fair share of revenue benefits between government and mining companies. Government should come up with clear policies that govern management of petroleum and mineral revenue for the benefit of its people through fostering of social development and stimulation of economic growth through local content and further attraction of foreign investments in the mineral sector. Access to revenue and contract information will be key to bring transparency, accountability and mitigation of mistrust from its citizens.
This paper identifies issues that need to be addressed to ensure that Malawi obtains a fair share of mineral rents and manages its revenues wisely. Malawi must strive to devise a fiscal regime that takes account of the uncertainty, risks and rewards inherent in mineral resource development within the context of offering competitive investment incentives with its neighbours in the region. There is need to ensure that revenue from the minerals sector benefit its people especially those that live in mining areas. At all costs, Malawi, should avoid over reliance of mineral revenues in order to promote economic diversity and sustainable economic development without fueling political and social conflict that comes with poor management of mining revenue. Support to local content using petroleum and minerals sector revenue will bring economic benefits and sustainable development.
Taxes and fees imposed on businesses form part of state income. This income is managed in such a way that it benefits its citizens through contribution to social development and triggering of economic growth.
The fiscal regime obtained in the petroleum and minerals sector is designed with the understanding that
- Petroleum and mineral resources are exhaustive and there is need for government to generate revenues that justify their exploitation;
- Investment in petroleum and mining requires high capital before starting to generate revenues;
- Project risks, including geological risks, volatility of commodity prices, technical uncertainties, and political risks, and
- Extractive revenues have the potential to represent a dominant share of a country’s public revenues, a thing that needs to be avoided in order to create economic diversity.
Fiscal instruments that are applicable to the petroleum and minerals sector include;
- Signature Bonuses which are a one-time payment made upon the finalization of a contract or launch of activities on a project especially in petroleum projects
- Royalties that are paid to government to compensate for depleting of a resource. These are either ad valorem or value per unit (tonne) produced.
- Income Tax deducted based on overall company profitability
- Windfall Profits Taxes or resource rent that are imposed when profits exceed the levels necessary to attract investment.
- Government Equity that gives government or a state-owned company or another public body equity stakes that can give the state access to a portion of dividend payments.
- Other Taxes and Fees includewithholding tax on dividends and payments made overseas, excise taxes, customs duties, and ground rent.
- Production Sharing prevails in many petroleum contracts that entitle the state to a share of the physical quantities of petroleum produced.
For countries to benefit from the above instruments, they need to understand and mitigate against;
- Transfer pricing arising from companies that use sales and services among various subsidiaries as a means to reduce their fiscal obligations within a particular country.
- Debt-Equity ratio that is restricted and punishable by non-deductible for tax purpose.
- Ring-Fencing which allows companies that have multiple activities within one country to use losses incurred in one project to offset profits earned in another project, thereby reducing overall tax payments
- Loss Carry-forwards by limiting them to a fixed term in order to control loss of long term revenue generation
- Stability clauses that are effective and limited to a part of the life time of the project
- Double taxation agreements that provide for the avoidance of double taxation on international income such as earning, dividends, interest, and royalties that are derived in one country and remitted to another country. Malawi has double taxation agreements with the following countries: Denmark, France, Kenya, Norway, South Africa, Sweden, Switzerland and United Kingdom. Double Taxation with Netherlands ceased in 2014.
Malawi fiscal regime as stipulated in the Mines and Minerals Act 1981 and Taxation Act is shown below:
|Mineral Royalty||Can be negotiated||Rates specified in the regulations are:
5% generally or 10% for exports of rough uncut precious and semi-precious stones; and
7% for exports of unprocessed industrial minerals
|Valuation basis in regulations is gross sales value less transport costs to point of sale|
|Income Tax||Fixed||30%||100% write-off of all eligible mining expenditures; loss carry forward permitted|
|Resource Rent Tax||Fixed||10% when return exceeds 20%||Base and method of determination is unspecified|
|Fixed||10 – 20%|
|Import Duty||Fixed||Varies by item in the Tariff Book|
|VAT||Fixed||16.5%||Exemption for range of capital items|
|State Equity||Can be negotiated||No legislated level|
Contribution to National Budget
The current system of revenue management does not take into account that the extractive industry is finite and therefore there is need to use revenues from the industry prudently for creation of local content and a future fund that will support the budget and future generation for it to benefit too.
Local content support should be to technical education, agriculture and infrastructure development. These sectors are crucial for supporting the mining and manufacturing sector in terms of availability of crucial technical personnel, food security and supply to the mining sector and support infrastructure (roads, electricity and telecommunication) to mine areas thereby benefiting rural areas and mining communities.
Tax revenue policy should be designed in a way that it is to collect and monitor and does not fall to encourage tax evasion. The appropriate policy for Malawi is to collect royalties, VAT, withholding tax and income tax efficiently.
Royalties are easy to collect because they are deducted early and based on current value of minerals or petroleum. VAT and withholding tax are also collected when transactions are happening. Income tax is usually paid on profit income. Incentives such as tax holidays to assist the company pay its initial capital dates can lead to over borrowing with the intention of avoiding income tax. Government should guard against low debt-equity rate and should impose a debt-equity rate of over 60-40 to avoid thin capitalization.
The petroleum industry commonly uses petroleum sharing agreements. The common agreement is to agree on reimbursements of production costs, then split the remaining “profit” oil or gas between the operating group of companies and the government. Government may also impose royalty and taxes on oil belonging to the group of companies.
The above discussion calls for a fiscal regime that minimizes discretion to vary fiscal terms in individual contract enforcement. This reduces risks and perception of corruption in negotiations. Increase in government revenues can also be achieved through introduction of progressive elements such as progressive income tax, windfall profit tax (resource rent) and variable-rate royalties in situations where super profits are being generated. Government needs to develop a fiscal regime that corresponds with national development plan such as the Economic Growth and Development Strategy without being tempted to adopt “Party Manifestos” that destabilize national development plans.
A good measure of assessing and keeping within fair limits of taxation in petroleum and mining industries is to be within common effective tax rates. Effective tax rates are calculated based on operational income and total tax revenue. The common effective tax rate in mining is between 30 to 40% while that of the petroleum industry is between 50 and 60%.
Contribution to Local Economy
Good revenue management should take into account mine community benefits through allocation of higher mine revenues to mining districts. This requires effective management of the revenue at district level and transparent allocation of this revenue for mining community development programs such as those that enhance local content in terms of employment, commercial agriculture (food supplies to the mine) and provision of social amenities.
Some extractive companies may practice corporate social responsibility. This should not be to a degree where the local communities fall into a trap where they are to forget the role of government in providing macro projects through social development. High expectation of the local communities on mining companies should be mitigated at all costs.
The Way Forward for Malawi
Malawi is a very poor country whose credit worth limits availability of capital for investment into the extractive industry. There is need to come up with a competitive, attractive and stable fiscal regime that is designed not from financial desperation but that which offers a fair deal between government and mining companies. Particular attention should also be put to environment, local development, community engagement and right to information on revenue management.
- Di John, Jonathan (2006). The political economy of taxation and tax reform in Developing Countries. Research paper No. 2006/74, UNU-Wider
- Land, Bryan (2007). Capturing a fair share of fiscal benefits in the extractive industry, Background paper for UNCTAD
- Malunga, Grain (2008). Malawi Mineral Sector Review commissioned by World Bank
- Natural Resource Governance Institute (2014). Natural Resource Charter, Second Edition